Thursday, December 17, 2009

Aggregate Production Planning - Part I

In this session we will learn about Aggregate Production Planning (APP).

Aggregate Production Plan (APP) is the exercise of developing approximate schedule of the overall operation plan for a company which specifies how resources (total number of workers, hours of machine time, or tons of raw materials) of the company are going to be committed over the next six months to one year for a given demand forecast.

Objectives of Aggregate Production Planning

• Minimize Costs/Maximize Profits
• Maximize Customer Service
• Minimize Inventory Investment
• Minimize Changes in Production Rates (Setup cost)
• Minimize Changes in Workforce Levels
• Maximize Utilization of Plant and Equipment

Let us understand the above definition through simple example. Hitachi company which manufacturing Window Air Conditioners with 0.75 Ton, 1 Ton, 1.5 Ton and 2 Ton models. During the year 2009 the total expected sales are 1 Lac pieces of all models put together in Indian Market. With aggressive Marketing plan the company expected to Sell 1.5 lac pieces (aggregation of all models) at product family level (Window AC) to customer during the year 2010. Also the company received an Institutional orders (firm order) of 10,000 pieces (all models) for the year 2010. Now the company need to produce totally 1,60,000 pieces of different models during the year 2010, i.e., 60,000 pieces extra over the current year production with the existing production facility (machines / labour force). During year 2009 the company produced 1 Lac units in 2 shifts (6AM – 1 PM and 2PM – 10 PM) with 300 workers in each shift. Since the ACs sales are driven by seasonality, the sales across the month during 2009 were not uniform. The sales were peak during summer and low during winter season. Please note that Aggregate Production Planning does not distinguish among sizes, colors, features etc.

By looking at the components of the APP definitions, as explained above, the following questions arise in our mind.

• Why Aggregate Plan and not SKU level Plan ?
• Why Approximate Plan and not exact Plan ?
• How the resources are going to be committed and its modus operandi?

Aggregate production plan (APP) is based on estimated / forecast volume, institutional firm orders and back orders. Back orders are the pending orders. As already seen in our blog (refer the characteristic of forecast) the forecast are always wrong and aggregate forecast are more accurate than SKU level forecast. Since the forecast volumes are estimated figures and hence the production plan based on forecast volume are also approximate plan and not exact plan. Aggregate forecast are more accurate than individual SKU level forecast. Even in the Hitachi company case, if you compare the individual SKU wise forecast for the year against the confirmed / actual sales volume there will always be variations. For one SKU the variation will be positive (i.e., the forecast volume are greater than actual sales and hence surplus stock) and another SKU of the same family group the variation will be negative (i.e., the actual volume are greater than forecast and hence back order). If you aggregate the individual SKUs of the same family group, the positive and negative variations will negate each other and the net result is less variation at family group level. The top management of the company who is responsible in strategic decision making is interested to know the company growth at aggregate level rather than individual SKU level.

In simple terms, aggregate planning is an attempt to balance production capacity and demand in such a way that costs are minimized. The term "aggregate" is used because planning at this level includes all resources "in the aggregate", for example, as a product line or family (not SKU level). Aggregate resources could be total number of workers, hours of machine time, or tons of raw materials. Aggregate units of output could include tons, liters etc.  The Aggregate Production Planning Function is given below.

Also the production facility of the company are used judiciously for the product family group, the production plan is done at aggregate level rather than individual SKU. In our Hitachi company example currently the factory facility to cater Window AC production. Let us assume they are planning to produce Split AC also then they will draw the production plan in such a way they will use the existing Window AC facility to produce certain parts of Split AC and for rest of the parts which cannot be produced through the existing facility, they can plan for additional facilities. In this case the Hitachi production plant are effectively used for Window and Split AC models. Once the company commit the facility (machine and workers) and resources (raw materials) to produce Window ACs 1 Ton model during first week (1 – 7) of Jan’2010 they cannot plan any other activity (i.e., to produce Window ACs of 1.5 Ton) during that period. If the company would like to produce 1.5 Ton Window ACs during the second week (i.e., 8 – 14), they have to make small alteration in the production facility (in production engineering terminology referred as setup changes) to produce 1.5 Ton Window AC from the existing 1 Ton Window AC. This is due to size, change in production type etc as compared to 1 Ton model. This set up changes is always associated with cost which referred as setup cost.

We will focus our attention how the company is going work out a plan during year 2010 to commit the existing resources/capacity (facilities, workers, materials) to meet the expected demand of 1,60,000 units during in such a way costs are minimized. For one year expected growth (60% over year 2009) the company will not go for additional factory / facility as they are capital intensive, which involve long term capacity planning. Also the sales volumes are not consistent and fluctuating throughout the month. The demand is more during summer season (ie March to October) and less during Winter season (November to February). Given below management option to meet the monthly fluctuating demand.

Management option to meet the Fluctuating Demand (Capacity Adjustment)

• Build inventories in slack period (November - February) in anticipation of meeting higher demand in peak period (March – October)
• Carry backorders / Pending orders or tolerate lost sales during peak period
• Use over time in peak periods, under time in slack period to vary output, while holding work force and facilities constant. Part time / casual labour is also utilized during peak period.
• Vary capacity by changing size of the work force through hiring and firing. This is not the good option as this will spoil the reputation of the company and getting skilled labour will also become problem which affect the quality of the product.
• Each option involves cost which could be tangible or intangible. Aim in aggregate production planning is to choose best option.
• Not considering capital intensive option like erection of new plant where facilities are constant and work force may vary.
• Subcontracting. Frequently firms choose to allow another manufacturer or service provider to provide the product or service to the subcontracting firm's customers. By subcontracting work to an alternative source, additional capacity is temporarily obtained.

Aggregate planning is considered to be intermediate-term (as opposed to long- or short-term) in nature. Hence, most aggregate plans cover a period of three to 18 months. Aggregate plans serve as a foundation for future short-range type planning, such as production scheduling, sequencing, and loading.

Aggregate Production Plan - Cost

• Procurement Cost
• Regular-Time Costs (production Cost)
• Overtime Costs
• Hiring and Layoff Costs
• Inventory Holding Costs
• Backorder and Stock out Costs
• Production rate changing cost

Aggregate Production Plan - Strategies

There are two pure planning strategies available to the aggregate planner: a Level strategy and a Chase strategy. Firms may choose to utilize one of the pure strategies in isolation, or they may opt for a strategy that combines the two.


Pure Strategy

1) Level Strategy

A level strategy seeks to produce an aggregate plan that maintains a steady production rate and/or a steady employment level. In order to satisfy changes in customer demand, the firm must raise or lower inventory levels in anticipation of increased or decreased levels of forecast demand.

A level strategy allows a firm to maintain a constant level of output and still meet demand. This is desirable from an employee relations standpoint. Negative results of the level strategy would include the cost of excess inventory, subcontracting or overtime costs, and backorder costs, which typically are the cost of expediting orders and the loss of customer goodwill.

2) Chase Strategy

A chase strategy implies matching demand and capacity period by period. This could result in a considerable amount of hiring, firing or laying off of employees; insecure and unhappy employees; increased inventory carrying costs; problems with labor unions; and erratic utilization of plant and equipment. It also implies a great deal of flexibility on the firm's part. The major advantage of a chase strategy is that it allows inventory to be held to the lowest level possible, and for some firms this is a considerable savings. Most firms embracing the just-in-time production concept utilize a chase strategy approach to aggregate planning.

Mixed Strategy

Most firms find it advantageous to utilize a combination of the level and chase strategy. A combination strategy (sometimes called a hybrid or mixed strategy) can be found to better meet organizational goals and policies and achieve lower costs than either of the pure strategies used independently.

Given below the table which contains pros and cons of pure strategies against the peak and slack season.

In the next session we will learn about the various techniques used in Aggregate Planning with few examples.

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