Monday, December 21, 2009

Aggregate Production Planning - Part II

In this blog, we will learn how various techniques used to compute the total cost of aggregate production using Chase strategy and Level Strategy and compare the cost advantage.

Techniques for Aggregate Planning

Techniques for aggregate planning range from informal trial-and-error approaches, which usually utilize simple tables or graphs, to more advanced mathematical techniques like Transportation method, Linear Decision Rule (LDR), etc. The general procedure consists of the following steps:

1. Determine demand for each period and capacity for each period. This capacity should match demand, which means it may require the inclusion of overtime or subcontracting.

2. Identify company, departmental, or union policies that are pertinent. For example, maintaining a certain safety stock level, maintaining a reasonably stable workforce, backorder policies, overtime policies, inventory level policies, and other less explicit rules such as the nature of employment with the individual industry, the possibility of a bad image, and the loss of goodwill.

3. Determine unit costs for units produced. These costs typically include the basic production costs. The production cost computed based on fixed and variable costs as well as direct and indirect labor costs. Also included other costs like set up costs which associated with making changes in capacity. Inventory holding costs, so as storage, insurance, taxes, spoilage, and obsolescence costs. Finally, backorder costs must be computed. While difficult to measure, this generally includes expediting costs, loss of customer goodwill, and revenue loss from cancelled orders.

4. Develop alternative plans for Chase and Level strategy and compute the cost for each method.

5. If satisfactory plans emerge, select the one that best satisfies objectives. Frequently, this is the plan with the least cost.

Aggregate Planning Method

• Graphical & Chart Technique
      o Trial and Error approach

• Mathematical Technique
       o Transportation Method
       o Linear Decision Rule
       o Management Coefficients Model
       o Simulation

In this blog we will focus our attention to graphical & Chart technique and general models used in computing the overall cost under chase and level strategy, to understand the basis concept.

Let us take an example of Sony Ericson company mobile and using monthly demand data to arrive graphical model and compute low production cost on chase and level strategy.  The data is given below.

Based on the above data we give below the graphical model by plotting  Monthwise cumulative demand data and monthwise cumulative average demand. 

The graphical models are heuristic in nature and not give optimum solution. Hence we will see now how to compute low cost production basis chase and level strategy and compare the two costs to take decision.

Given below the production cost computation based on Chase (demand) strategy model by varying work force and output rate.

The Chase (Demand) strategy require explanation. The above table consist of volume and total cost in terms of value. Since in the chase model we are keeping our production rate in line with demand pattern and hence there is no inventory or lost sales in terms of volume and value. However we are changing work force and output rate this resulted in overtime / under time cost along with rate change cost due to set up changes. Since each month we are varying the production quantity to meet the demand this involves set up changes and cost.
In the above example, we are holding Inventory in the beginning of the year (1000 units as ending inventory). Hence we are producing 700 units in January against the sales quantity of 1700 units after adjusting the inventory holding. During January end there is no inventory, we are matching production as per monthly demand requirements.

The manufacturing plant can produce 2400 units (Normal production rate) during any given month. During January the company is planning to produce 700 units the plant capacity is under utilized to the extent of 1700 units (Normal production rate – Actual quantity produced to meet the demand, i.e., 2400-700) which involves under time / utilization cost (i.e., Qty 1700 * Rs. 3/unit – Rs. 5100). Similarly in April, the demand (2800 units) exceed the normal production rate of 2400 units, the excess 400 units need to be produced to meet the demand and this involves over time cost (400 units * Rs. 7 / unit – Rs. 2800).

As regards production rate change cost, during January we are falling short of 1700 units against normal production rate of 2400 units and hence the cost will be Rs. 8500 (i.e., 1700 units * Rate change cost/ units Rs. 5). But in February we are changing the production rate from 700 units which is actual production rate to meet January demand to 1200 units to meet

February demand. The rate change cost computed basis change in production units of 500 units (1200 units in Feb – 700 units in Jan) and Rate change cost (Rs.5) per unit. During Feb the rate change cost will be Rs. 2500 and so on.

The total cost can be computed by adding all cost like production cost, inventory cost, lost sales cost, over time cost, under time cost and rate change cost.

Now we will learn about the production cost computation based on Level startegy model by keeing constant work force and output rate.

In the Level startegy we are keeping work force and production rate constant and hence there will be uniform production cost (2400 units * Rs. 75 Production rate / unit) across all month. Also there will be no over time or under time and there will no set up cost also due to constant production rate.  This level strategy involves only Inventory holding cost and Lost Sales Cost.

For example during January we are producing 2400 units against our actual requirement of 700 units (after adjusting inventory holding) and hence there will be excess stock of 1700 units (i.e., 2400 - 700).  The inventory holding cost during January will be 1700 units multiplied by Inventory holding cost of Rs.2 per unit (i.e., 1700 * 2 = Rs. 3400).

During August, we are producing 2400 units against the demand of 3,200 units and hence there will be sales lost to the extent of 800 units (i.e., Demand during August - Actual production during august). Lost sales cost per unit is Rs. 90 the lost sales cost during August will be Rs. 72000 (i.e., 800 * 90). 
Now the user can compare the total cost computed by using Chasing and Level startegy and decide on model to be adopted.  However as explained earlier we need to think twice before manipulating work force as it will bring bad reputation to the company and also we may not get skilled labour as when require.
I trust this will give you foundation with regards to Aggregate Production Planning.  In this blog I am not explaining Transportation model.  Based on the users request the transportation model will be covered in the subsequent blog.

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