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Strategies for Production Planning


Production planning.

Businesses operate according to a plan. Aggregation is a macro approach to planning, which concentrates on the overall capacity rather than individual products or services.

Consider IBM, a company making many different products in many plants with thousands of employees. To prepare a plan involving every product and employee to satisfy market demand would be virtually impossible, and the attempt would be extremely costly. Even if successful, necessary change would require much effort to keep the plan current. Therefore plans are made in an aggregate fashion. Aggregation means to bring a group of individual things together to make a whole.

1. Facilities planning. Top management makes decisions regarding the products that will be produced and the facilities required to produce them. These are strategic decisions made with an eye to the long-term future- in the order of five years.

2. Aggregate planning. These are medium term decisions, two to eighteen months in duration. The aggregate planning process produces decisions about how many to produce to meet demand. The decisions are made by top and middle management.

3. Schedule. Scheduling decisions are made by shop managers and are the decisions that are required to implement the aggregate plan.

Aggregation can be done on several bases:

1. Products. The most common system uses segregation by product. GM, for example might decide to produce one million cars, a half million vans, three hundred and fifty thousand trucks, and two hundred thousand sport utility vehicles. Even though a variety of different brands of car are produced by General Motors in many plants around the world, one number is decided on as the aggregate of all cars to be produced. The idea is to create broad product families so that the plan can include all products without including detail on any of them.

2. Labour. Often a company has groups of employees with similar skills that it can identify and use as a part of the aggregate. A company with specialized labour with various skills might be aggregated on the basis of these skills. We could think of IBM as doing this. Many software projects might be contemplated, but by aggregating the programmers, a single decision can be made on how many programmers to employ, and the individual projects can be considered in detail later.

3. Time. We might also tally time required for part of the effort, and add up the time required thus aggregating on the basis of time. A law firm might do this, allowing so many employee hours for criminal law, so many for corporate law, and so on.

While it is not obvious here, the basis on which to aggregate is usually quite obvious when the company is examined. The basis generally presents itself.

Production planning needs to be done on several time scales.

Long-range. Top management oversee strategic plans and makes strategic planning decisions. This plan is done annually for perhaps a five-year term. It is a game plan, in which management links possible markets, company expertise and facilities, and financial capability, and plots of direction for the company for the next five years.

Medium range. Medium range decisions are made for two months to a year. Based on the game plan above, medium range production goals are determined. This is where aggregate planning is used. Medium range goals are expressed as aggregate goals: so many cars and trucks, this year for GM, for example, so much code produced by IBM, so many new product developed, so many computers built. The medium range plan is desegregated into the MPS, the master production schedule. It is a schedule of the products that must be produced for each of the planned time periods.

Short range. The short range is no more than two months, with plans for perhaps a week or two. This is the plan or schedule that details what machine will be run for what period of time, what personnel will be assigned to what tasks etc.. This results in a schedule from which is formed the MRP, materials requirement plan. This plan lists all the materials, parts and so on, that will be required to produce the required volume.

The MRP is based on requirements of the MPS, and on inputs from the bills of materials for each product, which state what components of raw materials will be required for the production volume, and the state of inventory of both finished parts and components and raw materials. The MRP is now the basis for a detailed schedule of work centre loading, and of purchasing requirements.

The planning problem.

Planning involves three items. First is the work force level, the number of workers required for production. Second is production rate, the number of units produced per time period. The final item is the inventory level. This is the remainder of unused units carried from the last time period.

The problem is for each time period to find a production level, inventory level, and number of workers, that will meet the required forecast. This must be done at minimum cost.

There are a number of things we try to minimize. These are costs, inventory, work force changes, overtime, use of subcontractors, changes in production rate, number of machine set-ups, and idle time. At the same time we try to maximize customer service and profits.

The planning problem is to match supply to demand. Normally management spends their time manipulating things that affect the supply. However, we should note that it is possible also to affect demand. Price incentives, advertising and promotions, will all help to increase demand for future. Allowing backlogs or back orders lets us move a peak of demand to a month where the peak may not be so high. We can all also use complementary products to fill in some idle time and asked customers to reserve product ahead of time so that we can make the production during slack months.

There are various methods for adjusting supply. Since the planning process requires us to do things at lowest cost, let us note the costs involved in some of the actions used for modifying supply.

Hiring and firing. Costs are substantial: New people are not immediately productive, so that their cost per unit production is higher than for existing employees. Firing people always involve some cost; long term employees may require a package, the law requires that holiday be paid on termination. Finally the bad feelings between employees and management that hiring and firing creates can be costly to a company though such cost is difficult to estimate.

Overtime and slack time. Overtime is expensive since it is normally paid at a premium rate to the normal hourly rate. Long-term overtime, moreover, can produce health costs, as employees react to the additional stress. Slack or idle time, while costly, can sometimes be utilized for cleanup and maintenance, thereby possibly reducing costs in the future.

Part-time and temporary help. The cost of this type of assistance is generally less than full time employees because these people are paid no benefits. This is a popular strategy for today's management. Part-time and temporary help is sometimes not so productive as regular help, but often it is kept on for a long enough period of time that such a disadvantage disappears.

Subcontractors. The cost of subcontractors is usually very simple to calculate. It can be calculated on the basis of so many dollars per unit, and there is normally no hidden cost.

Cooperative arrangements. Often two companies in similar manufacturing areas will form an arrangement where one of buys from the other when additional production is required. This is usually a beneficial arrangement for both companies, smoothing the demand for each.

Inventory. Cost of inventory is often large. There are at least three reasons: depending on what is stored there can be losses due to breakage and spoilage. The cost of the storage space itself may be substantial depending on the size of the units and the number stored. Finally cost of the money invested in manufacturing the units in the first place can be substantial. It is estimated that the cost of storage runs between 10 and 40 percent per annum of the value of the items stored.

Back orders. While allowing a backlog or back orders can be used to reduce peak production in some months, there is a cost in lost business, and in possible loss of customers. These costs are quite difficult to quantify.

Production strategies.

There are two pure strategies in use, the chase strategy, and the level strategy. In practice a mixed strategy, a combination of the two, is more common.

Chase strategy. The chase strategy attempts to match production to meet demand in each time period, using overtime, layoffs and new hires, temporary help, or contractors. The chase strategy does not use any changes in inventory. This strategy keeps investment in inventory quite low but the effort required by planners can be very high.

Level strategy. This strategy attempts to maintain an average production level and use the inventory as a buffer. In months where demand is low production will exceed demand, with the balance going into inventory. In months were demand exceeds production the inventory is drawn down to replace the missing production.

Hard drive production , 1998

Demand for Hard Drives. 1998
Month Forecast demand Cumulative demand Working days Cumulative days Production/day
January 1000 1000 21 21 47.6
February 1200 2200 20 41 60.0
March 1400 3600 22 63 63.6
April 1600 5200 21 84 76.2
May 2000 7200 20 104 100.0
June 2500 9700 22 126 113.6
July 2500 12200 22 148 113.6
August 3000 15200 20 168 150.0
September 3000 18200 21 189 142.9
October 2000 20200 21 210 95.2
November 1600 21800 21 231 76.2
December 2000 23800 20 251 100.0
Average 1983
Costs of production
Cost Per
Materials $10 unit
Inventory cost $1 unit/month
Stockout cost $3 unit/month
Subcontracting cost $24 unit
Hiring & training cost $300 employee
Layoff cost $200 employee
Regular time cost $4 hour
Overtime cost $6 hour
Labour hours cost 3 hours/unit

Figure 1

Example. The simplest way to show the planning system is by an example. The following example will use the same numbers and same demands, and we will try four different strategies to meet the demand. We will cost each strategy and make a choice of one of the four after balancing the costs. The four strategies are:

1. Vary work force levels. This is the pure chase a strategy.

2. Use level work force, then vary inventories. This is the pure level strategy.

3. Use a lower level work force, and use subcontractors to make up the difference.

4. Use a lower level work force, and use overtime and subcontractors to make up the difference.

The first figure shows the demand levels for each month of 1998, along with other columns tallying cumulative demand, number of working days in the month, and production per day required to fulfill the demand. Below the main columns are a few cost factors on which our analysis will be based.

By dividing the cumulative monthly demand for the year by the number of working days available, we have a daily required production that would fulfill the requirements, but not at the right time. This is illustrated in the bar chart. Extra production in the first few months would need to be stored as inventory, to fill the deficit in the middle months.

Pure Chase Strategy.

The table below, Figure 2, is made up to cost out the pure chase strategy applied to this situation. This is done by manipulating workforce levels to allow production per month to match demand. The costs associated with each change in manpower are listed, and the final yearly cost is established. The various columns are:

1. Month

2. Demand in units

3. Production hours needed, obtained by multiplying the number of units by the labour hours cost, three hours per unit.

4. Workers required, obtained by dividing the production hours needed by the hours per month available per employee.

5. Workers hired, last months figure subtracted from workers required this month, if positive.

6. Workers fired. last months figure subtracted from workers required this month, if negative.

7. Cost to hire workers.

8. Cost to fire workers.

9. Production cost, the hours required times the hourly labour cost.

Total cost is the sum of columns 7, 8, and 9.

Note that no cost is required for inventory, shortages, overtime or subcontracting. Note also that for the first month, a backlog of 1000 units is made up as well as the month's demand of 1000. This will be carried through the other comparison strategies.

Hire and Fire....Chase Strategy
Month Demand Hours Days Workers Hired Fired $hired $fired Prod Cost
January 2000 6000 21 36 0 0 $0 $0 $24,000
March 1400 4200 22 24 0 12 $0 $2,370 $16,800
April 1600 4800 21 29 5 0 $1,412 $0 $19,200
May 2000 6000 20 38 9 0 $2,679 $0 $24,000
June 2500 7500 22 43 5 0 $1,534 $0 $30,000
July 2500 7500 22 43 0 0 $0 $0 $30,000
August 3000 9000 20 56 14 0 $4,091 $0 $36,000
September 3000 9000 21 54 0 3 $0 $536 $36,000
October 2000 6000 21 36 0 18 $0 $3,571 $24,000
November 1600 4800 21 29 0 7 $0 $1,429 $19,200
December 2000 6000 20 38 9 0 $2,679 $0 $24,000
$12,394 $7,906 $283,200
Total Cost.... $303,500

Figure 2

Pure Level Strategy.

As noted earlier, the pure level strategy uses enough workers to manufacture the required production without resorting to either subcontracting or overtime to make up for shortages. The number of workers required is found by dividing the cumulative demand for the year by the available working days to find the number required per day, then by the production per worker per day to find the number of workers. This number of workers is then the work force for the entire year- a level work force.

Figure 3 shows this strategy. The year begins with a production deficit of 1000 units, and production per month is used to clear deficits and satisfy the present month's demand. Units produced in excess of immediate requirements are placed in inventory at a cost of $1.00 per unit. If enough inventory is not available to satisfy shortages in a month with demand in excess of supply, a shortage cost of $3.00 per unit is charged. The cost of inventory, ($excess) and shortages ($short) is added to production cost to obtain the total cost of production for the year.

Some of the column headings are:

Units...the number of units produced in the month. It is not constant because of variable number of days in each month.

Begin and End....Inventory levels. The ending inventory is the begin+units-demand.

Short and Excess....reflect the End inventory. Negative ending inventory is list in the Short column.

$short and $excess...list the cost of shortages and inventory respectively.

Level work Force, Vary Inventory...Pure Level Strategy
Month Demand Days Employees Hours Units Begin End Short Excess $short $excess Prod. cost
January 1000 21 39 6552 2184 -1000 184 0 184 $0 $184 $26,208
March 1400 22 39 6864 2288 184 1072 0 1072 $0 $1,072 $27,456
April 1600 21 39 6552 2184 1072 1656 0 1656 $0 $1,656 $26,208
May 2000 20 39 6240 2080 1656 1736 0 1736 $0 $1,736 $24,960
June 2500 22 39 6864 2288 1736 1524 0 1524 $0 $1,524 $27,456
July 2500 22 39 6864 2288 1524 1312 0 1312 $0 $1,312 $27,456
August 3000 20 39 6240 2080 1312 392 0 392 $0 $392 $24,960
September 3000 21 39 6552 2184 392 -424 -424 0 $1,272 $0 $26,208
October 2000 21 39 6552 2184 -424 -240 -240 0 $720 $0 $26,208
November 1600 21 39 6552 2184 -240 344 0 344 $0 $344 $26,208
December 2000 20 39 6240 2080 344 424 0 424 $0 $424 $24,960
$1,992 $8,644 $288,288
Total Cost..... $298,924

Figure 3

Mixed Strategies...Use of subcontractors.

It is more common to use a strategy that mixes the chase and level strategies, and also utilizes overtime and subcontracting to supply small peaks in demand. We look at two of these methods. Figure 4 shows the details of a strategy utilizing a level work force with not enough capacity to fulfill the entire demand. Shortages are filled by using a subcontractor to supply units at $24.00 each. In some months we produce a surplus of units. These are placed in inventory at a cost. The total cost is the sum of production costs, subcontracting costs and inventory costs.

Column headings in Figure 4 should be self-explanatory. It should be noted that the number of employees used can dramatically affect the outcome. Too many and we begin to approach the pure level strategy, too few and the cost of subcontracting becomes high.

Level Work Force, Use Subcontracting.....Mixed Strategy
Month Demand Days Employees Hours Units Begin End Short Excess $Subcont. $excess Prod. cost
January 1000 21 36 6048 2016 -1000 16 0 16 $0 $16 $24,192
March 1400 22 36 6336 2112 16 728 0 728 $0 $728 $25,344
April 1600 21 36 6048 2016 728 1144 0 1144 $0 $1,144 $24,192
May 2000 20 36 5760 1920 1144 1064 0 1064 $0 $1,064 $23,040
June 2500 22 36 6336 2112 1064 676 0 676 $0 $676 $25,344
July 2500 22 36 6336 2112 676 288 0 288 $0 $288 $25,344
August 3000 20 36 5760 1920 288 -792 -792 0 $19,008 $0 $23,040
September 3000 21 36 6048 2016 -792 -1776 -1776 0 $42,624 $0 $24,192
October 2000 21 36 6048 2016 -1776 -1760 -1760 0 $42,240 $0 $24,192
November 1600 21 36 6048 2016 -1760 -1344 -1344 0 $32,256 $0 $24,192
December 2000 20 36 5760 1920 -1344 -1424 -1424 0 $34,176 $0 $23,040
$170,304 $3,916 $266,112
Total Cost..... $440,332

Figure 4

Mixed Strategy...Level work force, Overtime and Subcontracting .

The final strategy, shown in Figure 5, utilizes overtime as well as subcontracting to make up for shortages in production. There is a limit to the amount of overtime we can use. We set the level at one hour per working day, plus eight hours each Saturday. This works out to a standard number of hours available per month of 1440 hours. This overtime is used to supply short production in preference to subcontractors. Only when the overtime limit is exceeded are units obtained from a subcontractor. The cost of production in this strategy is the cost of normal production, the cost of overtime and subcontracting, and the cost of some units held in inventory when production exceeds the required demand that month.

Once again, number of workers affects the outcome. A number must be chosen to base the calculations on; checking the effect of other choices might result in better total costs.

To allow the numbers to fit the page, Figure 5 leaves off the first three columns, which are identical to the columns in Figure 4.

Level Work Force, Use Overtime.....Mixed Strategy
Employees Hours Units Begin End Short Excess O.T.Needed OT used $OT $Subcont. $excess Prod. cost
36 6048 2016 -1000 16 0 16 0 0 0 $0 $16 $24,192
36 6336 2112 16 728 0 728 0 0 0 $0 $728 $25,344
36 6048 2016 728 1144 0 1144 0 0 0 $0 $1,144 $24,192
36 5760 1920 1144 1064 0 1064 0 0 0 $0 $1,064 $23,040
36 6336 2112 1064 676 0 676 0 0 0 $0 $676 $25,344
36 6336 2112 676 288 0 288 0 0 0 $0 $288 $25,344
36 5760 1920 288 -792 792 0 2376 1728 10368 $5,184 $0 $23,040
36 6048 2016 -792 -1776 1776 0 5328 1728 10368 $28,800 $0 $24,192
36 6048 2016 -1776 -1760 1760 0 5280 1728 10368 $28,416 $0 $24,192
36 6048 2016 -1760 -1344 1344 0 4032 1728 10368 $18,432 $0 $24,192
36 5760 1920 -1344 -1424 1424 0 4272 1728 10368 $20,352 $0 $23,040
51840 $101,184 $3,916 $266,112
Total Cost... $423,052

Figure 5


Finally, Figure 6 compares the four strategies. The lowest cost would not necessarily be used, management must also consider non-financial aspects as well. After reviewing these strategies, others may be investigated as well.

It should also be noted that this is largely a trial-and-error system. Strategies are formulated, costed out and compared. There is no magic formula here that gives the optimum mix.

Strategy 1. Pure chase. $303,500
Strategy 2. Pure level $298,924
Strategy 3. Mixed with subcontracting. $440,332
Strategy 4. Mixed with overtime. $423,052