Aggregate Planning

Planning Tasks and Horison

Capacity planning

Capacity is the maximum output rate of a

production or service facility
Capacity planning is the process of establishing
the output rate that may be needed at a facility:
Capacity is usually purchased in chunks
Strategic issues: how much and when to
spend capital for additional facility &
equipment
Tactical issues: workforce & inventory levels, &
day-to-day use of equipment

Measuring Capacity Examples

There is no one best way to measure capacity

Output measures like kegs per day are easier to understand
With multiple products, inputs measures work better

Type of Business

Input Measures of Output Measures

Capacity
of Capacity

Car manufacturer

Labor hours

Cars per shift

Hospital

Available beds

Patients per month

Pizza parlor

Labor hours

Pizzas per day

Retail store

Floor space in
square feet

Revenue per foot

Capacity Information Needed

Design capacity:
Maximum output rate under ideal
conditions
A bakery can make 30 custom cakes per
day when pushed at holiday time

Effective capacity:
Maximum output rate under normal
(realistic) conditions
On the average this bakery can make 20
custom cakes per day

Calculating Capacity Utilization

Measures how much of the available capacity is

actually being used:

actual output rate

100%
Utilization
capacity
Measures effectiveness
Use either effective or design capacity in
denominator

Example of Computing Capacity Utilization: In the bakery example the

design capacity is 30 custom cakes per day. Currently the bakery is producing
28 cakes per day. What is the bakerys capacity utilization relative to both
design and effective capacity?

Utilization effective

actual output
28
(100%) (100%) 140%
effective capacity
20

actual output
28
Utilization design
(100%) (100%) 93%
design capacity
30

The current utilization is only slightly below its

design capacity and considerably above its effective
capacity
The bakery can only operate at this level for a short
period of time

How Much Capacity Is Best?

The Best Operating Level is the output than results in

the lowest average unit cost
Economies of Scale:
Where the cost per unit of output drops as volume of output
increases
Spread the fixed costs of buildings & equipment over multiple
units, allow bulk purchasing & handling of material

Diseconomies of Scale:
Where the cost per unit rises as volume increases
Often caused by congestion (overwhelming the process with too
much work-in-process) and scheduling complexity

Best Operating Level and Size

Alternative 1: Purchase one large facility, requiring one large

initial investment
Alternative 2: Add capacity incrementally in smaller chunks as
needed

Implementing Capacity
Decisions

Capacity flexibility
Plant, process, workers, outsourcing

Amount of capacity cushion

important in -to-order and services

Timing the capacity change

Leading [proactive]
Concurrent [neutral]
Lagging [reactive]

Size of the capacity increment

Timing the Capacity Change

Making Capacity Planning Decisions

The three-step procedure for making

capacity planning decisions is as
follows:
Step 1: Identify Capacity Requirements
Step 2: Develop Capacity Alternatives

Step 3: Evaluate Capacity Alternatives

Evaluating Capacity Alternatives

Could do nothing, or expand large now, or

expand small now with option to add later
Use Decision Trees analysis tool:
A modeling tool for evaluating sequential
decisions
Identify the alternatives at each point in time
(decision points), estimate probable consequences
of each decision (chance events) & the ultimate
outcomes (e.g.: profit or loss)

Efficiency and Utilization

Actual output
Efficiency =

Effective capacity
Actual output

Utilization =
Design capacity
Both measures expressed as percentages

Efficiency/Utilization Example
Design capacity = 50 trucks/day
Effective capacity = 40 trucks/day
Actual output = 36 units/day

Actual output

36 units/day

Efficiency =

90%

Effective capacity

Utilization =
72%

Actual output
Design capacity

40 units/ day
=

36 units/day
50 units/day

Efficiency vs Utilization
100.00%
90.00%
90.00%
80.00%
72.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
Efficiency

Utilization

Utilization Example

Best operating level = 120 units/week

Actual output = 83 units/week

Capacity used
83 units/wk
.692
=
Best= operating
Utilization
?
level 120 units/wk
Utilization

Ex.

Measuring capacity

Actual production last week = 148,000 rolls

Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week,
Shifts/day = 3,
Hours/shift = 8
Design capacity = (7 x 3 x 8) x (1,200)
= 201,600 rolls/week
Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%

Determinants of Effective Capacity

Facilities (size, location, layout, heating, lighting, ventilations)

Product and service factors (similarity of products)
Process factors (productivity, quality)
Human factors (training, skills, experience, motivations,
absentation, turnover)

Policy factors (overtime system, no. of shifts)

Operational factors (scheduling problems, purchasing
requirements, inventory shortages)

Supply chain factors (warehousing, transportation,

distribution)

External factors (product standards, government agencies,

pollution standard)

Steps for Capacity Planning

Estimate future capacity requirements
Evaluate existing capacity
Identify alternatives
Conduct financial analysis for each alt.
Assess key qualitative issues for each alt.
Select one alternative

Implement alternative chosen

Monitor results

Calculating Processing
Requirements
Determine type of products or services
Forecast for the Demand
Determine the process requirements
The standard processing time / unit of
product
The number of workdays / year
The number shifts that will be used

Calculating Processing Requirements

A dept. works 8-hour shift, 250 days/year
Standard
processing time
per unit (hr.)

Product

Annual
Demand

Processing time
needed (hr.)

#1

400

5.0

2,000

#2

300

8.0

2,400

#3

700

2.0

1,400
5,800

annual capacity is 250*8 = 2000 hours,

number of machines required = 5,800 hours/2,000 hours = 2.90 machines
then we need three machines to handle the required volume

Make or Buy ?
In-House or Outsourcing
Outsource: obtain a good or service completely or partially
from an external provider

1.

2.
3.
4.
5.
6.

Available capacity (equip.,skills,time)

Expertise
Quality considerations (labs, inspect.)
Nature of demand (high, steady)
Cost (fixed, savings)
Risk

EX.

Make or Buy ?

A firms manager must decide whether to make or buy a

certain item used in the production of vending machines ,
making the item would involve annual lease costs of
$150000 . Cost and volume estimates are as follows:
Make

Buy

Annual fixed cost

$150000

None

Variable cost/unit

$60

$80

Annual volume (units)

12000

12000

Should the firm make or buy ?

If the volume changed , at what volume would the
manager be indifferent between making and buying ?

Sol.

Make or Buy ?

Total cost = Fixed cost + (Volume * Variable cost)

in case of make = $150000 + (12000*60) = $870000
in case of buy =
0
+ (12000*80) = $960000
TCost (make) < TCost (buy)
So the solution is Make
Tcost(make) = Tcost(buy)
$150000 + Q*60 = 0 + Q*80
Q = 7500 unit

Determinants of Effective Capacity

Facilities
Product and service factors
Process factors ( output quality )
Human factors
Operational factors ( late delivery
for the raw materials )
Supply chain factors
External factors

Key Decisions of Capacity Planning

1.
2.
3.

4.

Amount of capacity needed

Timing of changes
Need to maintain balance
Extent of flexibility of facilities

Capacity cushion extra demand intended to offset uncertainty

Steps for Capacity Planning

1.
2.
3.
4.
5.

6.
7.
8.

Estimate future capacity requirements

Evaluate existing capacity
Identify alternatives
Conduct financial analysis
Assess key qualitative issues
Select one alternative
Implement alternative chosen
Monitor results

Make or Buy
1. Available

capacity

2. Expertise
3. Quality

considerations
4. Nature of demand
5. Cost
6. Risk

Example 2

Example 3

A manager must decide which type of equipment

to buy , type A or type B. type A equipment costs
$15000 each and type B costs $ 11000. the
equipment can be operated 8 hours a day ,250
days a year.
Either machine can be used to perform two types
of chemical analysis C1 and C2 annual service
requirement and processing times are shown in
the following table.
Which type of equipment should be purchased
and how many of that type will be need ? The
goal is to minimize total purchase cost.

Processing
time per
analysis ( HR)

Processing
time per
analysis ( HR)

Analysis type

Annual volume

C1
C2

1200
900

1
3

2
2

Total processing time ( annual volume processing time per analysis ) needed by
type of equipment.

Analysis type

C1
C2

1200
2700

2400
1800

3900

4200

Solution:

Total processing time available per price of

equipment is 8 hours/day 250 days/year
=2000
Hence , one piece can handle 2000 hours of
analysis ,two pieces of equipment can handle
4000 hours and so on.
Given the total processing requirement two of
type A would be needed for a total cost of 2
15000=30000 or three of type B for a total cost of
3 11000=33000 thus two pieces of type A would
have sufficient capacity to Handle the load at
lower cost than three of type B

Planning Service Capacity

Need to be near customers

Capacity and location are closely tied

Inability to store services

Capacity must be matched with timing of
demand

Degree of volatility of demand

Peak demand periods

Assumptions of Cost-Volume
Analysis
1. One

product is involved
2. Everything produced can be sold
3. Variable cost per unit is the same
regardless of volume
4. Fixed costs do not change with volume
5. Revenue per unit constant with volume
6. Revenue per unit exceeds variable cost
per unit

Financial Analysis

Cash Flow - the difference between

cash received from sales and other
sources, and cash outflow for labor,
material, overhead, and taxes.

Present Value - the sum, in current

value, of all future cash flows of an
investment proposal.

Aggregate Planning Goals

Meet demand
(Sales Forecast)
Use capacity efficiently
Meet inventory policy
Minimize cost

Labor
Inventory
Plant & equipment
Subcontract

Aggregate Planning Strategies

Pure Strategies
Demand Options change demand:

influencing demand (e.g. change price)

backordering during high demand periods
counterseasonal product mixing

Aggregate Planning Strategies

Pure Strategies
Capacity Options change capacity:

changing inventory levels

varying work force size by hiring or layoffs
varying production capacity through
overtime or idle time
subcontracting (aka outsourcing)
using part-time workers

Aggregate Scheduling Options Advantages and Disadvantages

Option

Advantage

Disadvantage

Changing
inventory levels

Changes in
human resources
are gradual, not
abrupt
production
changes

Varying
workforce size
by hiring or
layoffs

Avoids use of
Hiring, layoff,
other alternatives and training
costs

Inventory
holding costs;
Shortages may
result in lost
sales

Some
Comments
Applies mainly
to production,
not service
operations

Used where size

of labor pool is
large

Advantages/Disadvantages continued
Option

Advantage

Disadvantage Some
Comments

Varying
production rates
through overtime
or idle time

Matches seasonal
fluctuations
without
hiring/training
costs
Permits
flexibility and
smoothing of the
firm's output

Overtime
premiums, tired
workers, may not
meet demand

Allows
flexibility within
the aggregate
plan

Loss of quality
control; reduced
profits; loss of
future business

Applies mainly
in production
settings

Subcontracting

Advantages/Disadvantages continued
Option

Advantage

Disadvantage

Some
Comments

Using part-time
workers

Less costly and

more flexible
than full-time
workers

Good for
unskilled jobs in
areas with large
temporary labor
pools

Influencing
demand

Tries to use
excess capacity.
Discounts draw
new customers.

High
turnover/training
costs; quality
suffers;
scheduling
difficult
Uncertainty in
demand. Hard to
match demand to
supply exactly.

Creates
marketing ideas.
Overbooking
used in some
businesses.

Advantage/Disadvantage continued
Option

Advantage

Disadvantage

Back ordering
during highdemand periods

May avoid
Customer must
overtime. Keeps be willing to
capacity constant wait, but
goodwill is lost.

Counterseasonal Fully utilizes

May require
products and
resources; allows skills or
service mixing
stable workforce. equipment
outside a firm's
areas of
expertise.

Some
Comments
Many companies
backlog.

Risky finding
products or
services with
opposite demand
patterns.

The Extremes
Level
Strategy

Chase
Strategy

Production rate
is constant

Production
equals sales
forecast

Aggregate Planning Strategies

Level scheduling strategy

Produce same amount every day
Keep work force level constant
Vary non-work force capacity or demand options
Often results in lowest production costs
Chase scheduling strategy
Vary the amount of production to match (chase) the
sales forecast
This requires changing the workforce (hiring & firing)
Mixed strategy
Combines 2 or more aggregate scheduling options

The Trial & Error Approach to

Aggregate Planning

Forecast the demand for each period

Determine the capacity for regular time,
overtime, and subcontracting, for each
period
Determine the labor costs, hiring and firing
costs, and inventory holding costs
Consider company policies which may
apply to the workers, overtime,
outsourcing, or to inventory levels
Develop alternative plans, and examine
their total costs

The IDES Sales Forecast for 2003

Quarter 1

Unit Sales Forecast

For 2003
307,200

Quarter 2

379,200

Quarter 3

360,000

Quarter 4

489,600

Total

1,536,000

IDES Manufacturing Example

IDES Manufacturing wants to compare the

annual (year 2003) costs associated with
scheduling using the following three (3)
options:
Option 1 Maintain a constant work force
during the entire year (Level).
Option 2 Maintain the present work force of
150 and use overtime and sub-contracting as
needed (Mixed)
Option 3 Hire/layoff workers as needed to
produce the required output (Chase).

IDES Cost Information

Inventory Carrying Cost

(per quarter)
$ 0.50/unit
Subcontracting cost
$ 7/unit
Pay rate regular time
$20/hr
Pay rate overtime
$30/hr
Labor standard per unit
0.2 hrs
Cost to increase production
$ 3/unit
Cost to decrease production
$ 2/unit
IDES has 0 units in inventory
Each Quarter has 60 working days
At end of 2002, IDES has 150 prod. workers
IDES Policy Maximum of 72,000 units/qtr produced
using overtime

Option 1 Constant Workforce

without overtime or subcontracting

First, determine the number of workers

required to produce the units forecast for
2003.
Ave. Prod/day = 1,536,000 = 6,400/day
240 days
Then determine how many workers are
needed.
Workers needed =
6,400/day
= 160
5 units/hr X 8 hrs

Option 1 Continued:
Calculate Inventory Carrying Costs
Qtr

Sales
Forecast

Inventory Ending
Change Inventory

Production
@ 6400/day
384,000

307,200

+76,800

76,800

384,000

379,200

+ 4,800

81,600

384,000

360,000

+24,000

105,600

384,000

489,600

-105,600

1,536,000

1,536,000

Total

0
264,000

Option 1 Continued:
Calculation of Annual Costs

Inventory carrying cost:

264,000 units X $0.50/unit =
Cost to increase capacity:
(384,000-360,000) units X $5/unit =
Regular time labor cost:
1,536,000 units X $4/unit =
Total Annual Cost for Option 1 =

$ 132,000
$ 120,000
$6,144,000
$6,396,000

Option 2 Present Workforce (150) using

O/T & subcontracting
Qtr

Sales
Forecast

307,200

Inv
Change

End
Inv

360,000

+52,800

52,800

379,200

360,000

-19,200

33,600

360,000

360,000

33,600

489,600

360,000

-33,600

96,000

72,000

24,000

1,536,000

1,440,000

72,000

24,000

Tot
al

In-house
Production

Units
Reqd

O/T

Out
Source

Option 2 Continued:
Calculation of Annual Costs

Inventory Carrying Costs

120,000 units X $.50/unit =
$ 60,000
Regular time labor (150 workers)
$4/unit X 1,440,000 units =
$5,760,000
Overtime labor
$6/unit X 72,000 units =
$ 432,000
Out-sourcing
$7/unit X 24,000 units =
$ 168,000
Total Annual Costs for Option 2 = $6,420,000

Option 3 Vary Production

(Workforce) to match Sales Forecast

307,200

360,000

Capacity
Change
Needed
-52,800

379,200

307,200

+72,000

216,000

360,000

379,200

-19,200

38,400

489,600

360,000

+129,600

388,800

Qtr

Total

Sales
Forecast

1,536,000

Beginning
Capacity

Cost of
Capacity
Change
$105,600

$748,800

Option 3 Continued
Calculation of Annual Costs

Regular time labor costs

1,536,000 units X $4/unit =
$6,144,000
Capacity Change Costs =
$ 748,800
Total Annual Cost - Option 3 = $6,892,800

Annual Cost Comparison of the

Aggregate Scheduling Strategies
Option

Annual Cost

1. Level No use of O/T or

Outsourcing
2. Mixed Present work
force w/ O/T & Outsourcing

$6,396,000

3. Chase Vary Production

(workforce)

$6,892,800

$6,420,000

Homework Problem Due at the

beginning of class Tuesday March 11
Use the Revised IDES Cost information
shown on the following two slides to
evaluate the following scheduling
options:
Level Strategy
Chase Strategy
Maintain Present work force and use
overtime production and sub-contracting
as needed

The IDES Sales Forecast for 2003

Revised

Quarter 1

Unit Sales Forecast

For 2003
388,000

Quarter 2

440,000

Quarter 3

400,000

Quarter 4

500,000

Total

1,728,000

IDES Cost Information - Revised

Inventory Carrying Cost

(per quarter)
$ 0.75/unit
Subcontracting cost
$ 7.50/unit
Pay rate regular time
$20/hr
Pay rate overtime
$30/hr
Labor standard per unit
0.2 hrs
Cost to increase production
$ 1.50/unit
Cost to decrease production
$ 1/unit
IDES has 0 units in inventory
Each Quarter has 60 working days
At end of 2000, IDES has 140 prod. workers
IDES Policy Maximum of 78,000 units/qtr produced
using overtime