Aggregate Planning

in the Supply Chain

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 Outline

– Role of aggregate planning in a supply chain

– The aggregate planning problem
– Aggregate planning strategies
– Implementing aggregate planning in practice

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 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?

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 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
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 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

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 Information Needed for
an Aggregate Plan
– Demand forecast in each period
– Production costs
– labor costs, regular time (Rs/hr) and overtime (Rs/hr)
– subcontracting costs (Rs/hr or Rs/unit)
– cost of changing capacity: hiring or layoff (Rs/worker) and cost of adding or reducing
machine capacity (Rs/machine)
– Labor/machine hours required per unit
– Inventory holding cost (Rs/unit/period)
– Stockout or backlog cost (Rs/unit/period)
– Constraints: limits on overtime, layoffs, capital available, stockouts and backlogs
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 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
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 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

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 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

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 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
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 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

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Aggregate Planning at
Red Tomato Tools (A case)
Month Demand Forecast
January 1,600
February 3,000
March 3,200
April 3,800
May 2,200
June 2,200

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Red Tomato Tools (A case)
– Red Tomato sells each tool through retailor for Rs. 40.
– Company has starting inventory of 1000 units in January.
– Company has starting workforce of 80 at the beginning of January.
– Each employee works for 8 hours a day, and 20 working days/month.
– No worker should work more than 10 hours per month as overtime.
– At the end of June, at least 500 units should be available as inventory.

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 Fundamental Tradeoffs in
Aggregate Planning
– Capacity (regular time, overtime, subcontract)
– Inventory
– Backlog / lost sales

Basic Strategies
– Chase strategy
– Time flexibility from workforce or capacity
– Level strategy

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Aggregate Planning

Item Cost
Materials Rs.10/unit
Inventory holding cost Rs.2/unit/month
Marginal cost of a stockout Rs.5/unit/month
Hiring and training costs Rs.300/worker
Layoff cost Rs.500/worker
Labor hours required 4/unit
Regular time cost Rs.4/hour
Over time cost Rs.6/hour
Cost of subcontracting Rs.30/unit

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 Aggregate Planning
(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 7/9/2019
 OBJECTIVE FUNCTION

– Denote the demand in Period t by Dt.

– The objective function is to minimize the total cost (equivalent to maximizing
total profit) incurred during the planning horizon.
– The cost incurred has the following components:
– • Regular-time labor cost
– • Cost of hiring and layoffs
– • Overtime labor cost
– • Cost of holding inventory
– • Cost of stocking out
– • Cost of subcontracting
– • Material cost
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 EVALUATION OF COSTS

– 1. Regular-time labor cost

– Recall that workers are paid a regular-time wage of Rs640 (Rs4/hour X 8
hours/day X 20 days/month) per month. Because Wt is the number of
workers in Period t, the regular-time labor cost over the planning horizon is
given by 6 Regular-time labor cost = 𝚺640Wt
– 2. Cost of hiring and layoffs
– Cost of hiring a worker is Rs300 and the cost of laying off a worker is Rs500.
Ht and Lt represent the number hired and the number laid off, respectively,
in Period t. Thus the cost of hiring and layoff is = 𝚺300Ht + 𝚺500Lt
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– 3. Overtime labor cost.
– As overtime labor cost is Rs6 per hour and Ot represents the number of overtime
hours worked in Period t, the overtime cost over the planning horizon is = 𝚺6Ot
– 4. Cost of inventory and stockout.
– The cost of carrying inventory is Rs2 per unit per month, and the cost of stocking
out is Rs5 per unit per month. It and St represent the units in inventory and the
units stocked out, respectively, in Period t. Thus, the cost of holding inventory
and stocking out is = 𝚺 2It + 𝚺 5St
– 5. Cost of materials and subcontracting.
– The material cost is Rs10 per unit and the subcontracting cost is Rs30/unit. Pt
represents the quantity produced and Ct represents the quantity subcontracted
in Period t. Thus, the material and subcontracting cost is = 𝚺 10Pt + 𝚺 30Ct

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Aggregate Planning
(Define Objective Function)
6 6
Min 640W t   300 H t
t 1 t 1
6 6 6
  500 Lt   6 Ot   2 I t
t 1 t 1 t 1
6 6 6
  5 S t  10 Pt   30 C t
t 1 t 1 t 1

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 Aggregate Planning (Constraints
Linking Variables)
– Workforce size for each month is based on hiring and layoffs

W t  W t 1  H t  Lt, or
W t  W t 1  H t  Lt  0
for t  1,...,6, where W 0  80.

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 Aggregate Planning
(Constraints)
– Production for each month cannot exceed capacity

Pt  40 W t  Ot 4 ,
40 W t  Ot 4  Pt  0,
for t  1,...,6.

– (Since, 4 hours required per unit, 20 days a month and 8 hours per day)

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 Aggregate Planning
(Constraints)
– Inventory balance for each month

I t 1  P t  C t  Dt  S t 1  I t  S t ,
I t 1  P t  C t  Dt  S t 1  I t  S t  0,
for t  1,...,6,where I 0  1,000 ,
S 0  0,and I 6  500 .
– Where, It-1 is previous inventory, Pt is in-house production and Ct is
subcontracted production.
– Dt is current demand, previous backlog St-1, inventory added It and
inventory backlogged St
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 Aggregate Planning
(Constraints)
– Over time for each month

Ot  10 W t,
10 W t  Ot  0,
for t  1,...,6.
– Total cost over planning horizon is =Rs. 422660.

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 Aggregate Plan

Period, t Dt Ht Lt Wt Ot It St Ct Pt
0 0 0 0 80 0 1000 0 0 0
1 1600 0 16 64 0 1960 0 0 2560
2 3000 0 0 64 0 1520 0 0 2560
3 3200 0 0 64 0 880 0 0 2560
4 3800 0 0 64 0 0 220 140 2560
5 2200 0 0 64 0 140 0 0 2560
6 2200 0 0 64 0 500 0 0 2560

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 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

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 Summary of Learning Objectives
– What types of decisions are best solved by aggregate planning?
– What is the importance of aggregate planning as a supply chain activity?
– What kinds of information are needed to produce an aggregate plan?
– What are the basic trade-offs a manager makes to produce an aggregate
plan?
– How are aggregate planning problems formulated and solved using
Microsoft Excel?

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