AGGREGATE PLANNING :
MANAGING PREDICTABLE
VARIABILITY
Preetam Basu
Assistant Professor
Operations Management
IIM Calcutta
Role of Aggregate Planning
Aggregate planning:
processby which a company determines levels of
capacity, production, subcontracting, inventory, stockouts,
and pricing over a specified time horizon
how can a firm best use the facilities it has?
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
Outputs of Aggregate Plan
Production quantity from regular time, overtime, and subcontracted
time: used to determine number of workers and overall capacity
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
Aggregate Planning Strategies
Trade-off between capacity, inventory,
backlog/lost sales
Chase strategy – using capacity as the lever
Level strategy – using inventory as the lever
Mixed strategy – a combination of one or more of these
two strategies
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
Chase Strategy
Demand
Production
Units
Time
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
Level Strategy
Demand
Production
Units
Time
Example: Aggregate Production Planning
QUARTER SALES FORECAST (LB)
Spring 80,000
Summer 50,000
Fall 120,000
Winter 150,000
Hiring cost = $100 per worker
Firing cost = $500 per worker
Inventory carrying cost = $0.50 pound per quarter
Regular production cost per pound = $2.00
Production per employee = 1,000 pounds per quarter
Beginning work force = 100 workers
Level Production Strategy
Level production
(50,000 + 120,000 + 150,000 + 80,000)
= 100,000 pounds
4
SALES PRODUCTION
QUARTER FORECAST PLAN INVENTORY
Spring 80,000 100,000 20,000
Summer 50,000 100,000 70,000
Fall 120,000 100,000 50,000
Winter 150,000 100,000 0
400,000 140,000
Cost of Level Production Strategy
(400,000 X $2.00) + (140,000 X $.50) = $870,000
Chase Demand Strategy
SALES PRODUCTION WORKERS WORKERS WORKERS
QUARTER FORECAST PLAN NEEDED HIRED FIRED
Spring 80,000 80,000 80 0 20
Summer 50,000 50,000 50 0 30
Fall 120,000 120,000 120 70 0
Winter 150,000 150,000 150 30 0
100 50
Cost of Chase Demand Strategy
(400,000 X $2.00) + (100 x $100) + (50 x $500) = $835,000
Responding to Predictable Variability
Predictable variability is change in demand that can be
forecasted
Can cause increased costs and decreased responsiveness
A firm can handle predictable variability using two broad
approaches:
Manage supply using capacity, inventory, subcontracting, and
backlogs
Manage demand using short-term price discounts and trade
promotions
Managing Supply
Managing capacity
Use of seasonal workforce
Use of subcontracting
Use of dual facilities – dedicated and flexible
Designing production flexibility into production processes
Managing inventory
Using common components across multiple products
Building inventory of high demand or predictable demand
products
Inventory/Capacity Trade-off
Leveling capacity forces inventory to build up in
anticipation of seasonal variation in demand
Carrying low levels of inventory requires capacity to
vary with seasonal variation in demand or enough
capacity to cover peak demand during season
Managing Demand
Promotion
Timing of promotion and pricing changes is important
Demand increases can result from :
Market growth (increased sales, increased market
size)
Forward buying (same sales, same market)
