CHAPTER FOUR

OPERATION PLANNING AND SCHEDULING

4.1. AGGREGATE PLANNING

Aggregate planning is also called the production plan is a process that determines the resource
capacity a firm will need to meet its demand over an intermediate time horizon—6 to 12 months
in the future. Within this time frame, it is usually not feasible to increase capacity by building
new facilities or purchasing new equipment; however, it is feasible to hire or lay off workers,
increase or reduce the workweek, add an extra shift, subcontract out work, use overtime, or build
up and deplete inventory levels.

The aggregate plan details the aggregate production rate and the size of the workforce, which
enables planners to determine the amount of inventory to be held; the amount of overtime or
undertime authorized; any authorized subcontracting, hiring, or firing of employees; and back-
ordering of customer orders. The aggregate plan is usually updated and reevaluated monthly by
the operations group.

The term aggregate is used because the plans are developed for product lines or product
families, rather than individual products. An aggregate operations plan might specify how many
bicycles are to be produced but would not identify them by color, size, tires, or type of brakes.
Resource capacity is also expressed in aggregate terms, typically as labor or machine hours.
Labor hours would not be specified by type of labor, nor machine hours by type of machine. And
they may be given only for critical processes.

For services, capacity is often limited by space—number of airline seats, number of hotel rooms,
number of beds in a correctional facility. Time can also affect capacity. The number of customers
who can be served lunch in a restaurant is limited by the number of seats, as well as the number
of hours lunch is served. In some overcrowded schools, lunch begins at 10:00 A.M. so that all
students can be served by 2:00 P.M.!

There are two objectives to sales and operations planning:

1) To establish a company-wide game plan for allocating resources, and
2) To develop an economic strategy for meeting demand. Insist
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The first objective refers to the long-standing battle between the sales and operations functions
within a firm. Personnel who are evaluated solely on sales volume have the tendency to make
unrealistic sales commitments (either in terms of quantity or timing) that operations is expected
to meet, sometimes at an exorbitant price. Operations personnel who are evaluated on keeping
manufacturing costs down may refuse to accept orders that require additional financial resources
(such as overtime wage rates) or hard-to-meet completion dates. The job of operations planning
is to match forecasted demand with available capacity. If capacity is inadequate, it can usually be
expanded, but at a cost. The company needs to determine if the extra cost is worth the increased
revenue from the sale, and if the sale is consistent with the strategy of the firm. Thus, the
aggregate plan should not be determined by manufacturing personnel alone; rather, it should be
agreed on by top management from all the functional areas of the firm—operations, marketing,
and finance. Because this is such an important decision, companies engage in a structured,
collaborative decision making process called sales and operations planning (S&OP).

Figure 4.1: Major Operations planning activities

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The aggregate plan should reflect company policy (such as avoiding layoffs, limiting inventory
levels, and maintaining a specified customer service level) and strategic objectives (such as
capturing a certain share of the market or achieving targeted levels of quality or profit). Other
inputs include financial constraints, demand forecasts (from sales), and capacity constraints
(from operations).

Given these inputs, the sales function develops a monthly sales plan. A forecasting model is run
to create preliminary demand figures, then adjusted based on input from key customers and sales
personnel in the field. The forecast is further adjusted for planned promotions, product
introductions, and special offers. Finally, a customer service level is set which specifies the
percent of customer demand that should be satisfied.

Aggregat
e
Planning

Figure 4.2 Inputs and outputs of aggregate Planning

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 MEETING DEMAND STRATEGIES

An economic strategy for meeting demand can be attained by either:

A. Adjusting capacity or
B. Managing demand.

I. STRATEGIES FOR ADJUSTING CAPACITY

If demand for a company’s products or services is stable over time, then the resources necessary
to meet demand are acquired and maintained over the time horizon of the plan, and minor
variations in demand are handled with overtime or under time. Aggregate planning becomes
more of a challenge when demand fluctuates over the planning horizon. For example, seasonal
demand patterns can be met by:
1) Producing at a constant rate and using inventory to absorb fluctuations in demand (level
production)
2) Hiring and firing workers to match demand (chase demand)
3) Maintaining resources for high-demand levels
4) Increasing or decreasing working hours (overtime and undertime)
5) Subcontracting work to other firms
6) Using part-time workers
7) Providing the service or product at a later time period (backordering)

Strategies used to adjust capacity can be classified as: Pure and Mixed strategies. When one of
the alternatives of capacity adjustment strategies is selected, a company is said to have a pure
strategy for meeting demand. When two or more are selected, a company has a mixed strategy.

A. Level Production

The level production strategy, shown in Figure 14.3a, sets production at a fixed rate (usually to
meet average demand) and uses inventory to absorb variations in demand. During periods of low
demand, overproduction is stored as inventory, to be depleted in periods of high demand. The
cost of this strategy is the cost of holding inventory, including the cost of obsolete or perishable
items that may have to be discarded.

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B. Chase Demand

The chase demand strategy, shown in Figure 14.3b, matches the production plan to the demand
pattern and absorbs variations in demand by hiring and firing workers. During periods of low
demand, production is cut back and workers are laid off. During periods of high demand,
production is increased and additional workers are hired. The cost of this strategy is the cost of
hiring and firing workers. This approach would not work for industries in which worker skills are
scarce or competition for labor is intense, but it can be quite cost-effective during periods of high
unemployment or for industries with low-skilled workers.

Figure 4.2: Pure Strategies for Meeting Demand

C. Peak Demand

Maintaining resources for peak demand levels ensures high levels of customer service but can
be very costly in terms of the investment in extra workers and machines that remain idle during
low-demand periods. This strategy is used when superior customer service is important (such as
Nordstrom’s department store) or when customers are willing to pay extra for the availability of
critical staff or equipment. Professional services trying to generate more demand may keep staff
levels high, defense contractors may be paid to keep extra capacity “available,” child-care
facilities may elect to maintain staff levels for continuity when attendance is low, and full-
service hospitals may invest in specialized equipment that is rarely used but is critical for the
care of a small number of patients.

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D. Overtime and Undertime

Overtime and undertime are common strategies when demand fluctuations are not extreme. A
competent staff is maintained, hiring and firing costs are avoided, and demand is met temporarily
without investing in permanent resources. Disadvantages include the premium paid for overtime
work, a tired and potentially less efficient workforce, and the possibility that overtime alone may
be insufficient to meet peak demand periods. Undertime can be achieved by working fewer hours
during the day or fewer days per week. In addition, vacation time can be scheduled during
months of slow demand.
Subcontracting
Subcontracting or outsourcing is a feasible alternative if a supplier can reliably meet quality and
time requirements. This is a common solution for component parts when demand exceeds
expectations for the final product. The subcontracting decision requires maintaining strong ties
with possible subcontractors and first-hand knowledge of their work. Disadvantages of
subcontracting include reduced profits, loss of control over production, long lead times, and the
potential that the subcontractor may become a future competitor.
E. Part-Time Workers

Using part-time workers is feasible for unskilled jobs or in areas with large temporary labor
pools (such as students, homemakers, or retirees). Part-time workers are less costly than full-time
workers—they receive no health-care or retirement benefits—and are more flexible—their hours
usually vary considerably. Part-time workers have been the mainstay of retail, fast-food, and
other services for some time and are becoming more accepted in manufacturing and government
jobs. Japanese manufacturers traditionally use a large percentage of part-time or temporary
workers. Part-time and temporary workers now account for one-third of our nation’s workforce,
and are expected to increase as companies gingerly enter recovery from the recession.

F. Backlogs, Backordering, And Lost Sales

Companies that offer customized products and services accept customer orders and fill them at a
later date. The accumulation of these orders creates a backlog that grows during periods of high
demand and is depleted during periods of low demand. The planned backlog is an important part
of the aggregate plan. For make-to-stock companies, customers who request an item that is
temporarily out-of-stock may have the option of backordering the item. If the customer is
unwilling to wait for the backordered item, the sale will be lost. Although in general both

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backorders and lost sales should be avoided, the aggregate plan may include an estimate of both.
Backorders are added to the next period’s requirements; lost sales are not.

II. STRATEGIES FOR MANAGING DEMAND

Aggregate planning can also involve proactive demand management. Strategies for managing
demand include:

 Shifting demand into other time periods with incentives, sales promotions, and
advertising campaigns;
 Offering products or services with countercyclical demand patterns; and
 Partnering with suppliers to reduce information distortion along the supply chain.

Winter coat specials in July, bathing-suit sales in January, early-bird discounts on dinner, lower
long-distance rates in the evenings, and getaway weekends at hotels during the off-season are all
attempts to shift demand into different time periods. Electric utilities are especially skilled at off-
peak pricing. Promotions can also be used to extend high demand into low-demand seasons.

Holiday gift buying is encouraged earlier each year, and beach resorts plan festivals in
September and October to extend the season. Successful demand management depends on
accurate forecasts of demand and accurate forecasts of the changes in demand brought about by
sales, promotions, and special offers.

For industries with extreme variations in demand, offering products or services with
countercyclical demand patterns helps smooth out resource requirements. This approach involves
examining the idleness of resources and creating a demand for those resources. McDonald’s
offers breakfast to keep its kitchens busy during the pre-lunch hours, pancake restaurants serve
lunch and dinner, and heating firms also sell air conditioners.

QUANTITATIVE TECHNIQUES FOR AGGREGATE PLANNING

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One aggregate planning strategy is not always preferable to another. The most effective strategy
depends on the demand distribution, competitive position, and cost structure of a firm or product
line. Several quantitative techniques are available to help with the aggregate planning decision.
In the sections that follow, we discuss pure and mixed strategies, linear programming, the
transportation method, and other quantitative techniques.

Developing the Aggregate Plan

Here are the steps in developing an aggregate plan:

Step 1: Identify the aggregate plan that matches your company’s objectives: level, chase, or
hybrid.
Step 2: Based on the aggregate plan, determine the aggregate production rate.
 If you use the level plan with inventories and back orders, the aggregate production rate
is set equal to average demand. In addition, if you allow no back orders, the size of the
workforce is changed initially so that all demand is met on time.
 If you use the chase aggregate plan, calculate how much output capacity you need each
period. Calculate how many units will be produced on regular time and overtime and how
many units will be subcontracted.
Step 3: Calculate the size of the workforce.
 If you use the level aggregate plan, calculate how many workers you need to achieve the
average production rate needed.
 If you change capacity each period with hires and fires, calculate how many workers you
need each period and make the necessary change in the workforce.
 If you change capacity through a variety of options, calculate how much of a particular
option you need each period.
Step 4: Test the aggregate plan.
 Using the production rate and initial workforce size, calculate your inventory levels
(excesses and shortages), any shortages you face, expected number of employees hired
and fired, and when you will need overtime.
 Calculate the total costs for your plan.
Step 5: Evaluate the plan’s performance in terms of cost, customer service, human
resources, and operations.

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After you develop a plan, it is critical to evaluate it in terms of cost, customer service, operations,
and human resources. Cost comparisons are simple if you are comparing similar ending positions
—that is, plan with the same ending inventory level or producing the same number of units.

A. PURE STRATEGIES

Solving aggregate planning problems involves formulating strategies for meeting demand,
constructing production plans from those strategies, determining the cost and feasibility of each
plan, and selecting the lowest cost plan from among the feasible alternatives. The effectiveness
of the aggregate planning process is directly related to management’s understanding of the cost
variables involved and the reasonableness of the scenarios tested. Example 4.1 compares the cost
of two pure strategies: level production and chase demand.

Example 4.1 Aggregate Planning Using Pure Strategies

The Good and Rich Candy Company makes a variety of candies in three factories worldwide. Its
line of chocolate candies exhibits a highly seasonal demand pattern, with peaks during the winter
months (for the holiday season and Valentine’s Day) and valleys during the summer months
(when chocolate tends to melt and customers are watching their weight). Given the following
costs and quarterly sales forecasts, determine whether (a) level production, or (b) chase demand
would more economically meet the demand for chocolate candies:

Solution

a. For the level production strategy, we first need to calculate average quarterly demand.

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This becomes our planned production for each quarter. Since each worker can produce 1000
pounds a quarter, 100 workers will be needed each quarter to meet the production requirements
of 100,000 pounds. Production in excess of demand is stored in inventory, where it remains until
it is used to meet demand in a later period. Demand in excess of production is met by using
inventory from the previous quarter. The production plan and resulting inventory costs are as
follows:

Cost of Level Production Strategy = (400,000 * $2.00) + (140,000 * $.50) = $870,000

b. For the chase demand strategy, production each quarter matches demand.

To accomplish this, workers are hired at a cost of $100 each and fired at a cost of $500 each.
Since each worker can produce 1000 pounds per quarter, we divide the quarterly sales forecast
by 1000 to determine the required workforce size each quarter. We begin with 100 workers and
hire and fire as needed. The production plan and resulting hiring and firing costs are given here.

Cost of Chase Demand Strategy = (400,000 * $2.00) + (100 * $100) + (50 * $500) = $835,000

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Comparing the cost of level production with chase demand, we find that chase demand is the
best strategy for the Good and Rich line of candies.

Although chase demand is the better strategy for Good and Rich from an economic point of
view, it may seem unduly harsh on the company’s workforce. An example of a good “fit”
between a company’s chase demand strategy and the needs of the workforce is Hershey’s,
located in rural Pennsylvania, with a demand and cost structure much like that of Good and Rich.
The location of the manufacturing facility is essential to the effectiveness of the company’s
production plan. During the winter, when demand for chocolate is high, the company hires
farmers from surrounding areas, who are idle at that time of year. The farmers are let go during
the spring and summer, when they are anxious to return to their fields and the demand for
chocolate falls. The plan is cost-effective, and the extra help is content with the sporadic hiring
and firing practices of the company.

B. MIXED STRATEGIES

Most companies use mixed strategies for production planning. Mixed strategies can incorporate
management policies, such as “no more than x% of the workforce can be laid off in one quarter”
or “inventory levels cannot exceed x dollars.” They can also be adapted to the quirks of a
company or industry. For example, many industries that experience a slowdown during part of
the year may simply shut down manufacturing during the low-demand season and schedule
employee vacations during that time.

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Example 1:

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Example 2

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Example 3

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4.2. OPERATION SCHEDULING

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