CHAPTER FOUR

AGGREGATE PLANNING
Dr. Mulugeta K.
Department of Management
Aggregate Planning Defined

• Aggregate planning: a planning 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 work,
use overtime, or build up and deplete inventory levels.
• Aggregate planning is also called Sales and Operations Planning.
 Cont…

• The term aggregate indicates that the plans are developed for
product lines or product families, rather than individual
products.
• There are two objectives to aggregate planning:
1. To establish a company-wide game plan for allocating
resources
 the long-standing battle between the sales and
operations functions within a firm.
2. To develop an economic strategy for meeting demand.
 matching forecasted demand with available capacity.
Inputs and Outputs of Aggregate Planning

Aggregate
Planning
Meeting Demand Strategies

• An economic strategy for meeting demand can be

attained by either:
I. Adjusting capacity
II. Managing demand.
I. Strategies for Adjusting Capacity

• If demand for a company’s products or services is stable over

time, minor 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 (peak
demand)
4. Increasing or decreasing working hours (overtime and
undertime)
 Cont…

5. Outsourcing work to other firms (Subcontracting)

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:
A. Pure strategy: when one of the alternatives of capacity
adjustment strategies is selected
B. Mixed strategy: when two or more strategies are
combined.
1. Level Production

• It sets production at a fixed rate

(to meet average demand) and
uses inventory to absorb
demand variations.
• During periods of low demand,
overproduction is stored as
inventory, to be used in periods
of high demand.
 Costs
• Inventory holding cost:
o Eg. cost of obsolete items
 2. Chase Demand

• Thus strategy matches the

production plan to the demand
pattern and absorbs variations
in demand by hiring and firing
workers.
• During periods of low demand,
workers are laid off.
• During periods of high demand,
additional workers are hired.
 Costs
• Hiring and firing Costs
 Cont…

• Chase demand strategy would not work for industries in

which:
– worker skills are scarce or
– competition for labor is intense,
• However, it is cost-effective:
– during periods of high unemployment or
– for industries with low-skilled workers.
3. Peak Demand

• It calls for maintaining resources for peak demand levels.

• It is used when:
– superior customer service is important, or
– customers are willing to pay extra for the availability of
critical staff or equipment.
 Cost
– investment in extra workers and machines that remain
idle during low-demand periods.
4. Overtime and Undertime

• These are common strategies when demand fluctuations are

not extreme.
 Overtime
– It can be achieved by letting regular employees stay on
work for extended hours.
 Advantages
• A competent staff is maintained,
• hiring and firing costs are avoided, and
• demand is met without investing in permanent resources.
 Cont…

 Disadvantages
• 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
– It can be achieved by working fewer hours during the day
or fewer days per week.
– Vacation time scheduled during months of slow demand.
5. Subcontracting/Outsourcing

• It is a feasible alternative if a supplier can reliably meet

quality and time requirements.
• Mostly used for component parts, and it requires maintaining
strong ties with possible subcontractors.
 Disadvantages
• reduced profits,
• loss of control over production,
• long lead times, and
• the subcontractor may become a future competitor.
6. Part-time workers

• This strategy is feasible for unskilled jobs or in areas with

large temporary labor pools
– Such as students, homemakers, or retirees.
 Advantages of using part-time workers:
– They are less costly than full-time workers
they receive no health-care or retirement benefits
– They are more flexible
their hours usually vary considerably.
7. Back Logs, Backordering, and Lost Sales

• For make-to-order companies, the accumulation of customer

orders creates a backlog, which must be filled at a later date.
• For make-to-stock companies, customers who request an item
that is temporarily out-of-stock may backorder the item.
• If the customer is unwilling to wait for the backordered item,
the sale will be lost.
– Backorders are added to the next period’s requirements; lost
sales are not.
 Associated Cost: Backlogging (order postponement) cost.
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.
Quantitative Techniques for Aggregate Planning

• One aggregate planning strategy is not always preferable to

another.
• The most effective strategy depends on the following three
important elements.
1. Demand distribution,
2. Competitive position, and
3. Cost structure of a firm or product line.
• Quantitative techniques for both pure and mixed strategies
will be discussed.
Developing the Aggregate Plan

Here are the steps in developing an aggregate plan:

• Step 1: Identify the aggregate plan that matches the
company’s objectives: level, chase, or hybrid.
• Step 2: Determine the aggregate production rate
– Calculate how many units will be produced on regular time
and overtime and how many will be subcontracted.
• Step 3: Calculate the size of the workforce.
– Calculate how many workers are needed to achieve the
production rate needed.
 Cont…

• Step 4: Test the aggregate plan

– calculate the inventory levels, expected number of
employees hired and fired, and shortages faced.
– Calculate the total cost for your plan.
• Step 5: Evaluate the plan’s performance
– It is evaluated in terms of cost, customer service, human
resources, and operations.
A. Pure Strategies

Example 1:
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 the candies.
 Cont…

Quarterly sales forecast and cost data for Rich and Good Company
Solution
 Cont…

• Production in excess of demand is stored as inventory, and

demand in excess of production is met by using stored inventory.
• The production plan is developed as follows.

• Cost of Level Production Strategy

= (400,000 * $2.00) + (140,000 * $.50) = $870,000
Cont…
 Cont…

• The production plan and resulting hiring and firing costs are
given below.

• Cost of Chase Demand Strategy

= (400,000*$2.00)+(100*$100)+(50*$500) = $835,000
NB: Chase demand is the best strategy (cost wise) for Good and Rich company.
B. Mixed Strategies

• Mixed strategies are the most commonly used strategies of

production planning.
• They 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.
• For example, companies that face a slowdown during part of
the year can arrange employee vacations during that time.
Example (1a)

Planners for a company are about to prepare an aggregate plan

that will cover six periods. They have assembled the information
given in the following table. Now they want to develop a plan
that calls for a steady rate regular time output, mainly using
inventory to absorb the uneven demand but allowing some
backlog.
Given additional information that:
– they intend to start with zero beginning inventory
– the planned ending inventory level is zero, and
– there are 15 workers (beginning), evaluate the plan.
 Cont…

Demand forecast and cost data

Period 1 2 3 4 5 6 Total

Forecast 200 200 300 400 500 200 1800

Costs
Output Regular time $2 per unit
Overtime $3 per unit
Subcontract $6 per unit
Inventory $1 per unit per period on average inventory
Backorders $5 per unit per period
Solution
Overall production plan for example (1a)

Period 1 2 3 4 5 6 Total
Forecast 200 200 300 400 500 200 1800
Output
Regular time 300 300 300 300 300 300 1800
Overtime -- -- -- -- -- --
Subcontract -- -- -- -- -- --
Output-Forecast 100 100 0 (100) (200) 100 0
Inventory
Beginning 0 100 200 200 100 0
Ending 100 200 200 100 0 0
Average 50 150 200 150 50 0 600
Backlog 0 0 0 0 100 0 100
Costs
Output
Regular time $600 600 600 600 600 600 $3600
Overtime -- -- -- -- -- -- --
Subcontract -- -- -- -- -- -- --
Hire/Fire -- -- -- -- -- -- --
Inventory $50 150 200 150 50 0 $600
Backorders $0 0 0 0 500 0 $500
Total $650 $750 $800 $750 $1150 $600 $4700
Example (1b)

After reviewing the plan developed in the preceding example,

planners have decided to develop an alternative plan. They
have learned that one person is about to retire from the
company. Rather than replace him, they would like to stay
with the smaller workforce and use overtime to make up the
lost output. The reduced regular-time output is 280 units per
period. The maximum amount of overtime output per period
is 40 units. Develop a plan and Compare it to the previous
one.
Solution
Overall production plan for example (1b)

Period 1 2 3 4 5 6 Total
Forecast 200 200 300 400 500 200 1800
Output
Regular time 280 280 280 280 280 280 1680
Overtime -- -- 40 40 40 -- 120
Subcontract -- -- -- -- -- --
Output-Forecast 80 80 20 (80) (180) 80 0
Inventory
Beginning 0 80 160 180 100 0
Ending 80 160 180 100 0 0
Average 40 120 170 140 50 0 520
Backlog 0 0 0 0 80 0 80
Costs
Output
Regular time $560 560 560 560 560 560 $3360
Overtime -- -- 120 120 120 -- 360
Subcontract -- -- -- -- -- -- --
Hire/Fire -- -- -- -- -- -- --
Inventory $40 120 170 140 50 0 $520
Backorders $0 0 0 0 400 0 $400
Total $600 $680 $850 $820 $1130 $560 $4640
Comparison

• The total cost for the first plan (example 1a) is $4700.
• Whereas, the total cost for the second plan (example 1b) is
$4640, which is $60 less than the previous plan.
– In the second plan, regular time production and inventory
costs are down, but there is overtime cost.
– However, this plan achieves savings in backorder cost,
making it somewhat less costly overall than the plan in
example 1a.
 Total cost saving = $60
Example (1c) [Exercise]

The planners in the previous examples have decided to try out

another option. The plan is to use temporary workers to fill in
during months of high demand [rather than to stay with
smaller workforce and use overtime]. Suppose it costs an
additional $100 to hire and train a temporary worker, and
that a temporary worker can produce at a rate of 15 units per
period. Determine the number of temporary workers required
to fill-up the lost out put of 120 units, evaluate the plan and
compare it with the previous plans.
37