Operations Management / Supply Chain Management

Module 11.02 Key Concept: Aggregate Demand and Supply Planning Methods

The objective of aggregate planning is usually to meet forecast demand while minimizing cost over the planning period

Many company leaders think of Demand Planning as a passive activity.  Companies offer “stuff” for sale and customers purchase at will.  Customer demand must be forecast but the selling company has no control over when and how much the customer will buy so forecasts are tentative at best.  Is this really true?  Actually selling companies have a great deal of control over demand.  Marketing campaigns, product portfolio management, time to market management, customer service management, distribution strategy development and execution, all impacts product / service demand.

Once the Demand Plan is developed, a Supply Planning strategy must be decided and implemented.  We already discussed different manufacturing environments: Make-to-Stock, Make-to-Order, Assemble-to-Order and Engineer to Order.  In the case of Make-to-Stock, supply planners are developing forward plans to meet forecasted sales and inventory targets.   In the case of the other three strategies, planners are developing forward plans to support forecasted sales with raw materials, components and capacity, and they are managing customer backlog.  From a Sales & Operations Planning Perspective, Make-to-Stock teams create a demand plan, a supply plan, and an inventory plan for each product family.  For other environments teams create a demand plan, a supply plan and a backlog plan for each product family.

Aggregate Supply Planning combines appropriate resources into general terms.  This is a critical part of a larger production planning system.  Disaggregation breaks the plan down into greater detail and results in a master production schedule.
There are many different question to be answered in the process of Aggregate Planning:
  • Should inventories be used to absorb changes in demand?
  • Should changes be accommodated by varying the size of the workforce?
  • Should part-timers, overtime, or idle time be used to absorb changes?
  • Should subcontractors be used and maintain a stable workforce?
  • Should prices or other factors be changed to influence demand?

If there are imbalances then different options are available.

 Inventory levels can be altered. Inventory can be increased in low demand periods to meet high demand in the future.  This results in potential increased costs associated with storage, insurance, handling, obsolescence, and capital investment.  Also, shortages may mean lost sales due to long lead times and poor customer service.
Workforce levels can be varied by hiring or layoffs in order to match production rate to demand.  This results in increased training and separation costs for hiring and laying off workers.  In addition, new workers may have lower productivity. Laying off workers may lower morale and productivity.  Using part-time workers may may be useful for filling unskilled or low skilled positions, especially in services.
Production rates can be altered through overtime or idle time.  This allows a constant  workforce.  However, it may be difficult to meet large increases in demand.  Also, overtime can be costly and may drive down productivity and absorbing idle time may be difficult.
Subcontracting can be a reasonable temporary measure during periods of peak demand.  It may be costly and assuring quality and timely delivery may be difficult.  In addition, subcontracting exposes your customers to a possible competitor.

Demand can be influenced by using advertising or promotion to increase demand in low periods.  This represents an attempt to shift demand to slow periods but may not be

sufficient to balance demand and capacity.
Back ordering during high-demand periods requires customers to wait for an order without loss of goodwill or the order.  This is most effective when there are few if any substitutes for the product or service but often results in lost sales.
Counter-seasonal product and service mixing can be used to develop a product mix of counter-seasonal items.  However, this may lead to products or services outside the company’s areas of expertise.

There are two basic strategies for balancing supply with demand:

Chase–production:  Supply output is changed to match sales quantities.  Since demand is dynamic, this means that supply plans vary each period.  This approach minimizes changes in inventory but can have significant negative impact on production efficiency and cost if production flexibility is difficult to achieve.

Level–production:  Supply output is constant from period to period.  This optimizes production / supplier efficiency but can result in large variations in inventory as it is built up and depletion over time.  A level production strategy may result in high safety stocks in order to meet customer delivery expectations.

A Mixed strategy (combination of chase and level) and sub-contracting are often used to result in acceptable levels of flexibility and inventory / backlog.  There are many different possible mixing strategies and it may be difficult to determine the optimal approach,

A usual output of the Sales and Operations Planning Process is a spreadsheet that expands out, on a rolling bases, 18 months or more in the future.  The length of the planning horizon depends on the basic strategy of the business and the time to secure / expand key resources (i.e. production assets.)  The spreadsheet consists of a Demand Plan, a Production Plan and an Inventory Plan (for Make-to-Stock businesses).  The text shows a very basic example of the components of such a spreadsheet.    Alternate Production Strategies are then shown to achieve the ending inventory objective.

Many organization chose a Make-to-Order strategy rather than Make-to-Stock.  In this case:

  • Products are made to customer specifications
  • The customer is willing to wait for completion
  • Generally products are more expensive to make and/or store
  • Several options are often available
  • Company often monitors a backlog of unfilled customer orders rather than inventory

The same approach is applied in a Make-to-Order environment but instead of an Inventory Plan the S&OP creates a Backlog Plan.

The text provides a Graphical Approach as an alternate.  Graphical methods are practical because they are easy to understand and use.  A trial-and-error approach may not guarantee an optimal solution but requires only limited computations.

  • Determine the demand for each period
  • Determine the capacity for regular time, overtime, and subcontracting each period
  • Find labor costs, hiring and layoff costs, and inventory holding costs
  • Consider company policy on workers and stock levels
  • Develop alternative plans and examine their total cost

So, here we have a fairly simple example of trying different strategies and optimizing based on a single parameter – lowest total cost.  If you review the example you can see that we are balancing the cost of changes in inventory with a level production planning approach vs.  the cost of changing production capacity (usually people but can be equipment as well) with a chase type of strategy.

More complex mathematical models can also be employed in simulation mode to test different solutions vs. multiple parameters.  Linear programing is one of these approaches that is available in sophisticated information management systems and can even be accomplished in Excel for simple models.  The text provides an example of the use of Linear Programing to optimize based on transportation.   This approach produces an optimal plan and works well for inventories, overtime, subcontracting.   It does not work when nonlinear or negative factors are introduced – other models will need to be applied.