Lecture 6

Sales and Operations Planning and

Modelling

1
 Debriefing

Top-Down Approach

Sales and Operations Planning

2
 Why Sales and Operations Planning is important in
supply chain planning

Finished goods
Inventory

Sales and Operations MPS CRP

Forecasted Demand Planning(Aggregate Planning)
MRP ERP
(disaggregate) (feasibility check)

Horizon: 3-18 months Time bucket: Weekly

Production Capacity
Time bucket: Monthly

Horizon: 3-18 months

Time bucket: Monthly

• Master Production Schedule(MPS) • First we introduce Aggregate Planning

• Capacity Requirement Planning(CRP) • Then we discuss the Sales and Operations
• Material Requirement Planning(MRP) Planning
• Enterprise Resource Planning(ERP)
 Aggregate Planning

The objective of aggregate planning

is usually to meet forecast demand
while minimizing cost over the
planning period

4
 Capacity has a cost !!
Should a company invest in a plant with
large capacity that is able to produce
enough to satisfy demand even in the
busiest month ?

Aggregate Planning helps

companies answer these
Should a company build a smaller plant
types of questions.
but incur the costs of holding inventory
during slow periods in anticipation of
demand in later months ?

How should a firm best utilize the

facilities that it currently has ?

5
 Role of Aggregate Planning
in a Supply Chain
• Capacity has a cost and lead times are often long
• Aggregate planning:

 process by which a company determines levels of capacity,

production, subcontracting, inventory, stock-outs, 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
– Subcontracting
– Workforce
– Backlog
– Overtime
– Inventory on hand
– Machine capacity level
• All supply chain stages should work together on an aggregate
plan that will optimize supply chain performance

7
 Outputs of Aggregate Plan

• Production quantity from regular time,

overtime, and subcontracted time
• Inventory held
• Backlog/stock-out quantity
• Machine capacity increase/decrease

A poor aggregate plan can result in lost

sales, lost profits, excess inventory, or
excess capacity
8
 Identifying Aggregate Units of
Production ( 1st step )
• Aggregate unit should be identified in a way that the
resulting production schedule can be accomplished
in practice
• Focus on the bottlenecks when selecting the
aggregate unit and identifying capacity and
production times
• Account for activities such as setups and
maintenance

9
 Red Tomato Tools
Red Tomato Tools, a manufacturer of gardening equipment with manufacturing
facilities in Mexico. The company make 6 product families at its manufacturing Table 1
plant
Setup Net
Material Time/B Average Production Production Percentage
Cost/ Revenue/ atch Batch Time/ Unit Time/Unit Share of
Family Unit ($) Unit ($) (hour) Size (hour) (hour) Units Sold
A 15 54 8 50 5.60 5.76 10
B 7 30 6 150 3.00 3.04 25
C 9 39 8 100 3.80 3.88 20
D 12 49 10 50 4.80 5.00 10
E 9 36 6 100 3.60 3.66 20
F 13 48 5 75 4.30 4.37 15

• Weighted average approach

Material cost per aggregate unit
= (15 x 0.10) + (7 x 0.25) + (9 x 0.20) + (12 x 0.10) + (9 x 0.20) + (13 x 0.15)
= $10
• Similarly
- Revenue per aggregate unit = $40
- Net production time per aggregate unit = 4.00 hours

10
 Aggregate Planning
Strategies

Trade-off between capacity( regular time, overtime,

subcontracted) , inventory, backlog/lost sales because of
delay

• 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

• Tailored or hybrid strategy – a combination of strategies

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 Chase Strategy
using capacity as the lever
The production rate is synchronized with
the demand rate by vary machine
capacity or hire and lay off workers as
demand varies.

• 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
• Used when inventory holding costs are high and costs of
changing capacity are low

12
 Chase Strategy
using capacity as the lever
Demand

Units Production

Time

13
 Time Flexibility Strategy
-using utilization as the lever
This strategy may be used if there is excess
machine capacity ( i.e., if machine are not used
24 hours a day, 7 days a week ) and the work
force shows scheduling flexibility.
• Use excess machine capacity
• Workforce stable, number of hours worked varies
• Use overtime or a flexible work schedule
• Flexible workforce, avoids morale problems
• Low levels of inventory, lower utilization
• Used when inventory holding costs are high and capacity is
relatively inexpensive

14
 Level Strategy-
using inventory as the lever
Stable machine capacity and workforce
are maintained with a constant output
rate.

• Inventory levels fluctuate over time

• Inventories carried over from high to low demand
periods
• Better for worker morale
• Large inventories and backlogs may accumulate
• Used when inventory holding and backlog costs are
relatively low
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 Level Strategy-
using inventory as the lever

Demand

Units Production

Time

16
 Red Tomato Tools

Red Tomato sells each tool through retailers for $40. The company has a starting
inventory in January of 1,000 tools. At the beginning of January, the company has
a workforce of 80 employees. The plant has a total of 20 working days in each
month, and each employee earns $4 per hour regular time. Each employee works
eight hours per day on straight time and the rest on overtime. As discussed
previously, the capacity of the production operation is determined primarily by
the total labor hours worked. Therefore, machine capacity does not limit the
capacity of the production operation. Because of labor rules, no employee works
more than 10 hours of overtime per month. The various costs are shown in Table
3. It is important that the costs and labor hours are in aggregate units, as
represented in Table 3.

17
 Aggregate Planning Using
Linear Programming
LP is a tool for company to use
when it rises to maximize Item Cost
profits while being subjected
Material cost $10/unit
to a series of constraints.
Inventory holding cost $2/unit/month
Month Demand Forecast
Marginal cost of $5/unit/month
January 1,600 stockout/backlog
Hiring and training costs $300/worker
Februar 3,000
y Layoff cost $500/worker
March 3,200
Table 2 Labor hours required 4/unit
April 3,800
Regular time cost $4/hour
May 2,200
Overtime cost $6/hour
June 2,200
Cost of subcontracting $30/unit
Red Tomato Tools:
– Highly seasonal demand Table 3
– Develop a forecast
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 Red Tomato Tools

Currently, Red Tomato has no limits on subcontracting,

inventories, and stockouts/ backlog. All stockouts are backlogged
and supplied from the following months’ production. Inventory
costs are incurred on the ending inventory in the month. The
supply chain manager’s goal is to obtain the optimal aggregate
plan that allows Red Tomato to end June with at least 500 units
(i.e., no stockouts at the end of June and at least 500 units in
inventory).

19
 Red Tomato Tools
Decision Variables
For t = 1, ..., 6

Wt = Workforce size for month t

Ht = Number of employees hired at the beginning of month t
Lt = Number of employees laid off at the beginning of month t
Pt = Production in month t
It = Inventory at the end of month t
St = Number of units stocked out/backlogged at the end of month
t
Ct = Number of units subcontracted for month t
Ot = Number of overtime hours worked in month t

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 Red Tomato Tools
Objective Function
Minimize
(Regular-time labor cost + Overtime labor cost + Cost of
Item Cost hiring and layoffs + Cost of holding inventory + Cost of
Material cost $10/unit
stocking out + Material cost +Cost of subcontracting)
Inventory holding cost $2/unit/month
Marginal cost of $5/unit/month
stockout/backlog
Hiring and training $300/worker $640 ($4/hour * 8 hours/day * 20 days/month)
costs
6 6 6 6
Layoff cost $500/worker
Min( 640Wt   6Ot   300 H t   500 Lt
Labor hours required 4/unit t 1 t 1 t 1 t 1
Regular time cost $4/hour (1)
6 6 6 6
Overtime cost $6/hour   2 I t   5St   10 Pt   30Ct )
Cost of subcontracting $30/unit t 1 t 1 t 1 t 1

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 Red Tomato Tools
Constraints
1. Workforce, hiring, and layoff constraints
(2)

2. Capacity constraints
40(2 units/day* 20 days/month) (3)

3. Inventory balance constraints

What we need to
produce I t –1  Pt  I t  Ct  Dt  St –1 – St (4)

4. Overtime limit constraints

No employee work more than 10 hours of overtime each month (5)

All for t = 1,..., 6

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 Red Tomato Tools

Average time
in inventory

Little's law rule in OM: Cycle time= WIP/Throughput

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 Red Tomato Tools-
Aggregate plan solution
Table 4
Total cost over planning horizon = $422,660 Aggregate plan for Red Tomato
Revenue over planning horizon = 40 x 16,000 = $640,000

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 Red Tomato Tools

Average
seasonal 
(I0  I6 ) / 2   I   5, 250  875
5
t 1 t

inventory T 6

875
Average flow time   0.33  0.33 months
2, 667

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 Red Tomato Tools
Higher demand variability
Month Demand Forecast
January 1,000
February 3,000
March 3,800
April 4,800
May 2,000
June 1,400
Table 5

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 Red Tomato Tools
Higher demand variability
Total cost over planning horizon = $433,080

Table 6

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Red Tomato Tools Higher demand
variability

Average

( I 0  IT ) / 2   I   6,310  1,051
T –1
t 1 t

seasonal T 6
inventory

1, 051
Average flow time   0.39 months
2, 667

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 Red Tomato Tools
Lower hiring and layoff costs

Assume that demand at Red Tomato is as shown in Table 2, and all other data are the
same except that the costs of hiring and layoff are now $50 each. Evaluate the total cost
corresponding to the aggregate plan in Table 4. Suggest an optimal aggregate plan for
the new cost structure.

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 Red Tomato Tools
Lower hiring and layoff costs
Total cost over planning horizon = $412,800

Table 7

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Red Tomato Tools

Lower hiring and layoff costs

Average
seasonal 
( I 0  IT ) / 2   I   2, 410  401
T –1
t 1 t

T 6
inventory

401
Average flow time   0.15 months
2, 667

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Aggregate Planning In Excel Figure 1

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 Building a Rough Master Production Schedule(MPS)
Disaggregate an aggregate plan
• Production
Quantity(A)=2560*0.1=265

• Number of Setups(A)=
Round(256/50)=5

• Setup time(A)=8*5=40
hours

• Production time(A)=
5.6*256=1433.6

Table 9
• The plan calls for a workforce of 64 and a production of 2,560 aggregate units in Period 1

• The total planned production and setup time is 10,231.4 hours (209 for setup + 10,022.4 for
production). Given the 64 people planned, the available production time in the period 1
is 64 * 8* 20 = 10,240 hours. The planned schedule thus seems feasible.

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Sales and Operations Planning
Responding to Predictable Variability in a
Supply Chain
• Predictable variability is change in demand that
can be forecasted
• Can cause increased costs and decreased
responsiveness in the supply chain
• Two broad options
1. Manage supply using capacity, inventory,
subcontracting, and backlogs
2. Manage demand using short-term price discounts
and promotions

35
 Managing Demand
• With promotion, three factors lead to increased
demand
1. Market growth
2. Stealing share
3. Forward buying
• Factors influencing timing of a promotion
– Impact of promotion on demand
– Cost of holding inventory
– Cost of changing the level of capacity
– Product margins

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 Managing Demand

Impact on Timing of Promotion/

Factor Forward Buy
High forward buying Favors promotion during low-demand periods

High ability steal market share Favors promotion during peak-demand periods

High ability to increase overall market Favors promotion during peak-demand periods

High margin Favors promotion during peak-demand periods

Low margin Favors promotion during low-demand periods

High manufacturer holding costs Favors promotion during low-demand periods

High costs of changing capacity Favors promotion during low-demand periods

TABLE 10

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Base Case( no promotion)

FIGURE 2

Total cost over planning horizon = $422,660

Revenue over planning horizon = $640,000
Profit over planning horizon = $217,340
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 When to Promote

• Is it more effective to promote during

the peak period of off-peak?

• Analyze the impact of a promotion on

demand and the resulting optimal
aggregate plan

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 Promotion in January

• New Demand In Jan.

(1,600 * 1.1) + [0.2*(3,000 + 3,200)] = 3,000
• New Demand In Feb.
3000*0.8=2400
• New Demand In March:
3200*0.8=2560
• New price in Jan.
$40-$1=$39

• Lower seasonal inventory

Total cost over planning horizon = $422,080 • A somewhat lower total cost
• A higher total profit
Revenue over planning horizon = $643,400
FIGURE 3
Profit over planning horizon = $221,320

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 Promotion in April

FIGURE 4

• Higher seasonal inventory

• A somewhat higher total cost
• A slightly smaller total profit
• Total cost over planning horizon = $438,920

• Revenue over planning horizon = $650,140

• Profit over planning horizon = $211,220

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 Discount Leads to
Large Increase in Consumption
• Promotion in January

Demand in Jan.
(1,600 *2) + [0.2 * (3,000 + 3,200)] = 4,440

FIGURE 5

• Higher total profit than base case

• Total cost over planning horizon = $456,880

• Revenue over planning horizon = $699,560

• Profit over planning horizon = $242,680

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 Discount Leads to
Large Increase in Consumption
• Promotion in April

• Demand in April
(3,800*2) + [0.2 * (2,200 + 2,200)]
= 8,480

FIGURE 6

• Much higher level of seasonal inventory

• Uses more stockouts and subcontracting
• Total cost over planning horizon = $536,200 • Revenues increase
• Overall profits higher
• Revenue over planning horizon = $783,520

• Profit over planning horizon = $247,320

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 Supply Chain Performance

Percentage Percentage
Regular Promotion Promotion of Increase of Forward Average
Price Price Period in Demand Buy Profit Inventory
$40 $40 NA NA 875
NA $217,340
$40 $39 10% 20% 515
January $221,320
$40 $39 10% 20%
April $211,220 932
$40 $39 100% 20%
January $242,680 232
$40 $39 100% 20% 1,492
April $247,320
$31 $31 NA NA
NA $73,340 875
$31 $30 100% 20% TABLE 11
January
44 $84,280 232
 Conclusions on Promotion
1. Average inventory increases if a promotion
is run during the peak period and decreases
if the promotion is run during the off-peak
period
2. Promoting during a peak-demand month
may decrease overall profitability if there is
a small increase in consumption and a
significant fraction of the demand increase
results from a forward buy

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 Conclusions on Promotion
3. As consumption increase from discounting
grows and forward buying becomes a
smaller fraction of the demand increase
from a promotion, it is more profitable to
promote during the peak period
4. As the product margin declines, promoting
during the peak-demand period becomes
less profitable

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Implementing Sales and Operations
Planning in Practice

1. Coordinate planning across enterprises in

the supply chain
2. Take predictable variability into account
when making strategic decisions
3. Ensure that senior leadership owns the
S&OP process
4. Ensure that the S&OP process modifies
plans as the reality or forecasts change

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