Aggregate Planning & Capacity Planning

Overview of Planning Activities

Operations planning activities can be long-range, medium-range, or short-range in nature:

Long-range planning focuses on a time period of more than one year and is generally
carried out annually. Examples are process planning and strategic capacity planning.
Medium-range planning focuses on a time period of 6-18 months. Aggregate planning,
master production scheduling, and materials requirement planning are examples.
Short-range planning focuses on a time period of less than 6 months. Examples are order
scheduling and workforce scheduling.

Business Planning - The business planning process coordinates the activities of each
function or department such that all activities and resources are focused on achieving the
organization’s objectives. It is used to address concerns like new product development,
sales levels to be achieved, new process requirements, capital investments, and new
distribution strategies. Decisions on these issues are taken with the help of medium-term
and long-term plans and are evaluated on the basis of their impact on the profitability of
the business. Intermediate-term or medium-term planning involves developing specific
objectives for various departments or functions such as manufacturing, marketing,
finance, production, etc. These plans are subsets of long-term plans, and operate within
the constraints set by them. Long-term business planning is done on the basis of long-
term business forecasts. Planning decisions include setting capital budgets for acquiring
new facilities, expanding plant capacity, and purchasing high cost equipment. These
forecasts may not be too accurate as there is the possibility of changes occurring in the
economic and competitive conditions in the future. Long-term decisions limit the scope
for change during the intervening time period by acting as constraints. Therefore, they
must be periodically evaluated for their effectiveness and suitability in achieving
organizational goals.

Operations Planning - An operations or production plan is a part of the business plan that
defines how an organization plans to produce products or services and estimates the cost
of production. A production plan contains information regarding the production process,
manufacturing facilities, inventory requirements, suppliers, etc. Such a plan is made on
the basis of sales estimates. Production output is expressed in terms of revenue earned,
output generated, or units of aggregate product that represent all the products in the
product line of an organization. Operations plans have to be aligned with business plans
and objectives of marketing, finance, human resources functions, etc. A production plan
specifies the quantity of items to be produced, the quantity and timing of production, and
the final schedule for the completion of production.

The Aggregate Planning Process

Aggregate plans define how resources can be best utilized to meet market demand for the
given products. An aggregate plan aims to minimize production costs, make suitable
changes in production rates and workforce levels, and improve profits, customer service,
and resource utilization. The aggregate planning process is a complex one as a number of
variables have to be considered in the planning process:

Concept of Aggregation – In this stage, a meaningful measure of output is identified. This

is easy for organizations with a single product but difficult for those producing several
products. In cases of organizations producing several products, a measure is found by
identifying groups or families of individual products.

Aggregation Planning Goals – An aggregate plan has to simultaneously satisfy a number

of goals. Following are a few important goals:
Aggregate planning should contain information on the required output level to be
produced, inventory levels to be maintained, and the backlogs based on the business plan.
The aggregate plan should make efficient use of the facility’s capacity and the usage
should be consistent with the organization’s strategy. Capacity underutilization may lead
to wastage of resources.
The company’s objectives and its policies regarding its employees should be in line with
its aggregate plan.
Forecasts of Aggregate Demand – Aggregate planning can deliver better results through
accurate forecasting.
Inter-relationships among Decisions – All activities in an organization are interrelated
and dependent on each other. Operations managers must therefore consider the
consequences of current decisions on the future, as these decisions will have an effect on
activities in the future.

Strategies for Developing Aggregate Plans

An aggregate plan is developed after considering different variables which influence the
production plan. These variables are used in different combinations to enable an
organization to satisfy the market demands. (See figure 9.1)
Figure 9.1: Managerial Importance of Aggregate Plans
Pure Planning Strategies – Fluctuations in demand and uncertainties in production
activities can be managed effectively:
By varying the size of the workforce
By varying the utilization of the workforce
By varying the size of inventory
Through backorders, subcontracts, and by varying plant capacity
The strategy is called pure strategy if only one of these strategies is adopted to the
exclusion of others. Generally, a combination of these strategies is used instead of a
single strategy.

Varying the workforce size in response to the output requirements: In this strategy, the
workforce size is changed by hiring and laying off workers in direct proportion to
demand. Based on the productivity of the average worker, the management determines
the number of workers required to meet each month’s output requirements. When the
quantity to be produced is low, the workers are laid off and when there is an increase in
orders, workers are hired. This strategy is followed by many US automakers. The
disadvantages of this strategy are: it involves hiring costs, laying off costs and indirect
costs of training new employees; it affects workforce morale when some workers are laid
off; and skilled workers may not be available when they are needed. Moreover, firms
which have agreements with unions on wages, hiring, and layoffs cannot employ this
strategy.
Varying the utilization of the workforce: In this strategy, the firm maintains a stable
workforce and alters its utilization in line with the demand or required output. If the
demand is lean, the workforce is scheduled to produce only the output required to meet
the demand. This results in idle work hours. If the demand is high, the same workforce
works overtime to meet the demand. Thus, the workforce is overworked when demand is
high, and underutilized when demand is low. This strategy is disadvantageous as it
involves expensive overtime costs and legal and behavioral limits on overtime have to be
adhered to. Due to overwork, the employees may become inefficient and prone to job-
related accidents.

Alternatively, too much of idle time results in loss of interest and affects employee
morale.
Varying the size of inventory: In this strategy, an organization maintains the workforce
and production at a constant level. If the demand is low, the stable rate of production
results in accumulation of inventories. If the demand is more than the capacity, the
additional requirement is met by using the already accumulated inventories. This results
in varying inventory levels throughout the planning period. The advantages of this
strategy are stable employment, no idle time, and no overtime. There are disadvantages
too though, and they are increased inventory-carrying and materials handling costs,
additional storage space requirements, and the risk of damage or obsolescence.
Back orders, subcontracting, and plant capacity: To maintain smooth operations, a back
order strategy is used. In this, current order commitments are fulfilled in the future
assuming that customers are ready to wait for delivery. Though it effectively smoothens
out production, it may sometimes result in stock-out costs as when customers do not wait
till the product is delivered and switch to a competitor’s product. The subcontracting
strategy allows level production and sources the additional output required from
subcontractors. The adjusting plant capacity strategy allows the equipment capacity to be
changed during the short term and the long term to absorb demand fluctuations.

Aggregate Planning Techniques

Aggregate planning models like graphical, optimal, and heuristic models help planners to
formulate the aggregate output plan.
Graphical Method for Aggregate Output Planning - The graphical method is a two-
dimensional model linking cumulative demand to cumulative output capacity. It is a
technique used in developing and evaluating various alternative plans or a combination of
these alternatives and identifying the best plan through trial and error. Following are the
steps involved in this method:
A graph is drawn taking the cumulative productive days for the planning time period on
the X or horizontal axis, and the cumulative units of output on the Y or vertical axis. The
cumulative demand forecast for the entire planning time period is plotted on the graph.
A planning strategy is selected based on the aggregate planning goals. The planned
output for each period in the planning period is computed and plotted on the same axis
used to plot the demand.
The planned output is compared with expected demand and periods of excess inventory
and shortages are identified.
The costs involved in the implementation of the plan are calculated.
The plan is modified to meet aggregate planning goals by repeating steps (b) to (d) until a
satisfactory plan is established.
This method is simple to understand and requires the minimal computational effort.

Optimal Models for Aggregate Planning

Linear programming: The linear programming procedure identifies the optimal plan for
minimizing costs that specifies the number of units to be produced, the total number of
shifts for which the plan should operate in the planning time horizon, and the amount of
inventory that has to be carried in each time period. The model is used to allocate scarce
resources to strategic alternatives when the costs of various resources are linear functions
of their quantities. The model is useful when the cost and variable relationships are
linear, and demand can be forecast exactly.
Linear decision rules (LDRs): LDRs are a set of equations for calculating the optimal
workforce, aggregate output rate, and inventory level for each period in the planning
period. This method guarantees an optimal solution and eliminates trial-and-error
computations. It also overcomes the limitation of linear programming by considering
non-linear cost relationships. The disadvantage is that LDRs must be tailored to fit each
organization’s specific requirements. Further, an extensive mathematical analysis has to
be carried out to derive proper LDRs for a particular company. Finally, any changes in
the cost relationships like increase in wages will require redoing the whole process to
derive new LDRs.
Heuristic models – Heuristic models are based on the historical aggregate planning data
available with organizations. The management coefficient model is a heuristic model
which uses the regression method to identify capacity requirements based on the
management’s past decisions. The management coefficient model is used to generate a
set of equations that represents the historical patterns of a company’s aggregate planning
decisions. Heuristic models are easy to construct if the relevant historical data is
available. But they should be applied after careful consideration, as past patterns may not
always be an accurate indicator of future trends.
Computer Search Models – These models are used when an organization has a large
quantity of information on different production variables. A computer program simulates
conditions under all possible combinations of these variables and identifies the most cost-
effective combination that satisfies the production requirements. To identify the optimum
aggregate plan, it evaluates all possible combinations based on specified search
conditions.

Computer Simulation in Capacity Evaluation: Computer simulation is used for evaluating

the performance of a specific plan based on real-world variables and situations.
Simulation provides a what-if analysis of different situations, using different variables
with alternative values attached to them, to judge the performance of the system under
different conditions. Complex situations can be analyzed with the help of simulation
models. Using simulation, different layouts and schedules can be tested to see which will
enable an organization to maximize its capacity utilization. The formulation of the
simulation method is quite complicated, and the costs associated with it are high.

Master Production Schedule

The Master Production Schedule (MPS) defines the type and volume of each product that
is to be produced within the planning horizon. It is a detailed plan that states the exact
timing for the production of each unit and is also used in scheduling various stages of
production, depending on the type of operations. For example, the MPS of make-to-order
organizations deals only with final products, and not with components and sub-
assemblies. The MPS for assemble-to-order organizations concentrates on scheduling
major components that are assembled to make a product after receiving orders. The MPS
is based on an estimation of the overall demand for the end product. A final assembly
schedule is developed only when customer orders are received. Following are the
functions of an MPS.

Translate aggregate plans: The master schedule is a manufacturing plan which breaks up
the planned total production of the firm into groups of products or product lots. The lot
sizes are determined in such a way that the products are economical to produce and
utilize the firm’s facilities and resources at an optimal level. The aggregate plan sets a
level of operations that balances market demand with the material, labor, and equipment
capabilities of the firm, whereas the master schedule is more detailed and translates the
aggregate plan into a specific number of individual products to be produced in specific
time periods at specific workstations.

Evaluate alternative schedules: To evaluate alternative schedules, planners use

computerized production and inventory control systems with simulation capabilities.
After evaluating the alternatives, the detailed material and capacity requirements are
identified, and the exact lead times and delivery schedules are determined. The
simulations also show how increased demand for one product can affect the production
schedule of other products.

Identify material requirement: The master schedule is the prime requisite for a materials
requirements planning system. After drawing up the master schedule, it alerts the material
requirement planning system to produce or purchase the components that are needed to
meet the requirements of the final assembly schedules.

Generate capacity requirements: Capacity requirement planning needs inputs from the
material requirement plan, which in turn, is directed by the master schedule. So, the
master schedule is a prerequisite for capacity planning. The master schedule reflects the
most economical usage of labor and equipment capacities. Either the production capacity
or the MPS is revised if the capacity available does not satisfy the requirements of the
MPS.

Effectively utilize capacity: The MPS assigns loads for labor and equipment based on the
requirements. The load report considers the individual product requirements and
available resources in assigning load to individual workers, equipment, and workstations
in order to fully utilize the available capacity.

Master Production Scheduling - The master production scheduling process involves the
planning activities of Material Requirements Planning (MRP) and Capacity
Requirements Planning (CRP) to determine whether or not an operation can achieve the
production objectives mentioned in the MPS. The CRP determines whether the existing
production capacity is sufficient to achieve the objectives of the MPS. (See figure 9.2)
Figure 9.2: The Master Production Scheduling Process

Following are the steps involved in the process:

Determining the gross requirements of materials, components, and sub-components (total
demand in units of the end-product) for each product in the product line, using the MRP.
Obtaining the net requirements for each unit of materials, components, and sub
components, after considering the inventory on hand and the inventory on order.
Revising the preliminary MPS to accommodate the inadequacy of materials in the
inventory, if any.

Converting adjusted net requirements into planned order releases (the order quantity for a
specific time period) to determine unit or lot-sized production during the planning
horizon.

Developing load reports from the planned order releases. The load report contains
information on the amount of work assigned to individual workers, machines, and
workstations.

Modifying the MPS or adding capacity in case of a mismatch between available and
required capacities. Master production scheduling is generally based on the demand
forecast results. These results are not always accurate and the actual production output is
not always similar to the actual market demand. To accommodate these imbalances,
operations managers modify the MPS by Temporarily modifying the size or composition
of the product or service Allowing the inventory level to increase when the demand for
the product is low and decrease when the demand is higher Deferring routine
maintenance and diverting labor capacity to manufacturing
Subcontracting the additional capacity requirements
Changing the prices of products to influence the demand level

Master Schedule Formation - The MPS has to be properly implemented if the goals set in
the aggregate plans are to be implemented. Both the aggregate plan and the MPS are
influenced by the market environment and resource availability. Forecasts and customer
orders influence the MPS. A make-to-stock environment takes inputs from forecasts in
generating the MPS while a make-to-order environment takes inputs from customer
demand.

Make-to-stock items: Demand forecast is the major input for these items in the MPS.
Requirements are based on the need to replenish plants or distributor inventories of end
products or service parts. The MPS is generated after considering the end item level. In
this environment, products are produced in batches and a finished goods inventory for all
the products is always maintained. For e.g., home appliances and FMCG.

Make-to-order items: Detailed scheduling of time and materials required is essential for
these as the items and quantities specified are unique for a particular customer order. In
this environment, there is no finished goods inventory, customer orders are backlogged,
and production begins only after the orders have been placed. For e.g., jet engines.

Implementing Aggregate Plans and Master Schedules

Unplanned Events – The effects of unplanned events are contained by continuously
updating the aggregate plans. Due to unexpected events, the actual demand for a product
will differ significantly from the forecasted demand. While developing aggregate plans,
unexpected events which disrupt the plans like the planned output for the month not
being achieved or the workforce not being able to produce at its average capacity should
be considered. In such cases, the actual demand is taken as an input rather than the
forecasted demand. As the aggregate plans are updated, the MPS is also changed to
incorporate these changes. Sometimes the aggregate plan remains fixed, while the MPS
undergoes changes due to changes in demand for individual products, the production
process, and performance rates. The MPS transactions, records, and reports are updated
and reviewed continuously to lodge these changes. This process of reviewing and
updating, called “rolling through time,” shows the dynamic nature of planning and
scheduling activities in operations management.

Behavioral Considerations – These are vital for planning and implementing aggregate
plans. Intricacies in planning are dependent on the time horizon. A plan which is short-
term and based on judgment and experience would be costly while planning for the long-
term would be a difficult task. Therefore, an optimal time period should be selected for
aggregate planning. The implementation of the aggregate plan has an impact on all the
functions and departments of an organization. It sets off actions in various functions and
affects the organizational environment. If the plan specifies reduced output, people will
be removed from their jobs and this, in turn, will affect their motivation level and job
satisfaction.

Capacity Planning
Capacity is the maximum output that can be produced in a given system. If a factory has
a production capacity of 100 units per hour, it means that it can produce 100 units per
hour under optimal conditions. However, it is not possible to achieve 100% capacity
utilization in most of the cases. Capacity is measured in terms of output, such as, units
per unit of time (10 units/hour) or available resource hours (5 machine hours/day).
Capacity planning involves identifying and evaluating the long term and short-term
capacity requirements of an organization, and developing plans to fulfill them. It is vital
for determining adequate production capacity to meet forecast demand levels.

Capacity planning is used by organizations to decide whether or not to use subcontracting

or overtime to achieve production goals.
Measuring Capacity - Capacity of a manufacturing plant is usually measured in terms of
input or output of the plant. In service organizations like hospitals, the capacity can be
measured in terms of number of beds available, or number of tables available in a
restaurant, etc. Capacity can be measured by using the formula:
Capacity = Available time x utilization x efficiency
Capacity utilization rate is measure that indicates the capacity level at the production
process is operating.
Hence,
where, capacity available indicates the designed capacity.
The capacity planning process involves identifying the available capacity and additional
capacity requirements, and evaluating and summing up the capacities required at each
work center. Any gap between planned and available capacity is increased by revising the
MPS or by increasing the overtime, subcontracting, etc. For an effective capacity plan, an
organization has to first identify current capacity and forecast the future requirements;
then identify and evaluate the sources which can be used to meet the capacity
requirements; and finally select the most proper alternative.

Economies of Scale - As the quantity of output increases, the average cost per unit
decreases. This is termed as economies of scale. That is the per unit cost decreases with
the increase in the scale of production. This happens due to reduction in fixed costs,
adoption of efficient processes and automation technologies. But, as the scale of
production is further expanded beyond a point, the cost per unit takes the reverse
direction and would increase gradually. This reverse phenomenon is termed as
diseconomies of scale. This can be attributed to complexities in operations, high costs of
modification, need to replace existing facilities, and increased distribution and storage
costs.

Summary
Operations planning activities can be long-range, medium-range, or short-range in nature.
Long-range planning focuses on a time period of more than a year and is generally
carried out annually; medium-range planning focuses on a time period of 6-18 months;
and short-range planning focuses on a time period of less than 6 months.

The business planning process coordinates the activities of each function or department
such that all activities and resources are focused toward achieving the organization’s
objectives.

An operations or production plan is a part of the business plan that defines how an
organization plans to produce products or services and estimates the cost of production.

Aggregate plans define how resources can best be utilized to meet market demand for the
given products. It aims to minimize production costs, make suitable changes in
production rates and workforce levels, and improve profits, customer service, and
resource utilization. An aggregate plan is developed after considering different variables
which influence the production plan such as concept of aggregation, aggregation planning
goals, forecasts of aggregate demand, and inter-relationships among decisions.

Fluctuations in demand and uncertainties in production activities can be managed

effectively by varying the size and utilization of the workforce, by varying the size of
inventory, or through backorders, subcontracts, and varying plant capacity. If only one of
the strategies is used, it is called pure strategy.

Aggregate planning models like graphical, optimal, and heuristic models help planners
formulate the aggregate output plan.
The Master Production Schedule (MPS) defines the type and volume of each product that
is to be produced within the planning horizon. It is a detailed plan that states the exact
timing for the production of each unit and is also used in scheduling various stages of
production, depending on the type of operations.

The effects of unplanned events and behavioral considerations should be taken into
account while updating the aggregate plans and master schedules.

Capacity planning involves identifying and evaluating the long term and short-term
capacity requirements of an organization, and developing plans to fulfill them. It is vital
for determining adequate production capacity to meet forecast demand levels.

Capacity of a manufacturing plant is usually measured in terms of input or output of the

plant. The capacity planning process involves identifying the available capacity and
additional capacity requirements, and evaluating and summing up the capacities required
at each work center.

The per unit cost decreases with the increase in the scale of production (upto a certain
extent). This is termed as economies of scale.