Operations Management: Chase or Level Production - Term Paper Example

Operations Management Case Problem Identification Our problem is to determine which of two production management strategies – chase or level production – is best for the company to adopt, given the 12-month seasonal demand forecast specified in Table 1. Best here means determining which of the two strategies would cost less and, therefore, give the company higher profits. The problem is an example of aggregate planning. As Pan and Kleiner (1995) and Schroeder (2007) argued, firms must plan their manufacturing activities at a variety of levels and operate these as a system. Aggregate planning, a medium-range capacity planning system that typically covers a time horizon of anywhere from 3 to 18 months, has as its goal that of achieving a production plan that effectively utilizes the firm’s resources to satisfy expected demand. Decisions have to be made on output rates, employment and inventory levels and changes, back orders, and subcontracting, in effect determining not only the output levels planned but also the appropriate resource input mix to be used. Before we tackle the solution, we summarize the basic assumptions for our calculations. Basic Assumptions Table 1 contains the 12-month demand forecast and our assumptions. Aside from the total output, number of workers, cost assumptions, and labor force parameters given in the problem, we would like to highlight some key assumptions not indicated in the statement of the problem but which have an effect on the solution. The first is the capacity cushion, which determines how much excess inventory we would like to have at the end of the month to act as a buffer for potential variations in demand. A high cushion level would entail inventory costs, while a low level would entail stock-out costs that were neither given. The given initial inventory level of 200 units is equivalent to 22 percent of maximum demand (900 units in October) and 29 percent of year-end demand (600 units). Working on the principles of zero stock-outs and the maximization of resources, we calculated the standard deviation in monthly demand as plus or minus 20 percent and made the convenient assumption to keep the capacity cushion at this level of production capacity or roughly 100 units per month. We used this ending inventory level when considering both production strategies. Our second assumption is having a zero defect policy, which at the low production levels considered amount to having a moderately good quality system in place. A six-sigma quality standard would mean that there would be no product rejects within the production year, and that there would be no need to produce additional units in anticipation of possible rejects due to poor quality. The third set of assumptions concerns our labor costs, which include lay-off costs that we assumed to be equal to hiring costs, which is the given value of $100 per unit or $2,000 per worker per month for 20 units produced, and also worker wages that we assumed to be flat at $1,000 monthly regardless of job tenure. Our fourth assumption is that the factory does not have a second production shift. Solution Strategies We first worked on the Chase Production Strategy where the units produced match the quantity demanded, with a fixed cushion capacity of not less than 100 units as our end-month inventory. The findings are summarized in Table 2. In a chase production strategy, we increase the number of workers on overtime to produce enough goods to meet demand. The advantage is that we keep inventory levels to a minimum, resulting in minimal inventory holding cost each month. The advantage is control of cost increases – hiring, labor, and firing costs – depending on the required production capacity. Workers fluctuated between the original 25 workers to a maximum of 41 workers to meet the demand in October, although we end the year with only 32. The second strategy uses the Level Production Strategy, where we produce a fixed number of units each month. To determine the production level, we calculated the average monthly demand forecast and arrived at the figure of 670 units. This would ensure no stock-outs and a minimum inventory level of 100 for one month. Of course, in other months when the forecast demand is low, the inventory rises beyond this level and entails inventory costs, which may be greater than stock-out costs (which was not given). We considered two options to meet the forecast demand that was above the 500 units of production capacity per month. Option A calls for having a second production shift to utilize the same machines as the first shift. There are no overtime costs, but the increase in workers would entail hiring costs. For three months when cushion capacity is threatened to fall below 100 units, additional workers were hired for the second shift. This required hiring costs and, when production requirements fall below the required levels, firing costs. However, unlike the chase strategy that incurs hiring and firing costs from one month to the next, these costs in a level production strategy involves hiring additional workers in order to meet higher forecast demand in the succeeding month. The results are shown in Table 3. Option B entails maximizing the existing workers with overtime work up to the allowed 10 percent of capacity, bringing up production to 550 units, which is still short of the required 670 units each month. In order to increase the production capacity to 120 units, which entails additional costs, the alternative to having a second shift is to expand the production capacity to hire six new full-time workers and asking them to render overtime work up to the 10% limit. The results are in Table 4. Findings and Analysis The results of the three options – Chase strategy and two options for the Level strategy – are summarized in Table 5. The chase strategy is the most expensive of the three due to the cost of hiring and firing workers. Option B for the level strategy – hiring five additional workers that would render overtime up to the 10% limit – is the next most expensive, with the cushion capacity experiencing a low of 90 units in November. This could be addressed by subcontracting the production of 10 units at a cost that is $15 higher than if it were produced in the factory by the existing workers. Option A, which entails having a second shift has the lowest cost, $85,000 cheaper than the Chase strategy. The reason is that the same equipment can turn out the required production demand, the only expense being the need to hire 9 additional workers. This would result in a cost savings or additional profits of $10 per unit for the 12-month period. Final Recommendation We recommend the use Level Strategy Option A: having a second shift to produce 170 additional units monthly, and in the months where forecast demand would bring down our capacity cushion, hire additional workers for the second shift. Since capacity is less than the demand, we have several options: subcontracting, overtime, chase strategy, or having a second shift. In order to limit the inventory at a level that would minimize costs, we need to ensure production quality and efficiency as rejects would drive costs up due to wasted labor and materials expenses. Reference List: Armistead, C. and Clark, G. (1994). The coping capacity management strategy in services and the influence on quality performance. International Journal of Service Industry Management, 5, 2, p. 5-22. Leong, G.K., Snyder, D.L., and Ward, P.T. (1990). Research in the process and content of manufacturing strategy. Omega, 18, 2, p. 109-122. Maropoulos, P.G., McKay, K.R., Bramali, D.G. (2002). Resource-aware aggregate planning for the distributed manufacturing enterprise. Annals of the CIRP, 51, 1, p. 363-366. Olhager, J. and Rudberg, M. (2002). Linking manufacturing strategy decisions on process choice with manufacturing planning and control systems. International Journal of Production Research, 40, 10, p. 2335-2351. Olhager, J., Rudberg, M., and Wikner, J. (2001). Long-term capacity management: linking the perspectives from manufacturing strategy and sales and operations planning. International Journal of Production Economics, 69, 2, p. 215-225. Pan, L. and Kleiner, B.H. (1995). Aggregate planning today. Work Study, 44, 3, p. 4-7. Russell, R. S. and Taylor, B.W. III. (2000). Operations management. New Jersey: Prentice Hall. Schroeder, R.G. (2007). Operations management – Contemporary concepts and cases. 3rd Ed. Massachusetts: Irwin/McGraw-Hill. Stevenson, W. J. (1993). Production and operations management. Massachusetts: Irwin. Tables Table 1: 12-month demand forecast (Source: Case Study) Month Units JAN 600 FEB 700 MAR 800 APR 700 MAY 600 JUN 500 JUL 600 AUG 700 SEP 800 OCT 900 NOV 700 DEC 600 Table 2: Chase Strategy Option MONTHLY PROD. RATE (UNITS/WORKER/MONTH): 20 UNITS BEGINNING INVENTORY (UNITS): 200 UNITS BEGINNING NUMBER OF WORKERS: 25 WORKERS HIRING COST PER WORKER: $2,000 LAYOFF COST PER WORKER: $2,000 INVENTORY HOLDING COST ($ PER UNIT PER MONTH): $4.17 INVENTORY SHORTAGE COST (COST/UNIT SHORT) : $10.00 REGULAR HOURLY WAGE RATE: $6.25 OVERTIME HOURLY WAGE RATE: $9.38 HOURS/MONTH: 160 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sales Forecast 600 700 800 700 600 500 600 700 800 900 700 600 Units Produced 550 572 814 704 594 550 550 704 792 902 704 704 Ending Inventory 150 22 36 40 34 84 34 38 30 32 36 140 Number of Workers 25 26 37 32 27 25 25 32 36 41 32 32 Overtime Percent 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% Labor Requirements Total Equivalent number of workers 27.5 28.6 40.7 35.2 29.7 27.5 27.5 35.2 39.6 45.1 35.2 35.2 (# workers + O.T.) Cost Breakdown Reg. Labor Costs 25,000 26,000 37,000 32,000 27,000 25,000 25,000 32,000 36,000 41,000 32,000 32,000 O.T. Labor Costs 3,750 3,900 5,550 4,800 4,050 3,750 3,750 4,800 5,400 6,150 4,800 4,800 Change in # workers from last month 0 1 11 (5) (5) (2) 0 7 4 5 (9) 0 Hiring Cost 0 2,000 22,000 0 0 0 0 14,000 8,000 10,000 0 0 Layoff Cost 0 0 0 10,000 10,000 4,000 0 0 0 0 18,000 0 End-Inv. Hold. Cost 626 92 150 167 142 350 142 158 125 133 150 584 End-Inv. Short. Cost 0 0 0 0 0 0 0 0 0 0 0 0 Monthly Total Cost 29,376 31,992 64,700 46,967 41,192 33,100 28,892 50,958 49,525 57,283 54,950 37,384 Table 3: Level Strategy Option A Given Data: Initial inventory 200 Units Capacity Cushion 20% Current prod. capacity 500 Units Total workers 25 Workers Output per worker 20 Units/month Salary per worker $ 1,000 Dollars Material cost/unit $ 30 Dollars Work hours per worker 160 Monthly Prod per worker per hour 0.125 Units per hour 8 Hrs per unit Labor cost/unit $ 50 Dollars Overtime pay factor 1.5 Maximum OT pay 10% Inventory cost/unit/yr $ 50 $ 4.17 per unit/month Hiring/Firing Cost $ 2,000 Per Worker Subcontracting cost $ 15 Quality Standard 99.9% Average Demand Forecast 683 units per month Demand less Starting Inv 667 units per month LEVEL STRATEGY Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sales Forecast, Units 600 700 800 700 600 500 600 700 800 900 700 600 Production Target 670 670 670 670 670 670 670 670 670 670 670 670 Additional 2nd shift 20 80 30 Inventory end-month 270 240 110 100 170 340 410 380 250 100 100 170 Labor Requirements Current workers (1st) 25 25 25 25 25 25 25 25 25 25 25 25 New workers (2nd) 9 9 9 9 9 9 9 9 9 9 9 9 Total workers 34 34 34 34 34 34 34 34 34 34 34 34 Additional workers (2nd) 0 0 0 1 0 0 0 0 0 4 2 0 Equivalent workers 34 34 34 35 34 34 34 34 34 38 36 34 Cost Breakdown Labor Cost (incl. OT) 34,000 34,000 34,000 35,000 34,000 34,000 34,000 34,000 34,000 38,000 35,500 34,000 Inventory cost 1,125 1,000 458 417 708 1,417 1,708 1,583 1,042 417 417 708 Hiring cost 0 0 0 2,000 0 0 0 0 0 8,000 0 0 Firing cost 0 0 0 0 2,000 0 0 0 0 0 4,000 0 Additional capacity 0 0 0 0 0 0 0 0 0 0 0 0 Monthly Total Cost: 35,125 35,000 34,458 37,417 36,708 35,417 35,708 35,583 35,042 46,417 39,917 34,708 Table 4: Level Strategy Option B Given Data: Initial inventory 200 Units Capacity Cushion 20% Current prod. capacity 500 Units Total workers 25 Workers Output per worker 20 Units/month Salary per worker $1,000 Dollars Material cost/unit $ 30 Dollars Work hours per worker 160 Monthly Prod per worker per hour 0.125 Units per hour 8 Hrs per unit Labor cost/unit $ 50 Dollars Overtime pay factor 1.5 Maximum OT pay 10% Inventory cost/unit/yr $ 50 $4.17 per unit/month Hiring/Firing Cost $2,000 Per Worker Subcontracting cost $ 15 Average Demand Forecast 683 units per month Demand less Starting Inv 667 units per month LEVEL STRATEGY Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Sales Forecast, Units 600 700 800 700 600 500 600 700 800 900 700 600 Production Target 682 682 682 682 682 682 682 682 682 682 670 670 Inventory end-month 282 264 146 128 210 392 474 456 338 120 90 160 Labor Requirements Current workers (1st) 25 25 25 25 25 25 25 25 25 25 25 25 Overtime work 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 New capacity 6 6 6 6 6 6 6 6 6 6 6 6 Total workers 33.5 33.5 33.5 33.5 33.5 33.5 33.5 33.5 33.5 33.5 33.5 33.5 Additional overtime 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 Equivalent workers 34.1 34.1 34.1 34.1 34.1 34.1 34.1 34.1 34.1 34.1 34 34.1 Cost Breakdown Labor Cost 31,000 31,000 31,000 31,000 31,000 31,000 31,000 31,000 31,000 31,000 31,000 31,000 O.T. Cost 4,650 4,650 4,650 4,650 4,650 4,650 4,650 4,650 4,650 4,650 4,650 4,650 Inventory cost 1,175 1,100 608 533 875 1,633 1,975 1,900 1,408 500 375 667 Hiring cost 0 0 0 0 0 0 0 0 0 0 0 0 Firing cost 0 0 0 0 0 0 0 0 0 0 0 0 Additional capacity 17,000 Monthly Total Cost: 53,825 36,750 36,258 36,183 36,525 37,283 37,625 37,550 37,058 36,150 36,025 36,317 Table 5: Summary of Production Strategy Options Table 5: Summary of Strategic Options   Level Strategy Chase Cost Items Option A Option B   Labor 414,500 427,800 425,500 Inventory 11,000 12,750 2,819 Hiring 10,000 0 56,000 Firing 6,000 0 42,000 Capacity Increase 0 17,000 0         Total Cost: 441,500 457,550 526,319 Read More