MGMT 497

Lecture Notes on Production Planning

1. General Outline of the Analysis

o Obtain the companys sales forecasts for
individual market areas. This should be done
using the Sales Forecast Worksheet prior to
conducting inventory control and production
planning. Based on the sales forecasts obtained,
you will then do the following (with specific
steps detailed later):
Choose an inventory-to-sales ratio for safety
stock. Use the Shipment Orders Worksheet
to determine the amount of new units to be
shipped to satisfy sales office orders and
establish an overall production target for the
company.
Use the Production Schedule Worksheet to
design a production schedule (lines, shifts, and overtime) that can meet the desired production target.
Plan your production over other quarters as well.
o Further strategic analysis: Should there be additional capital investment in new production capacity (e.g.,
new lines or a new plant) to meet future demand? How should such investment be financed?
2. Sales Office Orders Determination & Production Planning
A. Initial Production Capacity
o The home-area plant has 6 production lines running at the beginning of Year 3.
o For each line, normal output is 4,000 units during a 40-hour week and 52,000 units over a 13-week
quarter. With 6 lines operating at normal capacity, the plant produces 312,000 units per quarter.
B. Inventory Control & Production Planning
o Safety stock: It is a buffer of extra inventory held to guard against stockouts that may arise from
unexpectedly high customer demand or production disruptions.
o Production uncertainty: Due to variations in, e.g., machine down-time, absenteeism, and supplier lead
time, actual output can be 5% (15% for foreign plants) different from what is scheduled at the capacity
level. Beginning inventory, actual output and ending inventory are all shown in the Quarterly Operating
Information Report (Report D).
o Overstocking & understocking costs: Carrying too much inventory can not only drive up storage costs
but also increase financial costs from tying up working capital in surplus stock. On the other hand,
carrying too little inventory may lead to costly stockouts, which can result in a loss of not only present
sales but also future sales. A significant proportion of the unhappy customers may not even come back.
Since losing market shares to your competitors is really bad, stockouts should be averted through proper
inventory control and production planning.
o Excel template: After obtaining company sales forecasts, you should next assess the companys
inventory needs and determine how much to produce. The Shipment Orders Worksheet will be used to
estimate how much more product units should be ordered for and shipped to individual market areas
based on their respective inventory conditions. The Production Schedule Worksheet will then be used to
determine the production schedule needed to satisfy forecasted product demand and inventory needs for
each market area over the next few quarters.
o

Step 1: Use the Shipment Orders Worksheet to determine the sales office orders (see the Decision
Form), as part of the companys operational decision for managing inventory levels at the distribution
centers in different market areas.
Remember to identify the location of your plant or plants so that the Excel spreadsheet can do the
shipment order analysis correctly.
Provide the information on how much inventory your company currently has in each market area
by checking the amount of ending inventory from the latest Report D (the Operating Information
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MGMT 497

Lecture Notes on Production Planning

Report). An inventory level of 30,000 to 80,000 units will be considered as normal. Any amount
greater than 80,000 units will indicate too much inventory, while any amount less than 30,000
units will indicate that the inventory level is too low with an increase in the stockout risk. If the
ending inventory is zero, a stockout has already occurred.
Choose an inventory policy that balances between the costs of overstocking and understocking
for each market area by selecting your desired inventory-to-sales ratio. Under normal situations
(i.e., without too much or too little inventory), a ratio from 25% to 45% should be sufficient.

Note: The choice of inventory-to-sales ratios will affect how many new product units to be shipped to
individual market areas. If your company wants to build up (draw down) inventory to meet demand in
a particular market area, you should choose a higher (lower) inventory-to-sales ratio for that market
area when doing inventory analysis. Indeed, if a stockout occurs, you should use a much higher
inventory ratio than 45% so that the company can rebuild its inventory in the corresponding market
area in the coming quarter. If there is excessive inventory, on the other hand, the company may
choose to set the inventory ratio to less than 15%. In the special case when the inventory ratio is set
equal to 0%, no additional new units will be shipped to the respective market area, allowing the
existing inventory to be drawn down more quickly in the coming quarter.
Note: If the company begins to produce a new product model, all remaining inventory of the old model will
be liquidated automatically by the end of the quarter.
Note: In general, sales office orders for a market area are to be computed as follows:
Sales Office Orders = Forecasted Product Demand + Desired Inventory Beginning Inventory.
[As a numerical example, suppose that the amount of beginning inventory is 26,000 units and that the
inventory-to-sales ratio is chosen to be 25%. If the product demand is projected to be 120,000 units in
the coming quarter, then the amount of desired inventory = 120,000 25% = 30,000 units. Hence, the
estimated sales office orders will be given by 120,000 + 30,000 26,000 = 124,000.]
o

Step 2: Use the Production Scheduling Worksheet to set up a production plan.

Decide how much to produce by setting a production target that is close in amount to the
estimated Total Sales Office Orders. Then, design a production schedule (including production
lines, overtime hours, and second-shift hours) to meet your companys desired output target.

Step 3: Check how well your production plan may work for at least the next few quarters.
Examine the projected estimate of the ending inventory in each market area. The projected
inventory level should not be too high or too low in each market area. For the company as a
whole, we have: Projected Ending Inventory = Beginning Inventory + Planned Output
Anticipated Sales.
If the projected inventory numbers do not look good for being too high or too low, you should
repeat Step 1 by adjusting your desired inventory-to-sales ratio for the corresponding market
areas and also repeat Step 2 by adjusting the production schedule in terms of production lines,
overtime hours and second-shift hours.

Note: If a companys actual total output far exceeds the total sales office orders, the surplus output would
accumulate and pile up as unsold inventory at the warehouse where the manufacturing plant is located.
Even without excessive output, an inventory pile-up might also occur if sales office orders were
misallocated and became too low in other market areas.
Note: Given the projected market size for the industry, it does not make business sense for a company to
have more than 2 production plants. Establishing 3 plants would involve too much capital expenditure
and severely strain a companys finances. The company would have considerably less financial
resources for other strategic uses in competing with other companies. Also, having too many plants
would not be operationally efficient. The companys production costs would go up significantly due
to the huge overhead costs from running so many plants.

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MGMT 497

Lecture Notes on Production Planning

Note: A company may choose to close a sales office and not to serve one of the market areas. This can be
done by transferring out or discharging all the salespersons at that regional sales office (see p.29 of the
Players Manual). The impact of such an action, if taken, must be incorporated into sales forecasts and
shipment orders analysis. If the sales office in M3 was closed, for example, this action should be
indicated on the Sales Forecast Worksheet for M3 by entering the word CLOSED somewhere in the
Industry Sales data column (column E). Company sales forecasts should all become zeros.
Note: In reading the Quarterly Operating Information Report (Report D), you may find that Sales Office
Purchases can be less than Sales Office Orders, when insufficient goods are produced. Also, when a
model change is initiated, unsold old inventory will be sold to liquidators during the quarter.
3. Production Scheduling and Capacity Changes
See Figure 2-3 in Chapter 2 of the Players Manual for a tabulated summary of all the costs associated with
individual options. Additional information can be found in Chapters 7 and 8 of the Players Manual.
A. Scheduling Overtime
o Time lag: Production can be increased in the current quarter with no time delay.
o Limit: No more than 20% over the normal 40-hour-a-week work.
B. Scheduling a Second Work Shift
o Time lag: It takes one quarter to hire and train workers to operate a second shift on a line. Enter the
number of second-shifts to be created at your plant under New Lines in the Construction section of the
Decision Form one quarter before these second-shift lines may be scheduled for production.
o Restriction: Second-shift operations are permitted for all lines but at the home-area plant only.
C. Temporary Layoff, Deactivation & Reactivation
o A production line can be idled by a temporary layoff for a quarter.
o A line can be deactivated and taken out of production until the firm chooses to reactivate the line.
D. Creating New Production Lines at the Existing Plant
o Space availability: The existing plant is initially built to provide space for 8 production lines, though only
6 lines are currently run. Hence, there is space to create two additional lines.
o Time lag: One quarter is required to install the necessary equipment and to hire and train workers for the
new production lines. Enter the number of new production lines to be constructed under New Lines in the
Construction section of the Decision Form one quarter before these production lines may be run.
E. Adding More Space to the Existing Plant
o Each addition will provide extra space for operating two new production lines in a given quarter.
o Time lag: Two quarters are required to complete construction of a new two-line addition. Enter 2, the
number of lines of capacity, under New Add in the Construction section of the Decision Form. New line
construction may follow as early as one quarter after construction of the new addition has begun.
o Space limit: A plant can be expanded to run a maximum of 12 production lines.
F. Constructing a New Plant in another Market Area
o Initial capacity allowed: The new building may be built with a capacity of 2, 4, 6, 8 or 10 lines. Enter the
desired number of lines under New Plant in the Construction section of the Decision Form.
o Time lag: Three quarters of time are required to complete construction.
o Production lines must be installed separately during the last quarter of plant construction (or later).
o A plant can be shut down (and sold for 90% of its book value) by entering -1 under New Plant in the
Construction section of the Decision Form and by deactivating all production lines concurrently.
4. Keys to Successful Production Management
o Reasonably accurate sales forecasts;
o Excellent inventory control to cope with demand and production uncertainties;
o Proper allocation of product shipments to regional sales offices and thereby to customers;
o Efficient production scheduling to meet production targets;
o Timely production capacity adjustment (including plant expansion or construction) to meet future product
demand.

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