- Email: [email protected]
Production planning
I-IoWARD L. TIMMS, Coordinator
Professor of Management, Indiana University JOHN F. MAGEE,Seminar Leader Head, Operations Research Group, A r t h u r D. Little, Inc.
Consulting Faculty WILLIAM L. NAUMANN
Vice-President, Caterpillar Tractor Company TRUMAN EVANS
Manager, Production Planning Pittsburgh Plate Glass Company
PRODUCTION
PLANNING
relationship to the total logistic problem. While organization, procedures, and "hardware" are all important in production planning, the concept of production planning as a process is most important. This process should be designed to determine what, how much, and when to produce in the light of market opportunities or forecasts.
SUMMARY
JOHN F. MAGEE
NOT TOO many years ago, production planning was of little interest to marketing people. Today, however, many marketing men are coming to recognize that production planning is important in the total logistic problem of producing and distributing goods successfully in competitive markets. Our discussions here are concerned with the elements of this problem the plant's supplier, the various stages of production, and the channels of distribution to customers. The subject of production planning could be approached from various points of v i e w - procedures, organization, or policy. We should not concentrate entirely on any one of these, but should consider each one in its
PLANNING
FUNCTIONS
The first concept central to the production planning process is that of an inventory or a stock of an item. An inventory is a buffer or cushion that absorbs pressures arising from various sources in the business. The inventory interrupts the physical flow from supply to use, permitting more flexibility and economy in the flow of goods. The inventory tends to absorb shocks or pressures arising in adjacent stages of the logistic sys41
SEMINAR ON INTERNATIONAL ~IARKETING
FIGURE
1
Pressures on Inventory
Financial capital management pressure Supplier pressure
42
> ]Inventory J-<--- User J,,,,,ofan item pressure
tem. In Figure 1, pressures are shown arising from the supplier and the user sides of the inventory as well as from the financial side (capital management). On the supply side of an inventory, pressures are normally in the direction of increasing the average size of the inventory. If the item is purchased, economies of quantity buying and incoming freight charges, as well as receiving, handling, and paper-work costs, encourage larger and fewer orders. If the item is produced, the economies of larger and fewer lot runs also result in pressures for a larger average inventory. On the user side, too, the pressures arising in the competitive marketplace tend to increase the average size of the inventory in order to provide quick service to customers. This is true regardless of where the inventory is in the many stages of supply from the dealer back through field and factory warehouses and production stages. Finally, offsetting the supplier and user pressures that tend to increase the average size of the inventory is financial pressure from above. Inventory is an investment that carries with it ownership costs. While it turns over more rapidly than investment in equipment, nevertheless, the inventory is owned at all times, and it has a carrying cost that must be reckoned with. Inventory must compete with all other assets for the company's limited supply of capital. The major function of the production planning process is to achieve a reasonable balance between the three sets of pressures
bearing on inventories throughout the various stages of production. Furthermore, these production stages are followed in the total logistic system of supply by the stages of distribution represented by regional warehouses, field warehouses, and dealers selling to the ultimate user. Effective production planning must take into account the pressures exerted on the production stages by the distribution stages. In attempting to achieve a reasonable balance between the conflicting pressures exerted on inventory, production planning reconciles marketing and production with financial objectives and interests. THE
NATURE
OF
INVENTORIES
Inventories perform various functions and may be classified according to function performed. Process inventories must be on hand to fulfill user requirements while additional stock is being purchased, produced, packaged, or transported.
Organization inventories "buy" organizat i o n - t h e more of these carried between stages in the manufacturing-distribution process, the less coordination is needed to keep the total process running smoothly. However, if inventories are already being used efficiently, they can be reduced only at the expense of greater organization effort and cost, that is, greater scheduling effort to keep successive stages in balance, and greater expediting effort and cost to eliminate the difficulties that unforeseen events may cause. Despite superficial differences among businesses and the characteristics of organization inventories they maintain, three types of this inventory are basic. Lot-size inventories permit flexibility in the operations of the supply side and the use side of the inventory by separating these functions. These inventories exist wherever the supply side wants to buy or produce in larger amounts than the user needs. The
PRODUCTION PLANNING
fixed cost of acquiring a lot of any size creates pressure to acquire large lots in order to write off this cost.
Fluctuation inventories exist wherever there is a delay in the reaction to changes in user requirements. Customer service may be maintained in the face of delayed supply by carrying this type of inventory, which is frequently called safety stock. The greater the delay in reacting to changes in user requirements, the larger the safety stock should be. Also, the greater the maximum deviation from mean expected user requirements, the larger the fluctuation stock should be if user service is to be maintained. Anticipation inventories provide for anticipated fluctuations in user requirements. Examples include goods sold in seasonal markets, goods for which materials may be only seasonally acquired--for example, tomatoes for canning--or a surge of output for simultaneous sales promotion in widespread markets. In all of these types of inventories, the various pressures from the supply side, the user side, and from financial management must be reconciled in the production planning process.
THE
RECONCILING
FUNCTION
A general discussion on organization for performing the reconciling function brought out several points. First, a central organization unit with authority to make reconciling decisions in both the production and distribution systems would practically run the company, particularly if this unit had authority to decide physical capacities at all production and distribution stages. Second, companies tend to hold to the classical division of marketing, production, and finance organization units and expect the units to work together where necessary to accomplish the reconciling function. This may be done through formal communications, through committee action, or infor-
mally. In any case, the prerequisite for successful reconciliation of pressures is an understanding of all factors involved and how they operate in support of over-all company success. Thus, training of the decision-makers in each of the three classical organization units is essential. All of the decisionmakers must understand the central questions involved: What is the cost of customer service failure? How fast can production react to changes in user requirements? How much production organization, or precision of control, can be achieved? How much is capital tied up in inventory worth? The answers bear directly on the main question: How much should be invested in inventory to best reconcile supplier and user pressures ?
Third, the following points were made in a discussion of the appropriate level of a central organization unit: The level should be quite high, but the exact location would depend to a great extent upon full understanding of the central questions and the cooperativeness of the executives to whom this production planning group reports. Disagreement at any level would have to be resolved by the executives at the next level. Fourth, if it does not have authority to make decisions on the physical capacity of the various stages in production and distribution, the organization unit will successfully operate at a lower level in the management group. Fifth, the level at which the central production planning unit operates may change with time. When first set up, it may report to top management, if only for the purpose of bringing the issues to top management attention for prompt policy decisions. Once top management is fully cognizant of the issues and policies are established to cover them, the central planning unit may report to a lower level in the organization. Much depends upon having personnel with the appropriate skills in the central planning unit, and upon top and lower management's haying confidence in the unit. Evans' description
43
SEMINAR ON INTERNATIONAL I~ARKETING
44
of the g r o w t h phases of the central planning d e p a r t m e n t for his company's fourteen glass plants illustrated these points. Sixth, in a company w h e r e the chief operating executive's background and principal interest are in one of the basic functions, such as sales, it m a y be necessary for the central planning unit to r e p o r t to a committee composed of those in charge of production, marketing, and finance, which reports directly to the chief executive. In this way, there is g r e a t e r assurance that all pressures will be appropriately reconciled. Seventh, whenever the pressures cannot be resolved at one level, the real contribution of the central planning group is in providing information on the costs of alternatives for higher-level decision. William L. Naumann, vice-president of Caterpillar Tractor Co., who has administrative direction of the nine domestic plant operations, made the following points in describing his company's production planning process : 1 Plant end items, including original equipment such as tractors and attachments, are scheduled by a central planning group at the company's main offices. Replacement parts are scheduled b y a central planning group in the P a r t s and Service Division. 2 Piece parts required to meet plant schedules are scheduled at the plant organization level--in other words, this scheduling is decentralized. 3 The centralized product scheduling function is initiated by a D e p a r t m e n t of Business Research. 4 Plant m a s t e r (end item) schedules are developed b y the business research group, which works with N a u m a n n ' s office to level individual plant loads while reconciling the various pressures on inventory. Plant manpower plans are established by this process. 5 Reconciliation of the various conflicting pressures, stressed earlier as the central function of the production planning process, is accomplished b y consultation with the various organization units involved, such as finance, employee relations, sales, and indus-
trial relations. In a sense, the organization chart is thrown away. The chiefs of all organization units concerned are familiar with the problems requiring reconciliation, are in close proximity to each other (communication channels are short, informal, and effective), and have proven their ability to work together. Discussion of Naumann's comments centered on policies concerning centralized purchasing and avoiding increased overhead charges caused by scientific planning and control. The main points in this discussion were as follows : 1 A centralized purchasing group in the company places orders f'or all nine plants on certain standard materials to be shipped directly to these plants. All other materials are acquired by each plant's decentralized purchasi,~g group operating according to general policy established at headquarters. 2 All m a j o r purchased items are under f r e q u e n t review to determine w h e t h e r local or centralized control is desirable. It is difficult to generalize about centralized versus decentralized procurement of items. The final decision on each item usually turns on conditions unique to t h a t item. The important point is that the status of each item be reviewed frequently, since conditions change often in competitive supply markets. This means keeping close touch with supply as well as use conditions. 3 Concerning increasing overhead charges for more scientific production scheduling and control, including the use of mathematical models, it was pointed out t h a t National Industrial Conference Board studies yield strong evidence that the higher overhead costs of American firms result in higher productivity, which means t h a t total cost per unit of output is no higher than in European firms. The total cost per unit of output is the relevant measure. Figure 2 illustrates the economics involved. The problem described in Figure 2 is one of finding the amount of organization effort (overhead) t h a t will result in lowest total
PRODUCTION PLANNING
FIGURE
Organization Effort (Overhead) DOLLARS
IA
OVERHEAD ORGANIZATION A--Optimum organization (overhead) (1)--Cost of organization effort (overhead) (2)--Total direct cost (3)--Totai cost (1 + 2)
cost. More overhead cost (curve 1) will usually result in lower total direct cost (curve 2). Total direct cost is the sum of direct manufacturing, selling, inventory carrying, and service failure (stock-out) costs. Up to a certain point, increased overhead cost will reduce total cost through improved productivity. Beyond this point of diminishing returns, increased overhead will cause total cost to increase. 4 The cost elements in Figure 2 can be found through a statistical t r e a t m e n t of accounting data but will usually shift with changes in the level of output, often making it costly to maintain up-to-date cost data. This, t o g e t h e r with the fact that even a statistical t r e a t m e n t of data on service failure (stock-out) costs involves careful judgment, tends to lower the usefulness of mathematical models in production planning. The main point is t h a t a full understanding of the philosophy behind mathematical models (and
their graphic equivalents) will result in better judgment. 5 Evans presented his company's approach to the problem of forecasting and scheduling production of replacement windshields for old model automobiles. These are stocked at a large number of depots as well as at the producing factories, and service failures cannot be averted w i t h o u t carrying excessively costly inventories or, alternately, spending the time and money for a good forecasting and scheduling job. The department found a w a y to use available data on past automobile sales by year and model to forecast quite accurately the annual, as well as seasonal, demand for particular models of windshields. It was found t h a t the large volume of data processing involved could be efficiently handled by an electronic computer. It is expected t h a t this system will eliminate service failures almost entirely while sharply reducing f a c t o r y and depot inventories.
INFLUENCE
OF
FORECASTING
F o u r m a j o r points were brought out in discussion of the role of forecasting and its influence on the production planning process. 1 Although some in m a r k e t i n g insist t h a t forecasts for the demand for their products are impossible to make, nevertheless forecasts are necessary and are made by someone in the company, if not by marketing personnel. 2 Since production or procurement takes time, someone must decide in advance of actual demand the amount that will be demanded, unless excessively costly stocks of all end items in the product line are to be carried to preclude stock-outs or service failure at higher than competitive rates. Capital m a n a g e m e n t pressure will usually result in more emphasis on b e t t e r forecasting. 3 The necessity for detailed forecasting of demand is diminished by flexibility in plant processes. This permits forecasting in terms of process hours r a t h e r than number of end
45
SEMINAR ON INTERNATIONAL ~V~ARKETING
FIGURE
3
Representative Distribution Systems Field Inventories Warehouse or
Distributors
o2re2L SgiP.m2"2. . . .
,.
// //.~"/ ,
:Regional -
-
.
.
.
,/""
.
\", \
," "~
"
4 Field I( : Warehouse : \ x I.. . . . . . . . .
J
DISTRIBUTION
\
--Existing distribution system ----Alternatlve distribution system
46
FIGURE
4
Product Line as Percentage of Sales
Percentage of sales loo 80
'i::"
20
items. The f o r m e r type of forecast is usually easier to make than the latter. And from the production viewpoint, all t h a t is available for sale is production process hours. 4 A single-figure forecast is not enough for scheduling plant operations economically. A figure on mean demand m u s t be accompanied by a figure on range or m a x i m u m reasonable demand, if service failure is to be held to a competitive level w i t h o u t excessively costly inventories. The word "reasonable" implies t h a t j u d g m e n t is involved. Statistical t r e a t m e n t of data on past demand fluctuations ought to be a powerful aid in making the necessary judgments.
l
0 40 60 80 I00 0 20 of items in product line Percentage
SYSTEM
It was observed t h a t discussion of the physical distribution system, including the cont r a - s y s t e m of information flow, was a good means of tying together the elements of production planning and integrating them with the over-all marketing system. This subject might well be called "the logistics of distribution." A representative distribution system, together with various alternative systems, is shown in Figure 3. One alternative to the existing system is the consolidation of two or more field warehouses or distributors. A n o t h e r is the establishment of a regional warehouse (inventory) to service two or more field warehouses. Still another is the direct shipment of products from the central i n v e n t o r y - - f o r example, the f a c t o r y wareh o u s e - - t o customers. An alternative not shown in Figure 3 would be to have more than one central inventory or factory. The logistic problem consists essentially of choosing t h a t alternative or combination of alternative distribution s y s t e m s t h a t maximizes return on total investment over the long r u n - - o r until m a r k e t conditions change significantly enough to call for a change. The inventories carried in the distribution s y s t e m represent one investment. The op-
PRODUCTION P L A N N I N G
FIGURE
FIGURE
5
Cost Elements of Distribution Alternatives
Economics of Distribution
DOLLARS
DOLLARS
6
I-L__]A-°,o. /
'--- carrying
I,, 1i
cost
ond
processing cost
D o
LEAD TIME ritual distribution system, as f a r as inventories are concerned, is one t h a t minimizes the total cost of its operation. The variable costs of operation are costs of c a r r y i n g inventories, transportation, customer service failure, communications (data gathering and processing), and changing m a n u f a c t u r i n g levels (supplying the central inventory). An alternative not shown in Figure 3, and one that m a y be superimposed on all alternatives shown, is t h a t of having some or all of the products in the product line carried at the various stock-points. Introduction of this variable into the logistics system complicates the problem considerably. Obviously, the longer the product line (or the g r e a t e r the proliferation of products), the more complex the problem. In dealing with the product line variable, it is useful to know the relative contribution to total sales of each fraction of the product line. The records of a large n u m b e r of firms in the consumer and industrial products fields demonstrate t h a t a relatively small
too
E I,ooo
ANNUAL VOLUME
Io, o o o
( A ) - - T o t a l variable cost of handling demand through central warehouse ( B ~ T o t a l variable cost of handling demand through regional warehouses ( C ) - - T o t a I variable cost of handling demand through local warehouses D--Break-even point between central (direct) and regional delivery E--Break-even point between regional and local delivery
fraction of the product line accounts for a large fraction of total sales. Figure 4 reveals that, while 10 to 20 per cent of total items sold characteristically yield 80 per cent of total sales, half the items in the line account for less than 4 per cent of total sales. It is the bottom half of the product line t h a t is responsible for much of the difficulty, expense, and investment involved in the distribution system. A complete analysis of the various alternative distribution s y s t e m s for any company, including the portion of the product line carried at each stock-point, requires data such as t h a t shown in Figure 4. If the inventory of an item is t r a n s f e r r e d from a field warehouse to a central warehouse, transportation costs will rise if the
47
SEMINAR ON INTERNATIONAL ~ARKETING
48
service level--and thus costs--is not to suffer. T h a t is, a f a s t e r and normally more expensive f o r m of transport, such as air freight, m u s t be used. Warehousing costs and inventory investment m a y be reduced, however, as a smaller central inventory of the item will provide the same customer service level. An i m p o r t a n t aspect of the logistics of distribution systems is the response or lead time involved in the system. The time requirements characteristic of all distribution systems are processing time, communications time, m a n u f a c t u r i n g time, transportation time, and cycle (review) time. The longer these periods, the greater the degree of error in forecasting over the total lead or response time and the higher the level of inventories required to cope with this error, given the permissible level of service failure. Techniques of exponential smoothing of demand were discussed in connection with the derivation of a set of cost curves asso-
ciated with various distribution alternatives. The alternative with m i n i m u m total cost can be determined f r o m a set of curves such as those shown in Figure 5. Finally, all the variables involved in the logistics of distribution can be brought together for a final decision t h r o u g h a process of analysis such as t h a t represented in Figure 6. The main point in the discussion of the logistics of distribution was t h a t minimizing total cost is the relevant criterion, and all functional groups, such as transportation, production, and marketing, m u s t be willing to raise costs whenever an increase will result in minimizing total variable cost. The tendency of each functional group to minimize the costs for which it is responsible often works against achieving m i n i m u m total cost. It would seem t h a t only a central research group, combined with functional groups trained in the underlying economics of the whole system, could achieve this goal.
Professor of Management, Indiana University JOHN F. MAGEE,Seminar Leader Head, Operations Research Group, A r t h u r D. Little, Inc.
Consulting Faculty WILLIAM L. NAUMANN
Vice-President, Caterpillar Tractor Company TRUMAN EVANS
Manager, Production Planning Pittsburgh Plate Glass Company
PRODUCTION
PLANNING
relationship to the total logistic problem. While organization, procedures, and "hardware" are all important in production planning, the concept of production planning as a process is most important. This process should be designed to determine what, how much, and when to produce in the light of market opportunities or forecasts.
SUMMARY
JOHN F. MAGEE
NOT TOO many years ago, production planning was of little interest to marketing people. Today, however, many marketing men are coming to recognize that production planning is important in the total logistic problem of producing and distributing goods successfully in competitive markets. Our discussions here are concerned with the elements of this problem the plant's supplier, the various stages of production, and the channels of distribution to customers. The subject of production planning could be approached from various points of v i e w - procedures, organization, or policy. We should not concentrate entirely on any one of these, but should consider each one in its
PLANNING
FUNCTIONS
The first concept central to the production planning process is that of an inventory or a stock of an item. An inventory is a buffer or cushion that absorbs pressures arising from various sources in the business. The inventory interrupts the physical flow from supply to use, permitting more flexibility and economy in the flow of goods. The inventory tends to absorb shocks or pressures arising in adjacent stages of the logistic sys41
SEMINAR ON INTERNATIONAL ~IARKETING
FIGURE
1
Pressures on Inventory
Financial capital management pressure Supplier pressure
42
> ]Inventory J-<--- User J,,,,,ofan item pressure
tem. In Figure 1, pressures are shown arising from the supplier and the user sides of the inventory as well as from the financial side (capital management). On the supply side of an inventory, pressures are normally in the direction of increasing the average size of the inventory. If the item is purchased, economies of quantity buying and incoming freight charges, as well as receiving, handling, and paper-work costs, encourage larger and fewer orders. If the item is produced, the economies of larger and fewer lot runs also result in pressures for a larger average inventory. On the user side, too, the pressures arising in the competitive marketplace tend to increase the average size of the inventory in order to provide quick service to customers. This is true regardless of where the inventory is in the many stages of supply from the dealer back through field and factory warehouses and production stages. Finally, offsetting the supplier and user pressures that tend to increase the average size of the inventory is financial pressure from above. Inventory is an investment that carries with it ownership costs. While it turns over more rapidly than investment in equipment, nevertheless, the inventory is owned at all times, and it has a carrying cost that must be reckoned with. Inventory must compete with all other assets for the company's limited supply of capital. The major function of the production planning process is to achieve a reasonable balance between the three sets of pressures
bearing on inventories throughout the various stages of production. Furthermore, these production stages are followed in the total logistic system of supply by the stages of distribution represented by regional warehouses, field warehouses, and dealers selling to the ultimate user. Effective production planning must take into account the pressures exerted on the production stages by the distribution stages. In attempting to achieve a reasonable balance between the conflicting pressures exerted on inventory, production planning reconciles marketing and production with financial objectives and interests. THE
NATURE
OF
INVENTORIES
Inventories perform various functions and may be classified according to function performed. Process inventories must be on hand to fulfill user requirements while additional stock is being purchased, produced, packaged, or transported.
Organization inventories "buy" organizat i o n - t h e more of these carried between stages in the manufacturing-distribution process, the less coordination is needed to keep the total process running smoothly. However, if inventories are already being used efficiently, they can be reduced only at the expense of greater organization effort and cost, that is, greater scheduling effort to keep successive stages in balance, and greater expediting effort and cost to eliminate the difficulties that unforeseen events may cause. Despite superficial differences among businesses and the characteristics of organization inventories they maintain, three types of this inventory are basic. Lot-size inventories permit flexibility in the operations of the supply side and the use side of the inventory by separating these functions. These inventories exist wherever the supply side wants to buy or produce in larger amounts than the user needs. The
PRODUCTION PLANNING
fixed cost of acquiring a lot of any size creates pressure to acquire large lots in order to write off this cost.
Fluctuation inventories exist wherever there is a delay in the reaction to changes in user requirements. Customer service may be maintained in the face of delayed supply by carrying this type of inventory, which is frequently called safety stock. The greater the delay in reacting to changes in user requirements, the larger the safety stock should be. Also, the greater the maximum deviation from mean expected user requirements, the larger the fluctuation stock should be if user service is to be maintained. Anticipation inventories provide for anticipated fluctuations in user requirements. Examples include goods sold in seasonal markets, goods for which materials may be only seasonally acquired--for example, tomatoes for canning--or a surge of output for simultaneous sales promotion in widespread markets. In all of these types of inventories, the various pressures from the supply side, the user side, and from financial management must be reconciled in the production planning process.
THE
RECONCILING
FUNCTION
A general discussion on organization for performing the reconciling function brought out several points. First, a central organization unit with authority to make reconciling decisions in both the production and distribution systems would practically run the company, particularly if this unit had authority to decide physical capacities at all production and distribution stages. Second, companies tend to hold to the classical division of marketing, production, and finance organization units and expect the units to work together where necessary to accomplish the reconciling function. This may be done through formal communications, through committee action, or infor-
mally. In any case, the prerequisite for successful reconciliation of pressures is an understanding of all factors involved and how they operate in support of over-all company success. Thus, training of the decision-makers in each of the three classical organization units is essential. All of the decisionmakers must understand the central questions involved: What is the cost of customer service failure? How fast can production react to changes in user requirements? How much production organization, or precision of control, can be achieved? How much is capital tied up in inventory worth? The answers bear directly on the main question: How much should be invested in inventory to best reconcile supplier and user pressures ?
Third, the following points were made in a discussion of the appropriate level of a central organization unit: The level should be quite high, but the exact location would depend to a great extent upon full understanding of the central questions and the cooperativeness of the executives to whom this production planning group reports. Disagreement at any level would have to be resolved by the executives at the next level. Fourth, if it does not have authority to make decisions on the physical capacity of the various stages in production and distribution, the organization unit will successfully operate at a lower level in the management group. Fifth, the level at which the central production planning unit operates may change with time. When first set up, it may report to top management, if only for the purpose of bringing the issues to top management attention for prompt policy decisions. Once top management is fully cognizant of the issues and policies are established to cover them, the central planning unit may report to a lower level in the organization. Much depends upon having personnel with the appropriate skills in the central planning unit, and upon top and lower management's haying confidence in the unit. Evans' description
43
SEMINAR ON INTERNATIONAL I~ARKETING
44
of the g r o w t h phases of the central planning d e p a r t m e n t for his company's fourteen glass plants illustrated these points. Sixth, in a company w h e r e the chief operating executive's background and principal interest are in one of the basic functions, such as sales, it m a y be necessary for the central planning unit to r e p o r t to a committee composed of those in charge of production, marketing, and finance, which reports directly to the chief executive. In this way, there is g r e a t e r assurance that all pressures will be appropriately reconciled. Seventh, whenever the pressures cannot be resolved at one level, the real contribution of the central planning group is in providing information on the costs of alternatives for higher-level decision. William L. Naumann, vice-president of Caterpillar Tractor Co., who has administrative direction of the nine domestic plant operations, made the following points in describing his company's production planning process : 1 Plant end items, including original equipment such as tractors and attachments, are scheduled by a central planning group at the company's main offices. Replacement parts are scheduled b y a central planning group in the P a r t s and Service Division. 2 Piece parts required to meet plant schedules are scheduled at the plant organization level--in other words, this scheduling is decentralized. 3 The centralized product scheduling function is initiated by a D e p a r t m e n t of Business Research. 4 Plant m a s t e r (end item) schedules are developed b y the business research group, which works with N a u m a n n ' s office to level individual plant loads while reconciling the various pressures on inventory. Plant manpower plans are established by this process. 5 Reconciliation of the various conflicting pressures, stressed earlier as the central function of the production planning process, is accomplished b y consultation with the various organization units involved, such as finance, employee relations, sales, and indus-
trial relations. In a sense, the organization chart is thrown away. The chiefs of all organization units concerned are familiar with the problems requiring reconciliation, are in close proximity to each other (communication channels are short, informal, and effective), and have proven their ability to work together. Discussion of Naumann's comments centered on policies concerning centralized purchasing and avoiding increased overhead charges caused by scientific planning and control. The main points in this discussion were as follows : 1 A centralized purchasing group in the company places orders f'or all nine plants on certain standard materials to be shipped directly to these plants. All other materials are acquired by each plant's decentralized purchasi,~g group operating according to general policy established at headquarters. 2 All m a j o r purchased items are under f r e q u e n t review to determine w h e t h e r local or centralized control is desirable. It is difficult to generalize about centralized versus decentralized procurement of items. The final decision on each item usually turns on conditions unique to t h a t item. The important point is that the status of each item be reviewed frequently, since conditions change often in competitive supply markets. This means keeping close touch with supply as well as use conditions. 3 Concerning increasing overhead charges for more scientific production scheduling and control, including the use of mathematical models, it was pointed out t h a t National Industrial Conference Board studies yield strong evidence that the higher overhead costs of American firms result in higher productivity, which means t h a t total cost per unit of output is no higher than in European firms. The total cost per unit of output is the relevant measure. Figure 2 illustrates the economics involved. The problem described in Figure 2 is one of finding the amount of organization effort (overhead) t h a t will result in lowest total
PRODUCTION PLANNING
FIGURE
Organization Effort (Overhead) DOLLARS
IA
OVERHEAD ORGANIZATION A--Optimum organization (overhead) (1)--Cost of organization effort (overhead) (2)--Total direct cost (3)--Totai cost (1 + 2)
cost. More overhead cost (curve 1) will usually result in lower total direct cost (curve 2). Total direct cost is the sum of direct manufacturing, selling, inventory carrying, and service failure (stock-out) costs. Up to a certain point, increased overhead cost will reduce total cost through improved productivity. Beyond this point of diminishing returns, increased overhead will cause total cost to increase. 4 The cost elements in Figure 2 can be found through a statistical t r e a t m e n t of accounting data but will usually shift with changes in the level of output, often making it costly to maintain up-to-date cost data. This, t o g e t h e r with the fact that even a statistical t r e a t m e n t of data on service failure (stock-out) costs involves careful judgment, tends to lower the usefulness of mathematical models in production planning. The main point is t h a t a full understanding of the philosophy behind mathematical models (and
their graphic equivalents) will result in better judgment. 5 Evans presented his company's approach to the problem of forecasting and scheduling production of replacement windshields for old model automobiles. These are stocked at a large number of depots as well as at the producing factories, and service failures cannot be averted w i t h o u t carrying excessively costly inventories or, alternately, spending the time and money for a good forecasting and scheduling job. The department found a w a y to use available data on past automobile sales by year and model to forecast quite accurately the annual, as well as seasonal, demand for particular models of windshields. It was found t h a t the large volume of data processing involved could be efficiently handled by an electronic computer. It is expected t h a t this system will eliminate service failures almost entirely while sharply reducing f a c t o r y and depot inventories.
INFLUENCE
OF
FORECASTING
F o u r m a j o r points were brought out in discussion of the role of forecasting and its influence on the production planning process. 1 Although some in m a r k e t i n g insist t h a t forecasts for the demand for their products are impossible to make, nevertheless forecasts are necessary and are made by someone in the company, if not by marketing personnel. 2 Since production or procurement takes time, someone must decide in advance of actual demand the amount that will be demanded, unless excessively costly stocks of all end items in the product line are to be carried to preclude stock-outs or service failure at higher than competitive rates. Capital m a n a g e m e n t pressure will usually result in more emphasis on b e t t e r forecasting. 3 The necessity for detailed forecasting of demand is diminished by flexibility in plant processes. This permits forecasting in terms of process hours r a t h e r than number of end
45
SEMINAR ON INTERNATIONAL ~V~ARKETING
FIGURE
3
Representative Distribution Systems Field Inventories Warehouse or
Distributors
o2re2L SgiP.m2"2. . . .
,.
// //.~"/ ,
:Regional -
-
.
.
.
,/""
.
\", \
," "~
"
4 Field I( : Warehouse : \ x I.. . . . . . . . .
J
DISTRIBUTION
\
--Existing distribution system ----Alternatlve distribution system
46
FIGURE
4
Product Line as Percentage of Sales
Percentage of sales loo 80
'i::"
20
items. The f o r m e r type of forecast is usually easier to make than the latter. And from the production viewpoint, all t h a t is available for sale is production process hours. 4 A single-figure forecast is not enough for scheduling plant operations economically. A figure on mean demand m u s t be accompanied by a figure on range or m a x i m u m reasonable demand, if service failure is to be held to a competitive level w i t h o u t excessively costly inventories. The word "reasonable" implies t h a t j u d g m e n t is involved. Statistical t r e a t m e n t of data on past demand fluctuations ought to be a powerful aid in making the necessary judgments.
l
0 40 60 80 I00 0 20 of items in product line Percentage
SYSTEM
It was observed t h a t discussion of the physical distribution system, including the cont r a - s y s t e m of information flow, was a good means of tying together the elements of production planning and integrating them with the over-all marketing system. This subject might well be called "the logistics of distribution." A representative distribution system, together with various alternative systems, is shown in Figure 3. One alternative to the existing system is the consolidation of two or more field warehouses or distributors. A n o t h e r is the establishment of a regional warehouse (inventory) to service two or more field warehouses. Still another is the direct shipment of products from the central i n v e n t o r y - - f o r example, the f a c t o r y wareh o u s e - - t o customers. An alternative not shown in Figure 3 would be to have more than one central inventory or factory. The logistic problem consists essentially of choosing t h a t alternative or combination of alternative distribution s y s t e m s t h a t maximizes return on total investment over the long r u n - - o r until m a r k e t conditions change significantly enough to call for a change. The inventories carried in the distribution s y s t e m represent one investment. The op-
PRODUCTION P L A N N I N G
FIGURE
FIGURE
5
Cost Elements of Distribution Alternatives
Economics of Distribution
DOLLARS
DOLLARS
6
I-L__]A-°,o. /
'--- carrying
I,, 1i
cost
ond
processing cost
D o
LEAD TIME ritual distribution system, as f a r as inventories are concerned, is one t h a t minimizes the total cost of its operation. The variable costs of operation are costs of c a r r y i n g inventories, transportation, customer service failure, communications (data gathering and processing), and changing m a n u f a c t u r i n g levels (supplying the central inventory). An alternative not shown in Figure 3, and one that m a y be superimposed on all alternatives shown, is t h a t of having some or all of the products in the product line carried at the various stock-points. Introduction of this variable into the logistics system complicates the problem considerably. Obviously, the longer the product line (or the g r e a t e r the proliferation of products), the more complex the problem. In dealing with the product line variable, it is useful to know the relative contribution to total sales of each fraction of the product line. The records of a large n u m b e r of firms in the consumer and industrial products fields demonstrate t h a t a relatively small
too
E I,ooo
ANNUAL VOLUME
Io, o o o
( A ) - - T o t a l variable cost of handling demand through central warehouse ( B ~ T o t a l variable cost of handling demand through regional warehouses ( C ) - - T o t a I variable cost of handling demand through local warehouses D--Break-even point between central (direct) and regional delivery E--Break-even point between regional and local delivery
fraction of the product line accounts for a large fraction of total sales. Figure 4 reveals that, while 10 to 20 per cent of total items sold characteristically yield 80 per cent of total sales, half the items in the line account for less than 4 per cent of total sales. It is the bottom half of the product line t h a t is responsible for much of the difficulty, expense, and investment involved in the distribution system. A complete analysis of the various alternative distribution s y s t e m s for any company, including the portion of the product line carried at each stock-point, requires data such as t h a t shown in Figure 4. If the inventory of an item is t r a n s f e r r e d from a field warehouse to a central warehouse, transportation costs will rise if the
47
SEMINAR ON INTERNATIONAL ~ARKETING
48
service level--and thus costs--is not to suffer. T h a t is, a f a s t e r and normally more expensive f o r m of transport, such as air freight, m u s t be used. Warehousing costs and inventory investment m a y be reduced, however, as a smaller central inventory of the item will provide the same customer service level. An i m p o r t a n t aspect of the logistics of distribution systems is the response or lead time involved in the system. The time requirements characteristic of all distribution systems are processing time, communications time, m a n u f a c t u r i n g time, transportation time, and cycle (review) time. The longer these periods, the greater the degree of error in forecasting over the total lead or response time and the higher the level of inventories required to cope with this error, given the permissible level of service failure. Techniques of exponential smoothing of demand were discussed in connection with the derivation of a set of cost curves asso-
ciated with various distribution alternatives. The alternative with m i n i m u m total cost can be determined f r o m a set of curves such as those shown in Figure 5. Finally, all the variables involved in the logistics of distribution can be brought together for a final decision t h r o u g h a process of analysis such as t h a t represented in Figure 6. The main point in the discussion of the logistics of distribution was t h a t minimizing total cost is the relevant criterion, and all functional groups, such as transportation, production, and marketing, m u s t be willing to raise costs whenever an increase will result in minimizing total variable cost. The tendency of each functional group to minimize the costs for which it is responsible often works against achieving m i n i m u m total cost. It would seem t h a t only a central research group, combined with functional groups trained in the underlying economics of the whole system, could achieve this goal.