5.5 Production planning (HL only)


The supply chain process
The supply chain process is how business adds value to manufactured products from their form, for example original raw materials, to finished or final goods. The supply chain is called the value chain for the very reason mentioned of adding value to products.
In order to understand the process fully, we need to again refer back to a concept mentioned more than once thus far; factors of production. At the very top of the supply chain (also referred to as upstream) is resources are provided by nature in their raw form. The factor of production we refer to as Land is the input we begin with in order to begin the value adding process. As we know, labor and capital are also be inputs in the production process and when this occurs upstream; we have already begun adding value to the process. As we move from our upstream position and continue adding value through additional factor inputs of labor and capital, the raw material is transformed into a final product. Generally the supply chain process involves the factory or industry level, the wholesaler and distribution outlets and the eventually the retailer or point of sale. The factory being at the top of the supply chain.
Consider for a moment a company such as British Petroleum (BP), which has control of all of its supply chain. BP will add value to the extracted oil with the use of labor and capital, add further value by transporting it with labor and capital and refine the oil, again with labor and capital. Once the oil is refined and processed into a final product it is available at the retail outlets (petrol stations).
Managing the supply chain means ensuring that the flow from extraction to consumption is designed, controlled and monitored for efficiency and quality. Businesses such as BP, which are very large, have to mange worldwide logistics and synchronizes the supply chain with market based demands. This is the most interesting aspect of operations and management.
As we have seen in Cradle-to-Cradle manufacturing, supply chain management can also includes the recycling process after consumers use the goods.
The difference between JIT and just-in-case (JIC)
JIT or Just-In-Time Manufacturing is at the heart of kaizen and lean production. The understanding is that when a business orders supplies or raw material, the costs of purchasing, distributing, administering and storing the raw material as inventory can be extremely high. Therefore, rather than ordering the material and storing it as inventory (with inventory related costs) the thinking behind JIT is to eliminate all excess supply related costs and order the raw material “just” when it is about to be used. This will free up additional cash and as mentioned, reduce costs as related to storage.


The cautionary note here is that the suppliers have to be highly dependable. This approach may not only mean that the business loses its wholesale pricing advantage, but it also puts increased pressure on the business by adding administrative costs related to continual reordering. Overall, the assumption is that the costs associated with storage and inventory control are higher and that therefore JIT is warranted.
Lets also try to understand the difference between these to production methods in the use of the term “Push and Pull”. Inventory that is pushed through production is done so on the assumption that consumers will demand the products. On the other hand, Inventory that is pulled through production is done when only when consumers demand the products.


To summarize, the advantages and disadvantages of JIT are as follows:
  • Costs such as storage, and administration that are related to inventory are reduced or eliminated.
  • With the reduction of costs, cash flow increases
  • The “pull” approach to manufacturing is in line with supply chain management and TQM
  • Suppliers are depended upon for timely delivery
  • Whole sale or bulk pricing advantages are lost
  • Sudden increased changes demand may not be met
  • Administrative costs related to frequent ordering under JIT may increase as do delivery costs
While JIT looks at ordering raw material when production needs it, the traditional approach is to stockpile and create an inventory of raw material. This traditional method is referred to as Just-In-Case production. If suppliers are not dependable and other factors such as supply shortages or fluctuating demand are common occurrences, then storing supplies is not such a bad idea, despite the associated costs.
Lean production methods, Kaizen and TQM (Total Quality Management) do not favor this “push” method of production. This is principally because JIC results in waste being a large component of the method.
In the JIC approach, companies will tend to hold a minimum level of stock allowing them to meet
  • unexpected demand
  • take advantage of wholesale pricing schemes also referred to as economies of scale
  • and avoid unexpected shortages
Stock control charts:
IN JIC the stock control chart plays a vital role in understanding when levels of stock or inventory need to be replenished. The chart shows the level of existing stock and the points when purchase is triggered.

Jic Chart.png

  • Maximum stock level: the largest amount of stock to be kept in storage (500).
  • Minimum stock level: the smallest amount of stock to be kept in storage (100).
  • Reorder level: the amount at which new stock is purchased.

lead time
The time between the repurchase of stock and when the stock arrives to replenish the minimum stock level is referred to as lead time. Above we see that 400 items are ordered (500-100) and it takes two weeks lead time for the ordered stock to arrive.

• buffer stock
The stock that is alway available is referred to as a buffer. Above we see that there is always a buffer stock of 300 items in the event that supply is not timely
• re-order level
The level at which the purchase of new stock is triggered is referred to as the reorder level. This is 100 as seen above at the minimum stock level and implies that automatically new inventory is requested.
• re-order quantity
When the order is placed for new stock, the maximum stock level is the re-order quantity, which is 400. Remember that 100 is always available and the difference between the 500 level and already existing 100 is 400.
Capacity utilization rate
If a business is continually ordering stock and replenishing its stock level under the JIT production method, this may seem to be a sound example of a smooth running manufacturing operation. However, under Kaizen and TQM, other questions are also continuously raised in order to question and improve upon the present status quo. One of these key questions is the whether manufacturing is operating at its full potential.
The capacity utilization rate, although is sounds difficult, is a rather easy to understand concept. Remember again that the factor inputs in production are land, labor and capital. Which this in mind and taking capital as machines and all human made production related material, how can we be certain that all the capital in operation is meeting its full potential? In addition if we consider labor as being human and contributing towards production, again how can we be certain that all the labor in operation is meeting its full potential?
The capacity utilization is the extent to which a business uses its production capacity. This is measured as the relationship between actual output, which is currently being produced, and potential output, what could be produced at full capacity. The capacity utilization rate is a percentage as follows:
(Actual Output - Potential Output /Actual output) x100
If therefore a business of operating at 60% it has the potential to operate to 100% and its slack is 40%.
Capacity utilization rate is more readily applied to the production of tangible or physical products as opposed to services.
Productivity rate
The rate or production over a given period of time is the productivity rate. This measure of production is also more readily applied to physical or tangible products and is usually associates the TQM. As we have seen in different production methods, the higher the productivity rate the lower the quality of the products.
Therefore a business has to determine the productivity rate where quality loss is not costing the business. To do this you will need the number of units manufactured during a time period and the amount of hours utilized. Then divide the units manufactured by the hours used. This will determine the production rate.
Cost to buy (CTB)
Operational decisions related to making or buying are important. If it costs more for a business to buy a product rather than manufacture it, then clearly the choice is to manufacture. However, is it truly as simply as that? What has to be considered when examining the cost to buy or cost to make. Lets start with the cost to buy.
Deciding to buy a product is essentially the concept of outsourcing that we reviewed earlier. If a business is to consider buying it must determine the impact of costs and ability to meet the capacity. This means that it may be cheaper to purchase or outsource the production and it may also mean that the capacity or demand cannot be met, and therefore it would be better to outsource the manufacturing.
Another factor beyond the profit margin that will also come into play is the quality of the final good and how this may affect the brand name and image.
When consider the Cost to Buy we therefore must consider:
  • Costs of in-house production vs Outsourcing
  • Insufficient ability to meet the capacity demanded
  • Technical Expertise and skill
  • Brand, quality and image considerations
Cost to make (CTM)
The decision to manufacture in-house and not outsource the manufacturing is also dependent on a number of factors.
  • Costs of in-house production vs Outsourcing
    • Brand, quality and image considerations
    • Direct control of the entire process
    • Concerns relating to intellectual property
    • Organizational tradition
With the trend in globalization and outsourcing, the questions raised in the cost-to buy and cost-to-make have come to the fore of decision-making in operations and management. There are other advanced concepts and considerations, which go further in providing managers with additional tools for decision-making, however the primary ones should now be clear to you.