N C/ a, HD28 .M4U no. 3500- ALFRED P. WORKING PAPER SLOAN SCHOOL OF MANAGEMENT Production Allocation Modeling System: Optimizing for Competitive Advantage in a Mature Manufacturing Industry R. Sloan Brown, J. Shapiro and V. Singhal WP# 3500-92-MSA November, 1992 MASSACHUSETTS INSTITUTE OF TECHNOLOGY 50 MEMORIAL DRIVE CAMBRIDGE, MASSACHUSETTS 02139 Production Allocation Modeling System: Optimizing for Competitive Advantage in a Mature Manufacturing Industry R. Sloan Brown, J. Shapiro and V. Singhal WP# 3500-92-MSA November, 1992 JAK I Production Allocation Modeling System: Optimizing for Competitive Advantage in a Mature Manufacturing Industry R. Brown, J. by Shapiro, V. Singhal November, 1992 I. INTRODUCTION Setting production targets for geographically dispersed production sites is a common problem routine decision, that it in large manufacturing companies. Although a it is encompasses important but sometimes subtle tradeoffs have a direct impact on corporate performance. The location of production clearly affects the cost of production, because the cost of inputs, as well as taxes and other financial factors, It may show wide geographic also affects the cost of distributing products to customers, which is variation. largely a function of distance. Service levels are also strongly related to the proximity of the production point to customers, and to such factors as the capacity of the plant. Production targets also set the stage for lower level manufacturing decisions, such as production scheduling and inventory management. More generally, targets largely determine the level of utilization for manufacturing sites. At the most extreme, the allocation of production may be shut down call for a site to or mothballed. This paper describes a production allocation modeling system (PRAMSYS) that we have done ArON for the corporation, a major producer of industrial gases (oxygen, nitrogen, argon), with sites and customers throughout the United States. active use as a routine planning tool for more than numerous manufacturing The system has been a year in the in company's Mid-Atlantic region, and installations in other regions are underway. PRAMSYS embedded generation. in a is a large Mixed Integer Programming (MIP) model menu-driven interface The immediate purpose for data preparation of PRAMSYS is to and report minimize combined regional manufacturing and distribution costs over a planning period of one 1 to three months. More allocate individual sites. PRAMSYS generally, corporate planners use customer demands to geographically because it is of general interest costs dispersed production and demonstrates the value of optimization reduction to be limited. model can be used to it mature industry in a to expect opportunities for cost how an demonstrates integrating bring the company's technical expertise in production and process engineering PRAMSYS In particular, capabilities. beyond the immediate application where conventional wisdom might lead one The each month to also optimally allocates idle time to sites in keeping with complex relationships between production PRAMSYS it on larger to bear strategic issues. project also illustrates how a model and an application evolve together over the course of a project through an interplay between practical, computational, and theoretical considerations. model became both more fortuitous correct outcome which applications. Among difficulties that is and simpler - a In this case the happy but perhaps by no means the rule with complex modeling other things, this evolution illustrates the subtle can arise when practitioners focus too closely on their mathematical abstractions and lose sight of the practical reality behind their models. II. INDUSTRY BACKGROUND Production of industrial gases is in many ways the quintessential mature manufacturing industry. The process of cryogenic which known air is distillation by separated into gaseous and liquid elemental fractions has been for over eighty years. Competing producers now operate intensive plants with similar intrinsic thermodynamic capital efficiencies; no radical breakthroughs material, is in free production technology are to be expected. Air, the sole raw and does not vary appreciably in quality. Nor there is much scope for product differentiation - except for special applications where extreme purity is essential, all liquid nitrogen is very much the same. Despite this stability on the supply side, however, the markets for industrial gases are changing, largely in response to structural changes in the national many and world economy. Demand for liquid and gaseous oxygen was years the driving force of the industry. In recent years this demand been declining as the centers of basic industries such as steelmaking offshore. in On the other hand, demand food preparation, enhanced oil for liquid nitrogen is recovery, and other domains the older to a shift in the location of midwestern industrial The result has been in the conditions where for a III. for to alter the prevailing is and cannot afford where is essential. demand, away from premises and operating no longer principally an adjunct to operate as if it were. This shift stability. that can adapt to the new It also opens up new opportunities conditions. PROJECT BACKGROUND The PRAMSYS upper management at project originated in a general desire ArON on the part of to bolster competitive position through better operation of the company's production and distribution system. cost a underlying competition in the industry raises hazards decades there had been company shift centers. procedures in the industry. The company of stable larger industries has increasing for use combination of very low temperature and chemical inertness These changes have also led for is one of the primary determinants of competitive advantage Delivered in this industry (the other being customer service.) The two primary elements of cost and medium term are distribution that are subject to control over the short and production. Production are still significant - costs are generally larger, but distribution costs on the order of 35%. attention should have focused at first It was therefore natural on reducing each of these that costs independently of the other, particularly since such an effort meshed with the prevailing division of responsibilities under the company's Distribution and Production functions. The use of formal models closely paralleled this division. For the purposes of production and distribution planning, groups principle, it customers and production its makes any site in a the product predicted customer ArON sites into several large regions. In region can serve any customer in that region, provided demanded by demands the customer. Within a region, are assigned to a site through a known or monthly planning cycle. These demands can then be aggregated into production targets for each product at each site. In practice, the regional distribution sites, since customers. it was they who managed In making department assigned customers the physical shipment of product to this decision, the department made heavy use of a model based on network algorithms which had been developed distribution costs. the nearest the site. site, to to minimize This naturally tended to favor assignment of customers to with out taking fully into account the cost of production at The production process and to be represented well in its such a model. economics were simply too complex In a very real sense, the model served only to formalize the standard operating procedures of the distribution department and interests to optimize the allocation of production with reference to capabilities of that department. and The production function improve the was also had in place a efficiency of production sites. A major element of and modeling software a set of data gathering procedures ArON Process Optimization Protocol (SIPOP). engineers had developed SIPOP for use at each should be operated to minimize very successful program to electric to produce at those rates, configured and operated to attain this localized called the Site chemical and process site to determine power demand. Given how the site a set of target minimum power production rates for each product, SIPOP calculates the demand program this and indicates how the plant should be this minimum. Although SIPOP performs optimization rapidly and very accurately, it could not in itself determine what the target production rates should be, since these directly reflect higher level decisions about the allocation of customer demand to the site. As we reviewed ArON's procedures and planning that cost reductions in production haphazard, by its if and distribution tools would be it became at best not illusory, unless they were achieved in concert. clear be Conspicuous absence was the ability to plan both production and distribution activities within a single, comprehensive framework to achieve the greatest overall cost reductions. This kind of coordinated planning looked to be relatively untapped area in which the company could distinguish itself from its competitors. In a competitive industry such as industrial gases cost reductions of even one or two percent can be extremely important, increases in profit. translating into much larger IV. MODEL DEFINITION Air separation produce gaseous and liquid sites distributed by pipeline to customers located near the by truck or railroad nitrogen, argon) are distributed deliveries; in fact, each vehicle that the distribution indirectly, through is site. Gases are Liquids (oxygen, tanker. There are no system - and costs - for each product are linked only joint production at the sites. commodity PRAMSYS is thus represented as a set arc networks (one for each product) linking production (or external supply) points to customers. In general, any deliver to customer any customer, but is if shipment from a given site to a reflects the distance intervening geography. historical data The the production sites. costs used in site may and be a PRAMSYS are derived from in use for distribution planning. of the model emerges from the representation of The complexity of variety of related factors, can between the two points, and perhaps the and were already Most of the structure site given undesirable or impossible, then the corresponding arc omitted from the network. Unit transportation cost between a customer joint dedicated to a single product. This means The distribution component of of simple, single air fractions. among them this representation stems from a joint production, electricity contracts, and shut-down operation. A. joint Production A site produces products to five products at once. A jointly from the same production process - up product can be produced at any rate, within upper and lower limits that depend upon the site, how the site is configured, the product, and the rates at which other products are being produced. P2 Figure The (instantaneous) power demand of production rates for liquid products. 1 of the site is an increasing function products, with strong cross terms, particularly for There are compelling theoretical and empirical reasons to believe that the surface KW=f (Pl,...Pn) all mcf/hr is KW is convex, but no closed form for the function known. 4 production rate, Figure 2 7 product P- Data that defines this surface in PRAMSYS although SIPOP was not developed for SIPOP is to find the difficult to purpose. The methodology of minimum power This point. is standard and process modeling, where the complexity practice in chemical engineering and non-linearity of ultimately derived from SIPOP, from that of PRAMSYS. SIPOP uses in fact radically different random search methods this is the underlying processes implement and cumbersome make to use (see gradient search methods Martin (1982), Wang (1978)). Electricity Contracts B. Virtually the only variable production cost to run compressors and liquefiers, so that to the site's use of electricity. production rates of say, LN LOX (liquid all Because is the cost of electricity used production cost KW demand is is very closely tied a function of the products, a decision to assign a customer's oxygen) to site A (liquid nitrogen) at that site, therefore alters the cost of both even though the production demand for, LOX: and of rate for LN remains the same. But production cost efficiency. power Sites are costs are complex and One at a site is not strictly a matter of thermodynamic such major consumers of electricity that energy and governed by special contractual terms that are often quite that differ, sometimes radically, typical contractual feature (KWH) consumption and demand during some for is that the site maximum site to site. is charged both for energy (instantaneous) contract billing period. same magnitude, although energy from These costs are roughly of the costs tend to be higher. 8 power (KW) Under most contracts the unit cost of energy varies discontinuously by time of day. Figure 3 depicts a situation in which the day is divided into on- peak, mid-peak, and off-peak hours. Energy charges are highest during the on-peak hours, lowest during off-peak, and take on an intermediate value during midpeak. The relative proportion of on-, in a may weekday, weekend day, and holiday may be absent from any day type. $/KWH all off-, and mid-peak periods be different. Any period type each type of day in order to take conditions C. is maximum advantage of contractual by no means easy. Shut-down Operation Given short- and long-term fluctuations occasionally has excess production capacity in in demand, some regions. ArON Gaseous products cannot be inventoried, and inventory capacity for liquids Therefore, it is often necessary to put a site into standby mode for is limited. some part of the month. It is of MIP here, in the representation of site shut-down, that the principal use arises in PRAMSYS. A pure choose to shut a plant power down Linear Programming only during on-peak hours, are both most expensive. (LP) when energy and In practice, such a solution impractical for operational reasons (repeatedly stopping model would and would be starting production places unacceptable stresses on equipment and requires an excessive was not amount to of operator intervention.) schedule site production day by day or hour by hour, that the solutions be operationally feasible. impose shut a kind of loose parity down during on, While the purpose of off, It was it PRAMSYS was vital therefore necessary to between the length of time the site would be and mid-peak. D. Slates: Discretizing the Decision Space Both energy and power costs can be very significant. Since both are directly related to KW demand relationships accurately. programming, but this it was clearly important to represent these One approach might have been was rejected for several reasons. 10 to use quadratic First, there are no commercial grade at best QP codes capable of handling only an empirically derived quadratic We rate for each product, produce the site to The function. Each . at those rates. slates define the function. However, the convex cost of is KW a vector containing a production KW draw associated with operating KW production rate is to determine surface. This itself would have (so called demand demand over charge) was operated. Representing cost and production V. MODEL FORMULATION and only if" activity also required the use of of modifications MIP the conclusion of this section. approach for how long that techniques. formulation upon which after their application to actual and Thus, relationship between MIP was based. Experience with MIP models drawn from number based on the set of production rates used during the this "if present here the original is the entire period. period that resulted in the greatest power draw, regardless of and how quite able to represent a convex cost power instantaneous power prior to site Slates in the set cover a "grid" of production would be incurred only by We we had slate. problem, since LP little maximum is basic decision of the model, therefore, presented slate Also, function. approximating the actual long to operate each potential The slate and the minimum rates for all products, closely this cost KW constructs. chose instead to discretize the production rate space for each into a set of production slates the MIP PRAMSYS this formulation, both planning problems, led to a simplifications. These are discussed briefly In the following section, we at discuss our implementing the system based on these models, and experience with the system. 11 Indices 1 i: j: to I index for plants to J index for slates at each plant k: 1 to K index for products m: 1 to M index for customers (slate plant shut-down) is Parameters Pjj = power draw ei = electric energy charge E = electric power demand charge = cost of transporting at plant i (KW) i ($ per KWH) at plant i per ($ KW) J Cj^jj, customer a for jth slate at plant jjjj = m ($ one unit of product k from plant i to per cubic foot) instantaneous production rate of product k by jth slate at plant i (cubic feet per hour) m = demand R = minimum run T = length of planning horizon (hours) d i^jj, for product k by customer (cubic feet) time for any slate at any plant (hours) Variables tjj = length of time plant Wj = maximal power demand |l = ij^jj, jth slate at plant i uses is jth slate at plant used i (hours) (KW) at a positive level \0 otherwise 'J y if i quantity of product k shipped from plant feet) 12 i to customer m (cubic Production Allocation Model (PAM) M I \ I K minimize (1) i Subject = i 1 , = \\ i=l k=l i to: For i = . . M J ^ I , . ^iik'^ii Mjk Sj ^ ~ m= for yikm k = 1, . . ., K (2) l J (3) Itij j = t,j - Rx^j tij - TXij ^ m = 1, . , . . tij The > j = l,...,J (4b) (4C) P X > M ^ i for y W; For (4a) fork = dkm Yikm K l (5) = 0, Wi > 0, objective function (1) in this energy power demand costs, = Xjj or model and distribution 13 is 1, the costs. Yikn, sum Note > (6) of energy costs, that energy and power from plant costs differ electric utilities to plant. This is because the contracts with vary by location, and furthermore, each plant has its unique design and operating characteristics. Note also that the slates available for use at each plant, and their costs, are have chosen the fixed number J We uniquely associated with that plant. of trial slates for each plant simply for expositional convenience. The constraints (2) state that the total quantity shipped from each plant cannot exceed the total production. In practice, the inequality was extended to account for small quantities of beginning and allowable ending inventories. The constraints the entire planning horizon (3) state that plant by production time and down The constraints slate.) slate is used at plant minimum R and the constraint in (4b) is it i, if it is that that (4b) state that the time at all, must lie T. The upper bounding based equals the slates selected The specific fewer than by the model for plant distinguish among electricity rates included power demand i. of the power The constraints the plants. total We note number of KM. models generated by complex than (PAM) we have maximum demand must be met by shipments from (6) is far that the jth between the conditional most customers demand only one product. Thus, the constraints t- Constraint (4c) ensures that the is each at the plant shut- is in the light of constraint (3); power charge the and used redundant demand draws among (5) state (4a) time (recall that slate maximal allowable time for expositional purposes. Wj upon which down consumed is for several reasons. PRAMSYS First, the turned out to be more model was extended peak, mid-peak and off-peak operations when to the vary significantly. Plant shut-downs were modeled more extensively to ensure that shut-down periods occur contiguously. 14 Moreover, may contracts with the electric utility example, terms relating to differences be more complicated, involving, for power draws between peak and in off- peak periods. These complications were modeled by straightforward extensions of the modeling techniques used above. manufacturing sites were extended so Finally, for complex involving several interconnected plants, the models that they would choose the plant configurations as well as the slates for each plant. Even without these extensions, (PAM) fixed charge variety. Wj behave the in a In particular, the manner is a large scale MIP model power demand charges associated with Tricks involving cutting similar to fixed charges. planes on the plant objective functions derived from an optimal proved relatively effective in causing the quickly. A uniform reduction energy charges A ej models in size of the LP solution produce good solutions to demand and bound also caused the branch of the charges Ej relative to the work more to efficiently. second pass through the MIP optimization with the best solution from heuristic as incumbent required far less CPU this time than that required from a cold start without an incumbent. Feedback from users that of for allowed the models to at the plants led to be still an important simplification more rapidly optimized. For monthly planning, the people running the plant prefer to each contract period (peak, mid-peak, off-peak.) The an optimal solution to (PAM) for each contract period is slate the purposes employ one slate suggested from the convex combination of the slates where the weights are the fractions of the time that a slate is used. Since the surface of the cost vs. slate function for the plants studied thus far has empirically proven to be convex, 15 we have been able to relax the corresponding MIP constructs in optimizing the model. MIP constructs are VI. IMPLEMENTATION AND RESULTS required to properly model shut-downs. still PRAMSYS was implemented the LOGS model However, IBM mainframe computer using an for generation language (see Brown et al (1986)) and the IBM optimization package MIP/370. It is PRAMSYS important to emphasize that the LOGS model produces a family of models. The precise formulation of a model for a specific region consisting of several plants it. generation in depends on the data passed For example, depending upon whether a certain contractual element present in the data, certain structures model. We was merely reiterate that the may or may to is not be present in the model (PAM) discussed in the previous section the point of departure for our implementation work, and the creation of a generator for a family of models. The MIP models generated thus tended to be quite large. As many far for the Mid-Atlantic Region have as 1000 slates for each of several plants were generated by the Site Process Optimization Protocol and included in the PRAMSYS models. Moreover, the models incorporate upward of 1000 customers demands over a typical monthly planning horizon. Automatic customer aggregation procedures were implemented, but have not yet been extensively used. many The resulting as 10,000 columns. models have a few thousand rows and as Using the simplifications and approximations outlined above, the models are usually optimized, at least to a close approximation, within a few CPU first minutes on an IBM 3083 computer. 16 We believe that the use of PRAMSYS lead to shifts in the prevailing production However, as is in the Mid-Atlantic Region has and distribution often the case in real-world applications, patterns. it is difficult to substantiate this belief with experimental results, for the simple PRAMSYS reason that demands to is not run in an experimental context. month fluctuate from to month, and there show what would have been done A used to "base case" was run in the is no and obvious Customer "control" process absence of a model. early in the project, in which PRAMSYS was second guess a recent month's allocation decisions. The model solutions showed an increase in distribution costs, with a decrease in production costs that more than compensates for estimate is that PRAMSYS this increase. Overall, the produces monthly production/distribution strategies that are several percentage points lower in total cost than solutions that VII. would have been obtained without CONCLUSIONS AND FUTURE RESEARCH PRAMSYS at it. ArON. at last Its has proven itself to be a useful and important planning tool success demonstrates once again that computer technology has reached a level of development permitting mathematical programming models to be implemented and effectively applied to business planning problems. The success of blending of this project and experience scientific skills in was also due to a felicitous chemical engineering, mathematical programming, and computer systems design and programming. radically Finally, the new approach to backing of top management planning was crucial 17 in supporting a to the project's success. PRAMSYS currently being extended for use in other is national In this regard, experimentation with the Site Process Optimization regions. Protocol is required for those sites consisting of several production plants that can be linked in different ways. more complex sites experimentation is new select A to link the Site Process (see Shapiro (1979). the mathematical An MIP model has been developed. PRAMSYS directly to the and ArON related area of future Optimization Protocol more models via price directed decomposition methods The idea would be programming model slates for the Once models for calculating slates for these to occasionally use to price PRAMSYS prices from out slates produced by SIPOP, model. have been developed, the intention for all regions construct a longer range, national shadow model for strategic is to planning purposes. The types of problems to be addressed by such a model include contract negotiations with customers and electric utilities, long term plant shut- downs, and economic evaluations of new markets. Moving project is underway PRAMSYS that the in the other direction to a to convert the with respect to time and scope, a production planning sub-model in production scheduling model. The reader model (PAM) selects new an optimal combination of may have slates, noted but makes no attempt to schedule the sequence in which they should be used. In the short- term when one on the plant, considers distinct production periods with varying and recognize that inventory storage for gas limited, the sequencing of slates to other process principle in perfornMng extremely becomes important. Finally, generalizations of the be applicable is demands models developed for PRAMSYS should manufacturing industries. The underlying modeling research 18 in this area is to better understand how to imbed process control optimization models, which provide an instantaneous prescription for the plant, in one or more mathematical programming models planning and scheduling. for how methodological problem is world of process control to the in which sequences of and setups are discrete, crucial. We A central from the essentially "instantaneous" to pass world of operational scheduling and control, on /off events associated with changeovers believe the models in PRAMSYS are an important step in this research direction. VIII. P. S. REFERENCES Bender, R. W. Brown, M. H. Purchasing Productivity Interfaces. 15, P. S. Bender, at Isaac, IBM with a and J. F. Shapiro, "Improving Normative Decision Support System," May-June, 1985, pp 106-115. W. Northup and D. J. F. Shapiro, "Practical Modeling for Resource Management," Harvard Business Review, 59, March-April 1981, pp 163-173. R. W. Brown, W. D. Northup and J. F. Shapiro "LOGS: A Optimization System for Business Planning," pp 227-241 Modeling and in Computer Assisted Decision Making, edited by G. Mitra, North-Holland, 1986. D. L. Martin and L. J. Randomly Directed J. F. Gaddy, "Process Optimization with the Adaptive Search," AIChE Symposium Series. Z8, 1982, pp 79-107. Shapiro, Mathematical Programming: Structures and Algorithms. John Wiley and Sons, 1979. B. Wang and R. Luus, "Reliability of Global Optimum," AIChE Optimization Procedures for Obtaining Journal. 24. 1978, 19 pp 619-626. 76 8 Date Due JUV i ', <^^ DUPL MIT IIBRARIES 3 lOaO D0a2404l 5