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Chapter 8
Introduction to supply chain and operations management (oper1420)
Conestoga College
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The Business Planning Process
The Business Planning Process incorporates all processes that help companies make their strategic and business plans a reality — from the first step of Strategic Business Planning, through making or buying the product/service, to satisfying the customer. Coordinating mechanisms between functional areas including Marketing, Accounting, Finance, and Engineering, ensures all areas are working towards the goals and objectives of the company. The Business Planning Process (as shown in Figure 1) facilitates that coordination. The purpose, level of detail, time frames covered, decisions, and degrees of risk vary for each level and will be discussed in detail in the following sections.
Figure 1 Business Planning Process
Strategic Business Planning
The Strategic Business Planning element outlines the broad direction of the business and what new markets, new products, major process, choices and major capital investments the company plans to participate in during the next 2-10 years. It incorporates the mission, vision, and strategy of the company. It is created by senior management and includes input from all functional areas involved in the business including marketing, finance, operations, and engineering. Each of these functional areas develops goals and objectives which support the firm’s Strategic Business Plan.
An example of Strategic Business Planning is a Six Sigma Consulting company deciding it wants to capture new customers in China, a new market penetration for it. An example of a new product and market is that Research in Motion (RIM) strategically decided to diversify beyond offering the BlackBerry for the business market only. They began offering the BlackBerry to the everyday consumer for personal use and created a product that now competes with the iP hone. An example of a major process change is when a dollar store in Waterloo, Ontario installed a new computer system to keep track of inventory. Instead of the cashier counting the number of items sold for a $1, each item is barcode scanned when sold and is reduced from inventory. Look at your receipt; is the part number and description on it? If so, then inventory is probably being tracked. Another example of a major process change is that an automotive assembly plant installed robots to weld instead of having operators weld parts.
Major capital investment would include “bricks and mortar” decisions such as building a new distribution centre or plant, or investing in new technology. An example of a major capital investment is that a number of years ago, Canadian banks invested in online banking software for consumers to use. A few large retailers have implemented self-serve checkouts, which are also considered capital investment.
Financial projections by product family on revenue, cost, and profit are included in the Strategic Business Plan. Typically financial statements include budgets, a balance sheet, an income statement, and a projected cash flow statement. These are completed with few details for this high level plan in the organization.
Plans developed at this level have the highest level of risk because decisions made here are to be implemented by the organization. Commitments to new markets, new products, new processes, and capital investment are hard to change once they have been made. These decisions can make or break a company.
Flexibility is the highest at this level as there is discussion about “what if” and “what might happen.” But at this stage, the organization is talking about strategic direction and what it wants to accomplish. In the subsequent processes, these plans get implemented. So the farther down in the Business Planning Process, the harder it is to change direction, and therefore, flexibility declines.
Sales and Operations Planning
Oliver Wight Americas, Inc. describes Sales and Operations Planning (S&OP) as a process lead by senior management that, on a monthly basis, evaluates revised, time-phased projections for supply, demand, and the resulting financials. “It’s a decision making process that ensures that tactical plans in all business functions are aligned in support of the business plan. The objective of S&OP is to reach a consensus on a single operating plan that allocates the critical resources of people, capacity, materials, time and money to most effectively meet the marketplace in a profitable way.” 1 (Wight n., p)
The S&OP element is where management is responsible for balancing supply and demand in an organization at the product family level. A product family or group includes products similar in the processes to make them, in marketing characteristics, and/or in specifications that can be summarized or aggregated for planning purposes. Examples of three product families for McDonalds include burgers, drinks, and salads.
The S&OP review happens monthly when cross-functional representation from Marketing/Sales, Finance/Accounting, Operations, Engineering, Purchasing, and suppliers are involved in developing a plan by product family or group in both dollars and units. Suppliers are encouraged to be involved or Purchasing communicates on their behalf. In these meetings, capabilities from each functional area are discussed, and if there are any constraints, they are communicated and resolved. The outcome of the meeting is a plan that supports the organization’s strategic direction, and all areas involved support and sign off on the plan. Usually several levels of a company are involved including senior management, middle management, and possibly front line staff. It is important that senior management is involved to
Aggregate capacity decisions made at this level include changes to workforce levels, aggregate inventory level adjustments, subcontracting, and logistics provider decisions.
Roles of Functional Areas in S&OP
It is important to get an idea of what each functional area in an organization brings to the S&OP process. The next sections will provide some details.
Figure 2 Functional Areas in Sales and Operations Planning
Marketing/Sales Marketing/Sales provide the projected customer demand or forecast. In developing the forecast Marketing/Sales identify current customer requirements, new customer requirements or opportunities, new product information, information about the competition, and upcoming promotions.
Marketing and Sales own the forecast and are accountable for its accuracy. Having an accurate forecast is a cornerstone of S&OP, If it is too high, there can be excess inventory. If it is too low, there is a risk of not satisfying the customer. In a service organization where it is not possible to build up inventory, if the forecast is high we will not have work for all our staff which could cost the company money and eventually put it into bankruptcy. On the other hand, if the forecast is low and we are not meeting the requirements of our customer, we can get a reputation of being unreliable and lose customers. Have you ever been in a restaurant when there were few customers and staff was standing around? That is an example of the forecast projection being too high. How about when there was not enough staff, did you go back? Granted there are other variables like weather that are out of the forecasters control, but the Sales and Marketing people have to continually refine their forecasting techniques to provide as accurate a forecast as possible. This forecast drives the whole process.
Sales and Operations Planning
Sales/Marketing
- Customer demand
- Customer needs
- Competitive Environment
Accounting/ Finance
- Cost Data
- Financials
Operations
- Supply Side
- Capacity information
- Production Plan
Engineering
- New Product Design
- Process Changes
Purchasing
- External supply- supplier's capabilities
- Improvements from suppliers
One approach to S&OP forecasting that proves successful for organizations involves the development of an upside or optimistic forecast, a downside or worst-case scenario, and a forecast that was really what they thought would happen. With this approach, a company can then cost out the differences and look at the potential of each forecast. It can then develop contingency plans for each scenario, such as plans to handle an unexpected increased or decreased demand. For example, if demand increases, Purchasing will have worked on setting up subcontractors to build products. If demand decreases, plans to reassign people can be developed.
It is important that the strategic business plan is considered here. Marketing/Sales need to develop a demand forecast that supports the Strategic Business Plan (SBP). For example, if the SBP has a sales projection of $10 million dollars and the sales forecast is $9 million dollars, Marketing/Sales has to find a way to increase demand to meet the SBP.
Marketing/Sales is responsible for the demand side of S&OP.
Accounting and Finance Accounting and Finance prepare cost information required for the detailed budgeting and cash flow analysis using the new S&OP plan and both the Demand and Supply plans, to project revenue, cost, and profit. Specifically they cost out the production plan, as well as create a projected balance sheet, income statements, and cash flow analysis. Finance staff has the responsibility to ensure the financial viability of the firm. From a cash flow perspective, they may need to acquire more cash, possibly a line of credit if required. They may also recommend that the S&OP be modified if they are unable to attain the credit required to support the plan as stated. For capital purchases, Finance will prepare a capital request which includes a return on investment and payback analysis for various alternatives. For example, a Spa company may evaluate purchasing new pedicure chairs. They could consider a basic comfortable chair with a basin or a fully massaging chair with a basin. What is the cost and payback period for each option? Could they charge more for a pedicure that gives a massage at the same time? In each scenario, how long would it take to pay back the investment and start making money on this capital investment? Do they have the funds available to make the purchase? Based on input from Finance, a decision is made for what type of equipment to buy.
Operations
Operations use the sales forecast and develop supply plans to meet projected customer demand. This includes plans that balance cost, customer service, inventory investment, manpower, and asset utilization. Operations know the resources they currently have and develop plans to utilize those resources to satisfy demand and ultimately the customer. Resources include people/manpower, machines/equipment, materials, and money. Operations are responsible for the internal supply and capacity side of the S&OP process. This process is called production planning and will be covered in more detail below.
Purchasing
Purchasing provides information about suppliers’ capabilities, possible new suppliers, and improvements to supplier processes or materials. In a sense, suppliers are considered part of the organization’s capacity in satisfying customer demand. Purchasing must continually be monitoring what
Figure 3 Linkages between Production Planning and Capacity Planning
The APICS dictionary defines a resource as “anything that adds value to a product or service in its creation, production and delivery.”² (APICS, APICS Dictionary Twelfth Edition 2008). A resource can be a person, machine, building, computer program, money, space, etc. At the production planning level, we are evaluating resources that take a long time to get: buildings, capital equipment, and people. In this phase, planning factors based on a bill of resources are used to convert product/service requirements to capacity information. This is done at a very high level in the organization with not a lot of detail and compared to capacity available.
To create a production planning spreadsheet, you need the forecast from marketing (demand management), planning factors to convert the forecast into required resource capacity information, and identification of the current capacity constraints. A spreadsheet best displays this information.
Company’s generally follow one of three production planning strategies: level, chase, or mixed.
Level
This planning strategy tries to level the amount of production built over the year. Figure 4 shows this concept graphically. Production is held constant while sales fluctuate.
Figure 4 Level Production Planning
The advantage of a level strategy is that the resources - labor, machines, etc. - are kept at a constant rate, and when demand fluctuates, inventory is built or consumed. This method is used if you have a highly skilled work force or expensive machines or equipment that needs to be run continuously. In the case of a skilled workforce, when demand drops you do not want to lay off these people. With skilled labor, typically jobs available at other companies, and it will be difficult to hire them back when you need them. The time and money invested in training them is also lost. With skilled employees, there is a longer learning curve, so you want to protect these employees. There are disadvantages with this method. When demand drops, inventory can be built up but it costs money to store inventory. Inventory carrying costs include the cost of borrowing money to finance inventory, the cost of the storage area where the inventory is held, and risk costs, for example the chance of it going bad or obsolete. When demand rises, you may very well stock out of product. There are penalties (costs) associated with not having product when your customer wants it.
When employing a level strategy, a company may try to influence demand to try to level it out. Methods used to influence demand include offering promotions or discounts during slower times. An example of using level production planning follows in Figure 5.
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Number of Units
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Level Production Plan
Sales Forecast Production Build
per part are the time it takes to make one part. Worker hours per month are the standard number of hours an employee works in a day, week, or month. These standard number of hours worked by an employee varies from industry to industry, company to company, department to department, and even shift to shift. In Fig. 4 we are assuming a simple 8 hour work day, 5 days per week, and 4 weeks per month. Worker hourly rate is the cost per hour for each employee including their hourly rate and benefits. Inventory cost per part per month is calculated based on the cost of the part and the inventory carrying cost. It is the cost to hold one unit in inventory for one month. Accounting is responsible for assigning these costs. Inventory carrying costs will be covered in more detail in the inventory chapter. Backorder costs per part per month are the cost if the company has a customer order and is unable to fulfill it. Backorder costs include the possibility of premium costs incurred to expedite product to meet customer requirements. They can also include the cost of a lost sale, and/or a lost customer. Backorder costs are usually more expensive than inventory carrying costs, but really depend on the product/service bundle and the customer expectations.
Hiring and Firing costs recognize that layoff and/or firing an employee costs the company money. With a layoff or firing, there are severance pay issues, government regulations to follow, possible legal fees, relocation support for the employee, legislated paperwork, etc. With respect to hiring, costs can include recruitment costs, costs during the selection process, and costs associated with the learning curve of a new employee, in this example our production build has been leveled at 1000 parts per month, therefore our work force is stabilized and we do not use the hiring and firing costs in our calculations. You can see from the example how inventory levels vary from month to month as demand varies yet production remains constant. Overall for the year, there is no change in inventory level. Opening inventory is 500 and it is the same for closing inventory. This is due to the fact that total annual demand is 12,000 units, the exact same amount as total annual production. At this point the costs of this plan would be calculated using the cost planning factors. Other costs like overtime or machine capacity constraints may also be included. For this course you will not need to know how to do the cost calculations. That will come in later courses. Having said that, see if you can calculate the inventory costs, labour costs, and backorder costs associated with this plan.
Chase- This planning strategy chases or matches production levels to the sales forecast. Sometimes there is minimal inventory carried, but often there is not. Figure 6 demonstrates this graphically where sales and production are matched.
Figure 6 Chase Production Planning
The advantage of this strategy is that little or no inventory is built up; you make what you need when you need it. This is the strategy that most services are forced to use because they cannot build inventory. There are ways to influence demand and capacity which will be covered in the S&OP for services section.
The disadvantage is you may be hiring people one month, then laying off people and not utilizing equipment in the next month. In fact you would need equipment available to meet peaks in the demand. This method works best if your work force is not skilled, is easily replaced (large labour pool) and/or training is minimal.
The post office does not level out delivering mail but needs to process it as it comes. I would hate to get my Christmas cards in January if they chose to use a leveling strategy! Highly perishable products like fruits and vegetables are planned using the chase strategy.
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correspondingly level. Management could decide to reduce the amount of inventory carried at the end of the plan, which would reduce the total cost of this or possibly any plan developed for that matter.
The costs of this chase production plan are $12,700 higher than the level production plan.
Mixed- Is probably used most often in business and combines both level and chase strategies. Figure 8 shows this concept graphically. Production is leveled from January to April and then stepped up from May until August, perhaps with the use of summer college students, then stepped down and leveled from September to December.
Figure 8 Mixed Production Planning
Another example would be a hot dog manufacturer like Maple Leaf Foods. In the summer months when demand rises, they may run a second shift of hot dog production. Conversely, they may only run one shift or less of hotdogs in the winter months when demand is lower. There may be times when workers can be shifted around to accommodate for changes in demand , rather than layoffs or firings. Changes in manpower levels typically corresponds to a significant change in demand.
In developing the mixed plan, management is responsible to develop a plan that achieves the best possible compromise for all involved; employees, managers, customers and shareholders of the company.
The advantage of the mixed production planning approach is that it combines the best of both the level and chase approaches and usually produces the lowest cost plan.
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Number of Units
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Mixed Production Planning Strategy Planning Factors Opening Inventory 500 Opening Workers 75 Hours per part 12 Worker hours per month 160 Worker Hourly rate $ Summer Student Hourly rate $ Inventory cost per part per month $ Backorder Costs per part per month $ Hiring Costs $1, Firing Costs $
Mixed Production Planning Strategy
Month
Sales Forecast
Production Build Inventory
Required Workers
Hire/Fire Workers January 900 900 500 68 - February 1000 900 400 68 0 March 1100 900 200 68 0 April 1000 900 100 68 0 May 1200 1200 100 90 22 June 900 1200 400 90 0 July 1300 1200 300 90 0 August 1200 1200 300 90 0 September 700 900 500 68 - October 1000 900 400 68 0 November 900 900 400 68 0 December 800 900 500 68 0 12000
Cost Calculations Regular Labor costs $ 2,611, Summer Student Wages $ 168, Inventory holding Costs $ 8, Backorder Costs $ - Hiring Costs $ 22, Firing Costs $ 21, Total Cost Level Production Plan $ 2,788, Figure 9 Mixed Production Planning
Figure 9 Mixed Production planning total cost is the lowest of the three plans developed to this point, at $2,804, 610 which is $ 84 ,290 less than the level planning alternative. In the mixed model example, the
b. During busy periods overtime may be used to increase capacity. The premium costs in extra wages paid to employees, as well as potential costs due to loss of productivity and /or quality do not make the use of overtime attractive in the longer term. c. Hiring part time, temporary or seasonal workers is an effective way to increase capacity for shorter periods of time. Retail stores hire Christmas staff for the sales period leading up to Christmas. Gardening and landscaping companies hire seasonal workers for spring to fall period. d. Shifting work to the customer is being used more often. Self serve checkouts at retail stores have reduced staffing needs and tend to have smaller line ups. Only one cashier is required for multiple self serve checkouts. The banking industry has shifted financial transactions from tellers to banking machines, to telephone banking to internet based banking. Many customers do their own banking online where they can do most of the transactions themselves. Only when a transaction is not available online, do the customers go into the bank and have the teller perform them. A reduction in the amount of bank cashiers has been the result and the customer is performing most of the work traditionally done by the banking cashiers. Another example, there once were separate employees responsible for clearing tables at fast food restaurants. Now this job is handled by servers or sometimes even the customer.
Most organizations will use a combination of approaches to successfully balance supply and demand. For example, Financial Planners have to look ahead to RRSP season and find ways to ensure they can meet with all current and potential new clients to maximize RRSP contributions prior to the deadline. Calling customers ahead of time and trying to schedule appointments before the deadline, or having clients make monthly contributions to their RRSP is how the astute Financial Planner tries to influence demand. Additionally, during the first few months of the year Financial Planners usually extend their working hours to be able to meet with all clients during this busy time. This is an example of them adjusting their capacity.
It is really important that S&OP planning is done for services to ensure that supply and demand are in balance. Many service companies are implementing S&OP to aid them in this process.
The next few sections to be covered will focus on making parts and the processes required to make them. Service organizations do not follow these processes exactly but they do have to go through the process of scheduling people and materials to meet their customer orders. As you go through the material you will get an appreciation of what each process is doing and its importance. At the end of each section we will discuss how these processes can be adapted for services.
Master Production Scheduling
Master Production Scheduling is the process of creating a build plan for individual end items otherwise known as finished goods. It is the anticipated build schedule for independent demand items which are usually shipped to the customer. Examples include finished goods and service parts. Service parts are replacement parts. When we buy a car and the windshield wipers wear out, we buy replacement windshield wipers. This is an example of a service (independent demand) requirement in the master schedule.
When we create the Master Production Schedule (MPS) we start from today and plan our build for each end item out into the future, typically in weekly amounts or time buckets. The length time into the future the MPS created for is called the Planning Horizon. The length of the minimum Planning Horizon is determined by the longest cumulative lead time of the part which includes both purchasing and manufacturing lead time, plus one additional planning period and time bucket. The longest cumulative lead time includes the total lead time of all the parts and processes to make a product or service. This longest cumulative lead time varies from product to product based on the product itself and the nature or complexity of the processes involved. You can well imagine that the longest cumulative lead time to manufacture a Popsicle is considerably shorter than that of a manufactured home. Whatever the product, we calculate its longest cumulative lead time, typically measured in weeks (the MPS time bucket). A manufactured home may have the longest cumulative lead time of 26 weeks from the time the order is placed until the home is completed and handed over to the home owners. In another example, if we were to make chocolate chip cookies, we would need to purchase ingredients such as flour, sugar, butter, salt, baking powder, and chocolate chips. Assuming we have no inventory in our pantry, we would go to the grocery store to purchase these ingredients, which would take us one hour. This is our purchasing lead time. As we follow our recipe and start creaming the butter, mixing in the sugar and the other ingredients, the cookie dough may be considered a sub-assembly. This takes 15 minutes (manufacturing lead time). At this point we would separate the dough into cookie size pieces on a baking sheet. We then bake and cool the cookies, which takes one hour (manufacturing lead time), Total manufacturing lead time including mixing, baking, and cooling, is 1 hours. We add the 1 hour of purchasing lead time to the 1 hours of manufacturing lead time to arrive at a total cumulative lead time of 2 hours.
The MPS must support the S&OP and the Production Plan. Remember that at the S&OP/Production Plan level the forecast and production was determined to meet our customer requirements and effectively utilize our resources at a minimum cost. If we start making changes at the MPS level without regard to the S&OP/Production Plan, we may not satisfy the customer or it could cost more to produce the product/service bundle than we originally planned for in the S&OP/Production Plan. The Master Scheduler must consider the availability of material and capacity as well as management’s policies and goals contained in the budget, which was derived at the S&OP/Production Planning level. Management goals on customer service, inventory levels, overtime policies and scheduling policies are all captured in the budget and support the strategic plans of the organization. Therefore, the MPS must also support the S&OP/Production Plans, thereby supporting the financial and strategic plans of the organization.
The Master Production Schedule (MPS) disaggregates the S&OP. What this means is that the MPS breaks down the S&OP into greater detail. Figure 10 demonstrates this concept. The approved production plan
available inventory (25 + 200 – 212) of 13 cases in Week 1. The 4th line is available to promise which is what marketing will use to book new customer orders. Let’s say a customer calls in and wants to order 25 cases of hamburgers with delivery ASAP. The salesperson can go to this grid and see that they could commit to providing the full 25 cases in week 3 as there are 47 in ATP. If the customer needs before that time, 13 could be committed in week 1, 3 in week 2 and the balance in week 3. This is a powerful tool in helping satisfy the customer.
Hamburger Week 1 Week 2 Week 3 Week 4 Forecasted Demand 200 200 200 200 Customer orders 212 197 153 79 Proj. Avail. Inv. 25 13 13 13 13 Available to Promise(ATP) 13 3 47 121 MPS 200 200 200 200 Figure 11 Example MPS Planning Chart
After the preliminary MPS of all finished goods in a product family is completed, the capacity of critical resources needs to be verified using rough cut capacity planning. Critical resources could include labor, machine time, or supplier capacity. During the Production Planning process planning factors or averages were used to look at capacity. Now at the MPS level, once we add the detail by finished good part numbers we may need to rebalance and make adjustments to our resources. For example, assume that the planning factor used in Production Planning for the burger product family is 1 hour per case. At the individual end item level, the time that is takes to make a case of hamburgers may be .9 hours, cheeseburgers 1 hours, and bacon cheeseburgers 1 hours. Depending on the product mix scheduled weekly there may need to be shorter term adjustments in capacity. Adjustments to resources could include changes to workforce, shifts, overtime, subcontracting, and inventory levels and logistics decisions. Once we have adjusted our capacity at critical resources, or changed our MPS quantities, we have a firmed MPS.
Flexibility is getting more limited as the Master Scheduler is constrained by the S&OP plan. Risk is fairly low, as decisions are being implemented.
In service industries it is really important to plan to have the service available when the customer needs it. This means having the right number of people and/or equipment available at the time the customer requires the service. At the S&OP level customer forecasts were used. At the Master Scheduling level, actual customer orders or customers arriving in person are used. A bank needs to know how many tellers and bank machines are needed to be available to satisfy customers. In some cases they can bring in cross trained employees who are performing other tasks when the lineups become long, and those peoples go back to other work when the lineups are shorter. The bank does their own type of master planning.
Material Requirements Planning
At the MPS level we planned finished goods. The next step in the planning process is Material Requirements Planning (MRP). MRP provides more detail in planning for all the purchased and manufactured component parts required to make a finished product. These are called dependent demand items. Dependent demand items are calculated based on a bill of material. Think of MRP as a
huge calculator that processes information, typically by a computer program. MRP is especially useful for manufactured parts where there is a build-up of sub-assemblies and parts to make a finished good. Computers, automobiles, airplanes, or any assembly manufacturing would be a good candidate for MRP.
MRP is the most detailed of the planning phases and the time frame is as long as the MPS offset by lead time in weekly time buckets for all parts. Sometimes in the nearer term the time buckets are daily or by shift. Risk is low and flexibility is also low.
Figure 12 Inputs and Output of MRP
Figure 12 provides the inputs MRP. It is crucial that each of these inputs is accurate for the system output to be useful throughout the supply chain. If any of these inputs are not accurate, it is ” garbage in, garbage out”. This is where many companies fall down in the use of computerized planning systems. We covered the MPS in the last section, so we’ll review each of the other inputs to MRP in more detail.
A Bill of Material (BOM) is a listing of all subassemblies, components and parts required to make a finished good and the quantity required of each. Think of it as a recipe, where the ingredients and quantity of each ingredient is listed. Figure 13 is an example of a chocolate chip cookie dough bill of material displayed as a product structure tree. The advantage of using a product structure tree is that it displays how the product is put together. Anything on the lowest level (without anything items underneath it) is a purchased part. Any items that have parts linked beneath it are subassemblies or finished goods. In Figure 13 there are two subassemblies; the wet ingredients and the dry ingredients. These have to be made first before mixing these two sub assemblies together with the chocolate chips to make the cookie dough, the finished item in this BOM.
MPS MRP
BOM
Inventory
Data
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Orders
Planning
Factors
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Orders
Chapter 8
Course: Introduction to supply chain and operations management (oper1420)
University: Conestoga College
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