INTRODUCTION

Operations: The production of goods and services; the

transformation process that converts inputs to outputs

Operations Management: The direction and control of the

processes that transform inputs into finished goods and
services

- The purpose of the operations function is to add value

during the transformation process.

- Operations can add value by decreasing the cost of

inputs or increasing the value of outputs or both.

Manufacturing vs. Service

• Operations Management covers issues in both

manufacturing and service.

• The differences of these two involve the following:

1. degree of customer contact

2. uniformity of input
3. labor content of jobs
4. uniformity of output
5. measurement of productivity
6. production and delivery
7. quality assurance
8. amount of inventory
9. evaluation of work
10. ability to patent design

Productivity Measure

Output
Productivity =
Input

Partial Measures of productivity:

1
 Output
Labor productivi ty =
Employee hours

Output
Multifacto r productivi ty =
Labor cost + Materials cost + Overhead cost

Current Period Productivi ty - Previous Period Productivi ty

Productivi ty Growth = ×100 %
Previous Period Productivi ty

2
OPERATIONS STRATEGY

- The successful implementation of an operations

strategy creates value for customers.

Order-Qualifiers and Order-Winners

Order-qualifiers are characteristics that customers

perceive as minimum standards of acceptability to be
considered as a potential for purchase. Companies need
only be as good as competitors.

Order-winners are characteristics of an organization’s

goods or services that cause it to be perceived as better
than the competition. Companies need to be better than
their competitors.

Components of the Operations Strategy

Structural decision Capacity

categories: Facilities
Vertical integration
Technology
Infrastructural decision Workforce
categories: Organization
Information/control systems
Capabilities: Unique to each firm

3
Competitive priorities: Cost
Quality
High-performance design
Consistent quality
Time
Fast delivery time
On-time delivery
Development speed
Flexibility
Customization
Volume flexibility

Criteria for Evaluating an Operations Strategy

Consistency (internal and external)

• Between the operations strategy and the overall
business strategy
• Between the operations strategy and the other
functional strategies within the business
• Among the decision categories that make up the
operations strategy
• Between the operations strategy and the business
environment (resources available, competitive behavior,
governmental restraints, etc.)

Contribution (to competitive advantage)

• Making trade-offs explicit, enabling operations to set
priorities that enhance the competitive advantage
• Directing attention to opportunities that complement
the business strategy
• Promoting clarity regarding the operations strategy
throughout the business unit so its potential can be fully
realized
• Providing the operations capabilities that will be
required by the business in the future

4
FORECASTING

Judgment Methods
- sales force estimates
- executive opinion
- market research
- Delphi Method

Linear Regression

Yi = a + bX i

where:

Y = dependent variable

X = independent variable

a = Y-intercept of the line

b = slope of the line

Coefficient of correlation (Multiple R)- strength of dependent

and independent variable

Coefficient of determination

Standard error of the estimate

R2- % of the variation of Y that can be explained by X

F-test: tests the overall fit of the model to the data

P-Value: significance of coefficients (a and b)

***P-Value<.05: REJECT hypothesis→ model is GOOD fit

***P-Value>.05: ACCEPT hypothesis→ model is NOT GOOD fit

Time Series Methods

5
Naïve forecasts- forecast of period is similar to last period’s
trend
- stable average, trend, seasonal

Ft=At-1

Moving Averages

n
∑ At − i
Ft = MAn = i =1
n

 F5 = A4+ A3 +A2
3

Weighted Moving Average

Ft = wn At −n + wn −1 At −( n −1) + ... + w1 At −1

 F5 = w 1 A4 + w 2 A3 + w 3 A2

Exponential Smoothing

Ft = (1 − α ) Ft −1 + αAt −1

Ft = Ft- 1 + a (At- 1 - Ft- 1 )

Trend-Adjusted Exponential Smoothing

St = TAF t +α( At −TAF t )

Tt = Tt −1 + β(TAF t −TAF t −1 −Tt −1 )
TAF t +1 = St + Tt

St = SmoothingFactor
Tt = TrendFactor
Errors

6
et = At − Ft

• Systematic errors --- Bias

• Random errors --- Variability

Bias:
n
∑et
Average error = t =1
n

Variability:
n 2
∑et
Mean squared error MSE = t =1
n −1
MSE= Total Error Sq
n-1
Standard deviation s
= MSE

Mean absolute error MAD

n
∑ et
= t =1
n
MAD= Total Abs Error
n
Mean percent absolute error MAPE
n et
∑[ (100 )]
t =1 At
=
n
MAPE= Total [(Abs E)/A] x 100
n

Control Chart for Forecast Errors

Upper Control Limit: UCL = 0 + z MSE

7
Lower Control Limit: LCL = 0 − z MSE

Z = the number of standard deviations from the mean

*Where to find “z” given the percentage of the

control chart, P0 ? Where to find “z” given the
probability for type I error, α ?
Normal Distribution Table (page 883, Table B.2)
Look for “z” corresponds to the probability:
α p0
P{Z<= z} = 1−
2
= 0.5+ ,
2
P0 =1- α
e.g. A 95% control chart has α = 1-95% = 5%, which means
its probability for type I error is 5%. Thus probability in the
table should be 0.975 (P = 1-0.025 or P = 0.5+ 0.475), which
corresponds to z = 1.96.

8
CAPACITY PLANNING

Actual Output
Utilization = Design Capacity

Actual Output
Efficiency = Effective Capacity

Effective Capacity = Design Capacity (maximum output rate)

– Allowances (e.g. personal time, maintenance, and scrap)

Cushion: the amount of the reserved capacity that a firm

maintains to handle sudden increase in demand or
temporary losses of production capacity

Capacity cushion =1 - Utilization

Bottleneck operation: An operation in a sequence of

operations whose capacity is lower than that of the other
operations.

The capacity of a process is the capacity of the bottleneck

operation.

Estimate Capacity Requirements

One type of product

Numbers of machines required
Processing hours required for year' s demand
=
hours available from one machine per year, after the desired cushion deducted
Dp
M =
N (1 − C )

where D = number of units (customers) forecast per year

p = processing time (in hours per unit or customer)
N = total number of hours per year during which the process
operates

9
C = desired capacity cushion rate (%)

More than one type of product: n types of products

Numbers of machines required

Processing and setup hours required for year' s demand, sumed over all products
=
hours available from one machine per year, after the desired cushion deducted

[ Dp + ( D / Q ) s ] product 1 +[ Dp + ( D / Q ) s ] product 2 +... +[ Dp + ( D / Q ) s ] product n

M =
N (1 − C )

Q = number of units in each lot

s = setup time (in hours) per lot

Note: Always round up the fractional part for the number of

machines required.

Capacity Planning Problem

You have been asked to put together a capacity plan for a

critical bottleneck operation at the Surefoot Sandal
Company. Your capacity measure is number of machines.
Three products (men’s women’s, and kid’s sandals) are
manufactured. The time standards (processing and setup),
lot sizes, and demand forecasts are given in the following
table. The firm operates two 8-hour shifts, 5 days per week,
50 weeks per year. Experience shows that a capacity
cushion of 5 percent is sufficient.

Time Standards
Demand
Processin Setup Lot Size Forecast
Product g (hr/lot (pairs/lot (pairs/yr)
(hr/pair) ) )
Men’s sandals 0.05 0.5 240 80,000
Women’s 0.10 2.2 180 60,000
sandals
Kid’s sandals 0.02 3.8 360 120,000

10
a. How many machines are needed at the bottleneck?
b. If the operation currently has two machines, what is the
capacity gap?
c. If the operation can not buy any more machines, which
products can be made?
d. If the operation currently has five machines, what is the
utilization?

Capacity Planning Problem

Solution

Total time available per machine per year:

(2 shifts/day)(8 hours/shift)(5 days/week)(50 weeks/year)
= 4000 hours/machine/year

With a 5% capacity cushion, the hours/machine/year that are

available are:
4000(1-0.05) = 3800 hours/machine/year

Total time to produce the yearly demand of each product:

(This is equal to the processing time plus the setup time.)
Men’s =(0.05)(80,000)+(80,000/240)(0.5)= 4167 hrs

Women’s =(0.10)(60,000)+(60,000/180)(2.2)= 6733 hrs

Kid’s =(0.02)(120,000)+(120,000/360)(3.8)= 3667 hrs

Total time for all products =4167+6733+3667= 14567 hrs

a. Machines needed = (14,567/3800) = 3.83 = 4 machines

b. Capacity gap is 4 - 2 = 2 machines

c. With two machines, we have (3800)(2) = 7600 hours of

machine capacity. We can make all of the women’s sandals
(6733 hours) and some of the men’s sandals, for example.

d. With five machines, (5)(4000) = 20,000 machine-hours/yr

are available. The total number of machine-hours/yr needed

11
for production are 14,567.

Utilization = (14,567/20,000)(100%) = 73%. Thus, the

capacity cushion is (100% - 73%) = 27%.

Vertical Integration Problem: Make or Buy

Hahn Manufacturing has been purchasing a key component

of one of its products from a local supplier. The current
purchase price is $1,500 per unit. Efforts to standardize
parts have succeeded to the point that this same component
can now be used in five different products. Annual
component usage should increase from 150 to 750 units.
Management wonders whether it is time to make the
component in-house, rather than to continue buying it from
the supplier. Fixed costs would increase by about $40,000
per year for the new equipment and tooling needed. The
cost of raw materials and variable overhead would be about
$1,100 per unit, and labor costs would go up by another
$300 per unit produced.

a. Should Hahn make rather than buy?

b. What is the break-even quantity?

c. What other considerations might be important?

12
PROCESS, LOCATION, LAYOUT (SYSTEM DESIGN)

Location Decisions

Dominant Factors in Manufacturing

• Favorable labor climate (unions, ex. Paris)

• Proximity to markets (transportation cost)

• Quality of life (talent is hard to find in a far away area)

• Proximity to suppliers and resources

• Proximity to other parent companies

• Utilities, taxes and real estate costs

Dominant Factors in Services

• Proximity to customers

• Transportation costs and proximity to markets

• Location of competitors (stay away from competitors,

clustering-malls, gas stations)

• Site-specific factors

Breakeven Location Problem

By chance, the Atlantic City Community Chest has to close

temporarily for general repairs. They are considering four
temporary office locations:

13
 Property Address Move-in Costs Monthly Rent
Boardwalk $400 $50
Marvin Gardens $280 $24
St. Charles Place $350 $10
Baltic Avenue $60 $60

a. Can any of these addresses be immediately eliminated

from consideration if the goal is to minimize total costs?

b. Use the graph on the next page to help determine for

what length of lease each location would be favored.
Calculate the breakeven lease lengths between addresses.

Breakeven Location Problem

500

400
Total Cost

300

200

100

0
0 1 2 3 4 5 6 7 8 9 10
Months

14
Breakeven calculations:

Layout Types

- Process- organize around process (can handle varied

requirements)
hospitals, universities, auto repair shops, airlines, public
libraries

- Product- organize resources around product/customer

(smooth, rapid, high-volume flow)
o assembly lines, cafeteria

- Hybrid- (all four combined)- ex. Hospital

- Fixed-Position- resources come to product, ex. Boeing, build

house (product or project remains stationary, and workers,
materials, and equipment are moved as needed)
o farming, fire-fighting, road-building, remolding and
repair, home building, drilling for oil

Production Layout

- L: space limitation, want straight line out of facility

- S: employees stay in circle, access to several
workstations, because inputs come in and outputs leave
it can reward product
- O: get more out of space, utilize it as much as you can
- U: try to organize inbound and outbound transportation

15
LEARNING CURVES

Tn = T1n b

where:

Tn = time for the nth unit

T1 = time for the first unit

b = ln(learning percent)/ln(2)

Tn = T1 x unit time factor

∑ Tn = T1 x total time factor

16
TOTAL QUALITY MANAGEMENT

Customer-Driven Definitions of Quality

• Conformance to specifications
• Value
• Fitness for use
• Support
• Psychological impressions

- Different dimensions of product quality vs. service

quality.

Quality as a Competitive Weapon

• The costs of poor quality are estimated to be 20% -

30% of product or service costs.

• Companies can improve their bottom line through

better quality in several ways:

• Lower costs (through consistent quality)

• Higher prices (through high-performance design)
• Greater market share (through both consistent
quality and high-performance design)

• Consistent quality has become (or is becoming) an

order qualifier in many markets.

3 Elements in TQM

- Source - Errors or defects should be caught and

corrected at the source, not passed along to an internal
or external customer. In other words, “Do It Right the
First Time”!
o Why??

17
 1. It costs less.

2. Inspection and sorting are often not effective.

- Employee Involvement- an important component of

TQM because perceived and actual quality is assessed
throughout the process, involving all employees
o This suggests that:
 Quality perceptions can be negatively
affected at one point in the process, even if
the rest of the process is fine.
 All employees can participate in improving
quality.

- Work Teams- small groups of people who have a

common purpose, performance goals, and
accountability
o Types of teams:
 Problem-solving teams
 Special-purpose teams
 Self-managing teams
o How can work teams help improve quality?
 Products and services are becoming more
complex and interrelated
 Quality can not be ensured by individual
efforts.
 Workers producing products or services often
have the best ideas how the processes can
be improved.

-
Costs of Quality

Cost categories:

• Prevention
⇒ Quality assurance costs (Increasing in level

18
 of quality)
• Appraisal

• Internal
failure
⇒ Nonconformance costs (decrease in level of
quality)
• External
failure

There is a tradeoff between quality assurance and

nonconformance costs.

As the product or service moves farther along in the process,

the cost to address a quality problem rises steeply.

19
STATISTICAL PROCESS CONTROL

Quality Measurements
Control charts can be used to monitor processes where
output is measured as either variables or attributes.

Variables measures - Characteristics of a product or

service that can be measured on a continuous scale.
Examples include length, width, and time.

Attributes measures - Characteristics of a product or

service that can be quickly counted for acceptable quality.
Examples include the number of defects in a product or
service.

Sources of Process Variation

Sources of process variation can be categorized as:

• Common causes - Random, natural, or unavoidable,

sources of variation within a process. A process with only
common causes of variation is stable (i.e. the mean and
spread do not change over time). Such a process is said
to be “in a state of statistical control” or “in-
control”.

• Assignable causes - Any cause of variation that can be

identified and eliminated, originating from outside the
normal process

Variable Control Charts

Standard Deviation of the Process, σ , Known

The control limits are:

UCL = X + zσ X

LCL = X − zσX

20
 - X = center line of the chart and the average of
several past sample means
- z is the standard normal deviate (number of standard
deviations from the average)
- σ X = σ / n and is the standard deviation of the
distribution of sample means
- n is the sample size
[z = 2.17 for 97%]
σ
Control limits : x ± 2
n
.01
UCL is 1.0 +2.17 =1.0043
25
.01
LCL is 1.0 −2.17 =.9957
25

Standard Deviation of the Process, σ , Unknown

Control charts for variables monitor the mean ( X chart) and

variability (R chart) of the process distribution. (n # top
rows in table)

R chart: To calculate the range of the data, subtract the

smallest from the largest measurement in
the sample.

The control limits are:

UCL R = D4 R and LCL R = D3 R

- R = average of several past R values and is the

central line of the control chart, and
- D3 , D4 = constants that provide three standard
deviation (three-sigma) limits for a given sample size

X chart: The control limits are:

UCL X
= X + A2 R and LCL X
= X − A2 R

- X = central line of the chart and the average of past

sample means

21
 - A2 = constant to provide three sigma limits for the
process mean.

**ALWAYS look at R-chart first

Control Chart for Variables Example X , R Charts

Webster Chemical Company produces mastics and caulking for

the construction industry. The product is blended in large mixers
and then pumped into tubes and capped. Webster is concerned
whether the filling process for tubes of caulking is in statistical
control. The process should be centered on 8 ounces per tube.
Several samples of eight tubes are taken and each tube is
weighed in ounces.

Tube number
Sampl 1 2 3 4 5 6 7 8 Avg. Range
e
1 7.98 8.34 8.02 7.94 8.44 7.68 7.81 8.11 8.04 0.76
0
2 8.23 8.12 7.98 8.41 8.31 8.18 7.99 8.06 8.16 0.43
0
3 7.89 7.77 7.91 8.04 8.00 7.89 7.93 8.09 7.94 0.32
0
4 8.24 8.18 7.83 8.05 7.90 8.16 7.97 8.07 8.05 0.41
0
5 7.87 8.13 7.92 7.99 8.10 7.81 8.14 7.88 7.98 0.33
0
6 8.13 8.14 8.11 8.13 8.14 8.12 8.13 8.14 8.13 0.03
0
8.05 0.38
0
X = 8.050, R = 0.38, n = 8
From Table 10.3:
UCL R = D4 R =1.86 (0.38 ) = 0.707
LCL R = D3 R = 0.14 (0.38 ) = 0.053
UCL X
= X + A2 R =8.050 +0.37 (0.38 ) =8.191

LCL X
= X − A2 R =8.050 −0.37 (0.38 ) = 7.909

b) We delete the sixth observation and recalculate the control limits.

The ranges, including the range for the first sample are now all
within the revised control limits, and the process average for the
second sample now falls just inside of the revised control limits.

22
 (0.76 + 0.43 + 0.32 + 0.41 + 0.33 )
R= = 0.45
5
8.040 +8.160 + 7.940 +8.050 + 7.980
X = = 8.034
5
UCL R = D4 R =1.86 (0.45 ) = 0.837
LCL R = D3 R = 0.14 (0.45 ) = 0.063
UCL X
= X + A2 R = 8.034 + 0.37 (0.45 ) = 8.201

LCL X
= X − A2 R = 8.034 − 0.37 (0.45 ) = 7.868

Control Charts for Attributes

p-Chart

A p-chart is a commonly used control chart for attributes,

whereby the quality characteristic is counted, rather than
measured, and the entire item or service can be declared
good or defective.

The standard deviation of the proportion defective, p, is:

σp = p(1 − p) / n , where n = sample size, and p=
å p
= average
n
of several past p values and central line on the chart.

Using the normal approximation to the binomial distribution,

which is the actual distribution of p,
UCL p = p + zσ p and LCL p = p − zσ p

where z is the normal deviate (number of standard

deviations from the average).

Calculating P
xi
pi =
n

pi = proportion of defective products

xi= number of the defected products
n = sample size
m = number of samples

23
 m
x1 x 2 x
( x1 + x 2 + ... + x m ) ∑
+ + ... m xi
( p1 + p 2 + ... + p m ) n n n
p= = = = i =1

m m m⋅n m⋅n

total number of defected products

p=
total number of products

p-Chart Example

A sticky scale brings Webster’s attention to whether caulking tubes are

being properly capped. If a significant proportion of the tubes aren’t
being sealed, Webster is placing their customers in a messy situation.
Tubes are packaged in large boxes of 144. Several boxes are
inspected and the following number of leaking tubes are found:
Sample Tubes Sample Tubes Sample Tubes
1 3 8 6 15 5
2 5 9 4 16 0
3 3 10 9 17 2
4 4 11 2 18 6
5 2 12 6 19 2
6 4 13 5 20 1
7 2 14 1
Total 72
Calculate p-chart three-sigma control limits to assess whether the
capping process is in statistical control.

72
Solution: n = 144, p = = 0.025
20 (144 )
p(1 − p) 0.025 (1 − 0.025 )
σp = = = 0.013
n 144
UCL p = p + zσ p = 0.025 + 3( 0.013 ) = 0.064
LCL p = p − zσ p = 0.025 − 3( 0.013 ) = −0.014 (adjusted to zero)

The highest proportion of defectives occurs in sample #10, but is still

within control limits: p10 = 9 / 144 = 0.0625 . Therefore, the process is in
statistical control.

c-Chart
A c-chart is another type of control chart for attributes,
whereby the quality characteristic is counted as the number

24
of defects/ unit.

Using the normal approximation to the Poisson distribution,

which is the actual distribution of c,
UCL c = c + z c and LCL c = c − z c

where c is the average number of defects/unit and the

center line of the c-chart.

Control Chart for Attributes Example

c-Chart
At Webster Chemical, lumps in the caulking compound could cause
difficulties in dispensing a smooth bead from the tube. Testing for the
presence of lumps destroys the product, so Webster takes random
samples. The following are the results of the study:

Tube # Lumps Tube # Lumps Tube # Lumps

1 6 5 6 9 5
2 5 6 4 10 0
3 0 7 1 11 9
4 4 8 6 12 2

Determine the c-chart two-sigma upper and lower control limits for this
process.

Solution:

( 6 + 5 + 0 + 4 + 6 + 4 + 1 + 6 + 5 + 0 + 9 + 2)
c= =4
12
σc = c = 4 = 2
UCL c = c + zσ c = 4 + (2)( 2) = 8
LCL c = c − zσ c = 4 − (2)( 2) = 0

The eleventh tube has too many lumps (9), so the process is probably
out of control.

Process Capability Exercise

Webster Chemical’s nominal weight for filling tubes of caulk

is 8.00 ounces ±0.60 ounces. The target process capability

25
ratio is 1.33. The current distribution of the filling process is
centered on 8.054 ounces with a standard deviation of 0.192
ounces. Compute the process capability index to assess
whether the filling process is capable and set properly.

Solution:

Process capability ratio:

Upper spec ification - Lower spe cification 8.6 − 7.4

Cp = = = 1.0417
6σ 6( 0.192 )

Process capability index:

X - Lower specificat ion Upper specificat ion - X

C pk = miminum of ,
3σ 3σ
8.054 − 7.400 8.600 - 8.054
=1.135 , = 0.948
3(0.192 ) 3(0.192 )

C pk = 0.948

The process is not capable of consistently meeting

specifications according to the minimum capability level set
by Webster.
** IF IT is LESS than 1.33, it is NOT CAPABLE

26
INVENTORY MANAGEMENT

Definition of Independent Demand Inventory

Independent demand inventory consists of items for which

demand is influenced by market conditions and is not related
to production decisions for any other item held in stock.

Contrast this with dependent demand inventory, consisting

of items required as components or inputs to a product or
service. We will talk about managing dependent demand
inventory in manufacturing using a material requirements
planning (MRP) system.

Total Annual Relevant Cost

Q
Annual holding cost = (H)
2

D
Annual ordering cost = Q
(S )

Q D
Total annual relevant cost: C = ( H ) + (S )
2 Q

Q= Order Quantity (units)

H= Hold, carrying cost per unit
D= YEARLY demand
S= ordering cost

2 DS
EOQ =
H

EOQ
TBO EOQ =
D

Optimal # Orders= 1/TBO

Overland Motors Example

27
Overland Motors uses 25,000 gear assemblies each year (i.e.
52 weeks) and purchases them at $3.40 per unit. It costs
$50 to process and receive each order, and it costs $1.10 to
hold one unit in inventory for a whole year. Assume demand
is constant.

Ralph U. Reddie has been ordering 1,000 gear assemblies at

a time, but can adjust his order quantity if it will lower costs.

a. What is the annual cost of the current policy of using a

1,000-unit lot size?

b. What is the order quantity that minimizes cost?

c. What is the time between orders for the quantity in part

b?

d. If the lead time is two weeks, what is the reorder point, R?

Economic Production Quantity

Similar to the EOQ but used for batch production. A complete

order no longer received at once and inventory is
replenished gradually (i.e., non-instantaneous
replenishment).

1. Maximum Cycle Inventory

Q p −u
I max = ( p − u ) = Q( )
p p

28
2. Total cost = Annual holding cost + Annual ordering or
setup cost

I max D Q p −u D
C= ( H ) + (S ) = ( )( H ) + ( S )
2 Q 2 p Q

3. Economic Production Quantity (EPQ) aka ECONOMIC LOT

SIZE (ELS)

2 DS p
EPQ =
H p −u

Economic Production Quantity Example

A domestic automobile manufacturer schedules 12 two-
person teams to assemble 4.6 liter DOHC V-8 engines per
work day. Each team can assemble five engines per day.
The automobile final assembly line creates an annual
demand for the DOHC engine at 10,080 units per year. The
engine and automobile assembly plants operate six days per
week, 48 weeks per year. The engine assembly line also
produces SOHC V-8 engines. The cost to switch the
production line from one type of engine to the other is
$100,000. It costs $2,000 to store one DOHC V-8 for one
year.

a. What is the economic lot size?

b. How long is the production run?

c. What is the average quantity in inventory?

d. What are the total annual relevant costs?

Quantity Discounts
In the case of quantity discounts (price incentives to

29
purchase large quantities), the price, P, is relevant to the
calculation of total annual cost (since the price is no longer
fixed).

Total cost = Annual holding cost + Annual ordering cost +

Annual cost of materials

Q D
C= ( H ) + ( S ) + PD
2 Q

GRAPH

Quantity Discounts
Two-Step Procedure

Step 1: Beginning with lowest price, calculate the EOQ for

each price level until a feasible EOQ is found. It is
feasible if it lies in the range corresponding to its
price.

Step 2: If the first feasible EOQ found is for the lowest price
level, this quantity is best. Otherwise, calculate
the total cost for the first feasible EOQ and for the
larger price break quantity at each lower price
level. The quantity with the lowest total cost is
optimal.

Quantity Discounts Example

Order Quantity Price Per Unit
0-99 $50
100 or more $45

If the ordering cost is $16 per order, annual holding cost is

20 percent of the per unit purchase price, and annual

30
demand is 1,800 items, what is the best order quantity?

Step 1. EOQ 45.00 =

EOQ50.00 =

Step 2. C76 =

C100 =

Reorder Point (Continuous Review System)

A continuous review system tracks the remaining inventory

of an item each time a withdrawal is made, to determine if it
is time to reorder.

Decision rule: Whenever a withdrawal brings the inventory

down to the reorder point (ROP), place an order for Q (fixed)
units.
Reorder Point
Demand Lead time ROP
pattern for
ordering
Known and None ROP = 0
constant
Known and Known and ROP = d × LT
constant constant
Variable, Known and ROP = d × LT + z LT σd
normally constant
distributed,
σd known
Known and Variable, ROP = d × LT + zd σLT
constant normally

31
 distributed
, σLT
known
Variable, Variable, ROP = d × LT + z LT σd2 + d 2σLT
2

normally normally
distributed, distributed
σd known , σLT
known
Uncertain, unknown Determine ROP for a given service
discrete level based on the cumulative
probability probabilities of demand during
distribution lead time.
Shortage and Service Levels

Expected Shortage per order cycle:

E (n) = E (z) σdLT

E(z) = standardization parameter obtained from Table 12.3.

σdLT = standard deviation of lead time demand

Expected shortage per year:

D
E (N) = E (n) Q

Annual Service Level:

E( N ) E ( z )σdLT
SL annual = 1 − =1 −
D Q

Continuous Review System Example

You are reviewing the company’s current inventory policies

for its continuous review system (Q system), and began by
checking out the current policies for a sample of items. The
characteristics of one item are:
• Average demand = 10 units/wk (assume 52 weeks
per year)
• Ordering and setup cost (S) = $45/order

32
 • Holding cost (H) = $12/unit/year
• Average lead time (L) = 3 weeks
• Standard deviation of demand during lead time =
17 units
• Service-level = 70%

a) What is the EOQ for this item?

b) What is the desired safety stock?

c) What is the desired reorder point R?

d) What is the decision rule for replenishing inventory?

e) What is the expected shortage per year?

Single Period (Newsvendor) Model

Used to handle ordering of perishables and items that have a

limited useful life.

shortage costs = unrealized profit per unit

excess costs = the unit cost less the salvage value

1. Calculate the shortage and excess costs:

C shortage = C s = Revenue per unit - Cost per unit

C excess = Ce = Original cost per unit - Salvage value per unit
2. Calculate the service level (SL), which is the probability
that demand will not exceed the stocking level:

Cs
SL =
C s + Ce

33
3. Determine the optimal stocking level, S o , using the
service level and demand distribution information.

S o = Mean demand + zSL*σ demand

Example of the Newsvendor Model

The concession manager for the college football stadium

must decide how many hot dogs to order for the next game.
Each hot dog is sold for $2.25 and makes a profit of $0.75.
Hot dogs left over after the game are sold to the student
cafeteria for $0.50 each. Based on previous games, the
demand is normally distributed with an average of 2000 hot
dogs sold per game and a standard deviation of 400. Find
the optimal stocking level for hot dogs.

34
SUPPLY CHAIN MANAGEMENT

The bullwhip effect is characterized by fluctuations in

inventory and order levels that tend to increase as one
moves back up the channel from the final customer.
De
man
d
Cust
ome
r
Whol Ret
Distri esale ailer
Manuf buto
acture r
r
r

Demand variations are amplified when moving up the

supply chain!

- Causes of bullwhip effect:

1. Demand forecast updating

2. Long lead time/Order batching

3. Price fluctuations

4. Rationing and shortage gaming

5. Lack of visibility/communication throughout the

supply chain

- The bullwhip effect can be alleviated by:

 Reducing the number of stages in the supply chain

 Communicating consumer demand directly up the

35
 supply chain
 talk to retailer like Wal-Mart and ask to share
info.
 Get EDI inventory system and send to P&G

 Reducing ordering and shipping delays

 Cuts LT so can reduce SS

 Reducing demand destabilizing practices

 sales and promotions (OP ppl don’t like b/c
distort consumer’s behavior)
 to stop: EDLP (everyday low price)-
encourages ppl to buy at regular price, ppl
stop buying in bulk

 Counter “gaming” during shortages

 must have enough capacity
 but, companies worry about cost of capacity
and uncertain demand
 so, use wait&see- but always have a shortage
with this strategy

Make vs. Buy

36
 Pros Cons
 Increased control over  Capital costs
price, quality, etc.  Capability limits
Mak  Economies of  Time limits
e combined operations  Opportunity costs
 Proprietary products  Reduced flexibility to
protected change partners
 Reduced volume
flexibility
 Low capital costs  Unfavorable allocation of
 Specialization product
Buy  Competition  Lack of control over
 Increased flexibility price, quality, etc.
 Lock-in from specialized
contracts and assets
 Transaction
(coordination) costs

Supplier Relations

Competitive Orientation
The view that negotiations between buyer and seller is a
zero-sum game. Often used when a firm represents a
significant share of the supplier’s sales or many
substitutes are available. Example: WalMart

Cooperative Orientation
The view that the buyer and seller are partners. Includes
sole sourcing. Often used with strategically important
and/or high value-added components. Example:
McDonald’s or Toyota

Mixed strategy
Seeks to combine the advantages of the competitive
orientation (e.g. low prices) with the cooperative
orientation (e.g. few suppliers). Example: Dell Computer

37
 Strategic Management of the Supply Chain

Efficient Supply Chains:

The purpose of efficient supply chains is to coordinate the
flow of materials and services so as to minimize
inventories and maximize the efficiency of the
manufacturers and service providers in the chain. Efficient
supply chains work best when demand is predictable and
products/services are stable. Examples of competitive
priorities: low cost.

Responsive Supply Chains:

The purpose of responsive supply chains is to react
quickly to market demands by positioning inventories and
capacities in order to hedge against uncertainties in
demand. Responsive supply chains work best when
demand is unpredictable, new product introduction is
frequent, and product variety is high. Examples of
competitive priorities: development speed, fast delivery,
customization, volume flexibility.

In addition:
Innovations in information technology and other practices
are facilitating the integration of the supply chain for
greater efficiency and responsiveness and enabling
“orchestrated” networks.

Choice of supply chain should serve a firm’s

competitive priority

Case study: One Industry, Two Supply Chains

1. Fashion predictor: Gap, J.Crew, etc

 Long lead time: 3 to 6 months

 Sourcing and manufacturing in Asian and South
American countries
 If prediction is wrong, huge inventory markdown
or salvage

38
Choice: efficient supply chain

2. Fashion follower: Zara

 Short lead time: 2 to 3 weeks

 Sourcing and manufacturing in Europe, mainly in
Spain
 Intentionally create shortage, very few inventory
markdown or salvage

Choice: responsive supply chain

39
 units arrival l
WAITING LINE MODELS = =
time service m
Single-Server Model (M/M/1)
Assumptions:

Number of servers = 1

Number of phases = 1

Input source: infinite, no balking or reneging

Arrival distribution: Poisson; mean arrival rate = λ

Service distribution: Exponential; mean service rate =

µ; mean service time = 1 / µ

Waiting line: single line; unlimited length

Priority discipline: FCFS

Single-Server Operating Characteristics

λ
Average utilization: ρ = µ

Probability that n customers are in the system: Pn = (1 − ρ) ρn

- has to wait: prob n>1= 1-Pr[n=0]

Average number of customers in the system(line and being

λ
served): Ls =
µ −λ

Average number of customers in line: Lq = ρLs

1
Average time spent in the system: Ws =
µ −λ

Average time spent in line: Wq = ρWs

40
 Single-Server Application
Customers arrive at a checkout counter at an average of 20
per hour, according to a Poisson distribution. They are
served at an average rate of 25 per hours, with exponential
service times. Use the single-server model to estimate the
operating characteristics of this system.

ρ=

Ls =

Lq =

Ws =

Wq =

What service rate is required to have customers average

only 10 minutes in the system?

Multiple-Server Model (M/M/s)

Assumptions:

Number of servers = M

Number of phases = 1

Input source: infinite, no balking or reneging

Arrival distribution: Poisson; mean arrival rate = λ

Service distribution: Exponential; mean service rate =

µ; mean service time = 1 / µ

41
 Waiting line: single line; unlimited length

Priority discipline: FCFS

Multiple-Server Operating Characteristics (TABLE)

λ
Average utilization: ρ=
Mµ

Idle Time= 1- ρ

Probability that zero customers are in the system:

M −1
( λ / µ ) n (λ / µ ) M 1
P0 = [ ∑ + ( )] −1
n =0 n! M! 1− ρ

Probability that n customers are in the system:

(λ / µ ) n
P0 0 < n < M
n!
(λ / µ ) n
P0 n ≥ M
M ! M n −M

Average number of customers in line:

P0 (λ / µ ) M ρ
Lq =
M !(1 − ρ ) 2
Lq
Average time spent in line: Wq =
λ
1
Average time spent in the system: Ws = Wq +
µ

λ
Average number of customers in the system: Ls = λWs = Lq +
µ

Multiple-Server Application
Suppose the manager of the checkout system decides to add
another counter. The arrival rate is still 20 customers per
hour, but now each checkout counter will be designed to
service customers at the rate of 12.5 per hour. Use the
multiple-server model to estimate the operating
characteristics of this system.

42
ρ=

1
P0 =
20 ( 20 / 12 .5) 2 1
[1 + + ( )]
12 .5 2! 1−ρ

Lq =

Wq =

How do the single-server and multiple-server models

compare?

Cost Analysis
Question: How many servers do we need?

Minimize: Total cost = Customer waiting cost + Capacity

cost

Example 6 on Page 846:

Trucks arrive at a warehouse at a rate of 15 per hour during

business hours. Crews can unload the trucks at a rate of 5
per hour. Recent changes in wage rates have caused the
warehouse manager to reexamine the question of how many
crews to use. The new rates are: Crew and dock cost is $100
per hour; truck and driver cost is $120 per hour. How many
crews does the warehouse need to minimize the total cost
per hour?

First question: At least how many crews does this warehouse

need? If we have 5 crews:

Crew/Dock cost per hour =

43
 λ
Average number of drivers in system Ls = Lq + =
µ

Driver/Truck cost per hour =

Total cost per hour =

# of Crew/Dock Avg. # Driver/Truck Total cost

crews cost per hour of cost per hour per hour
drivers
in
system
4 $400 4.528 $543.36 $943.36
5
6 $600 3.099 $371.88 $971.88
7 $700 3.028 $363.36 $1063.36
Finite-Source, Single-Server Model

Assumptions:

Number of servers = 1

Number of phases = 1

Input source: finite, equals N customers

Arrival distribution: Exponential inter-arrival times;

mean = 1 / λ

Service distribution: Exponential; mean service rate =

µ; mean service time = 1 / µ

Waiting line: single line; no more than N - 1

Priority discipline: FCFS

Finite-Source, Single-Server Operating Characteristics

Probability that zero customers are in the system:

44
 N
N! λ
P0 = [ ∑ ( ) n ]−1
n = 0 ( N − n )! µ

Average utilization: ρ = 1 − P0

λ+µ
Average number of customers in line: Lq = N − (1 − P0 )
λ

µ
Average number of customers in the system: Ls = N −
λ
(1 − P0 )

Average time spent in line: Wq = Lq [( N − L) λ]−1

Average time spent in the system: Ws = Ls [( N − L)λ]−1

Finite-Source, Single-Server Application

DBT Bank has 8 copy machines located in various offices
throughout the building. Each machine is used continuously
and has an average time between failures of 50 hours. Once
failed, it takes an average of 4 hours for the engineer from
the service company to have it fixed. What is the average
number of copy machines in repair or waiting to be repaired?

Hilltop Produce Problem

The Hilltop Produce store is staffed by one checkout clerk.
The average checkout time is exponential distributed around
an average of two minutes per customer. An average of 20
customers arrive per hour.

45
a. What is the average utilization rate?

b. What is the probability that three or more customers

will be in the checkout area?

c. What is the average number of customers in the waiting

line?

d. If the customers spend an average of 10 minutes

shopping for produce, what is the average time
customers spend in the store?

Using Waiting Line Models to Analyze Service

Operations
Balance costs against benefits of improving service system.
Also, consider the costs of not making improvements. There
are different measures of service operations:

• Line length - Long lines indicate poor customer service,

inefficient service, or inadequate capacity.

• Number of customers in system - A large number

causes congestion and dissatisfaction.

• Waiting time in line - Long waits are associated with

poor service.

• Total time in system - May indicate problems with

customers, server efficiency, or capacity.

• Service facility utilization - Control costs without

unacceptable reduction in service.

46
 Using Waiting Line Models to Design Service
Operations
• Arrival:
o Number of arrivals
o Adjust through advertising, promotions, pricing,
and appointments
o Reduce variability

• Service:
o Number of servers - adjust service system
capacity
o Server efficiency - training, incentives,
performance evaluation
o Number of phases - consider splitting service tasks
o Reduce variability

• Priority rule - decide whether to allow preemption

• Customer perceptions - shorter waiting time

47
AGGREGATE PLANNING

Planning Strategies

Chase strategy – Matching capacity to demand; the planned

output for a period is set at the expected demand of the
period.

Level strategy – Maintaining a steady rate of regular time

output while meeting the variations in demand by a
combination of inventories, overtime, part-time workers,
subcontracting, and back-orders.

Pros Cons
• Low inventory • Expense of
investment and adjusting output rates
Chas backlogs and/or work-force
e strategy • Alienation of work-
force
• Loss of productivity
• Lower quality
• Level output • Increased inventory
rates investment
Leve • Stable work- • Increased
l strategy force undertime and
overtime expense
• Increased backlogs

Level and Chase Strategies Example

Bob Carlton’s golf camp estimates the following workforce

requirements for its services over the next two years.

Quarter 1 2 3 4
Demand 4200 6400 3000 4800

Quarter 5 6 7 8

48
 Demand 4400 6240 3600 4800

Each certified instructor puts in 480 hours per quarter

regular time and can work an additional 120 hours overtime.
Regular-time wages and benefits cost Carlton $7200 per
employee per quarter for regular time worked up to 480
hours, with an overtime cost of $20 per hour. Unused
regular time for certified instructors is paid at $15 per hour.
There is no cost for unused overtime capacity. The cost of
hiring, training, and certifying a new employee is $10,000.
Layoff costs are $4000 per employee. Currently, eight
employees work in this capacity.

Level Strategy

Find a level work-force plan that allows for no delay in

service and minimizes undertime. What is the total cost of
this plan?

49
 Chase Strategy

Use a chase strategy that varies the work-force level without

using overtime or undertime. What is the total cost of this
plan?

50
RESOURCE PLANNING

Material Requirements Planning (MRP)

- Information system that translates master schedule
requirements for finished products into time-phased
requirements for subassemblies, parts and raw
materials.
Inputs to the MRP
• Bill of Materials (BOM)
• The Master Production Schedule (MPS)
• Inventory record
Outputs from the MRP
• Planned orders
• Order releases
• Secondary reports

- Bill of Materials
• A record of all the components of an item, the parent-
component relationships, and usage quantities derived
from engineering and process designs.
- The Master Production Schedule (MPS)
• A detailed plan that states how many END items will be
produced within specified periods of time.
- Inventory record
• Records status of each item by time period (time
bucket) with respect to gross requirements, schedule
receipts, expected amount on hand, lot-size policy, lead
time, supplier, etc.

BOM Example:

Parent BO Gross On-hand Availabl Net

s M requiremen inventor e requiremen
of X ts y of Inventor ts
For 10 Xs individu y
al items
B 5
C 0
D 0
E 30

51
F 0
Lead time (in weeks): X- 1, B-1, C- 2, D-2, E- 1, F-2
One scheduled receipt of 50 units of Item E to arrive at the
beginning of week 1.

B(2) C

D(3) E E(2) F(2)

E(4)

Net

Requirements = Gross Requirements –Available

Inventory

Available Inventory = Projected on-hand inventory –

52
Safety stock – Inventory allocated to other items

Projected on-hand inventory = On-hand inventory +

Scheduled Receipt

- Manufacturing Resources Planning (MRP II)

- Extension of MRP which includes MRP as well as
capacity requirements planning, financial planning,
marketing planning etc…

- Enterprise Resources Planning (ERP)

- Information system that integrates all functional areas
including MRP II, finance, accounting, HR, marketing
etc…
- all info integrated

53
LEAN SYSTEM

JIT System- a dependent demand production control

system designed to produce goods or services as needed
and minimize inventories
- stable and predictable environments with high volume
production, demand is certain
- philosophy: inventories are wasteful and non-value
added

Environments for Effective JIT

*0 Manufacturing: Firms that tend to have highly
repetitive manufacturing processes, well-defined
material flows, and reasonably high volumes use JIT
systems because the pull method allows closer control
of inventory and production at the work stations.
*1 Services: Firms that tend to have repetitive
operations, reasonably high volumes, and deal with
tangible items can benefit from JIT systems.
*2 In general, JIT works well in stable and predictable
environments because there is little forward visibility.

Characteristics of JIT Systems

• Pull method
• Consistently high quality
• Small lot sizes
• Short setup times
• Uniform workstation loads
• Standardization of components and work methods
• Close supplier ties
• Flexible work force
• Product focus
• Automated production
• Preventive maintenance

Customization & Standardized

 goal is to produce large # production with an efficient
system

54
Product or service customization has negative effects on
both:
• Predictability of demand
• Predictability of operations
Since uncertainty in operations requires extra resources,
customization is inherently less efficient than
standardization.

However, it is sometimes possible to increase operational

efficiency even with customization using standardization
strategies.

Standardization strategies include:

• Part standardization – Maximize component commonality
across products (ex. Dell)
• Process standardization – Delay customization as late as
possible (aka postponement, ex. HP)
• Product standardization – Carry a limited number of
products in inventory (SERVICE industry, car dealerships-
i.e. wait for colors, etc.)

Types of Scheduling
• Operations scheduling - Assigns workers to tasks or jobs
to machine work centers. Operations schedules are short-
term plans designed to implement the master production
schedule. (look at low volume with high variety)
• Work-force scheduling - Determines when human
resources are available for work
- biggest difference b/w service/mfg. industry is
inventory back logs

Scheduling in Services

Characteristics of services that have an impact on

scheduling:

*0 Services can not buffer demand uncertainties with

inventory./ backlog

55
 *1 Demand for services is difficult to predict. (should have
a good idea of demand- always match capacity with
demand)
*2 Scheduling systems can facilitate the capacity
management of service providers.

Two approaches:
*3 Schedule customer demand (capacity remains fixed
and demand is leveled)
*4 Appointments
*5 Reservations
*6 Backlogs
*7 Schedule the work force to meet forecasted demand
(adjust capacity to demand)

Priority Sequencing Rules

Single dimension rules:

EDD = Select Job With Earliest Due Date

FCFS = Job That Arrives First is Processed First

SPT = Select Job With Shortest Processing Time

Multiple dimension rules:

Time Remaining to Due Date - Total Shop Time Remaining

S/O =
Number of Operations Remaining

Performance of Priority Sequencing Rules

• Earliest due date (EDD) - Performs well with respect to:
minimizing percentages of jobs past due, minimizing the
maximum amount of time a job is late. Performs poorly
with respect to: job flow time, work-in-process inventory,
utilization.

• First come, first serve (FCFS) - Perceived as being fair.

56
Performs poorly with respect to all performance measures.

• Shortest processing time (SPT) - Performs well with

respect to: average job flow time, work-in-process
inventory, minimizing percentages of jobs past due,
utilization. Performs poorly with respect to: minimizing
the maximum amount of time a job is late, minimizing
total inventory (it pushes work to finished goods before it
is needed), adjusting schedules when due date changes
(due date is not used in the calculation of priority).

• Critical ratio (CR) - Performs well when we are

concerned with global operation of a system of work
centers.

• Slack per operations (S/O) - Performs similarly to EDD

with added advantages of a global view and accounting
for the duration of the jobs.

57
PROJECT MANAGEMENT

Total slack- allowable slippage for entire activity without

stopping project

Free slack- slack that does not affect the following activity
(ex. Taking an extra week to do an activity- will it affect the
following nodes?)

Network Time Calculations

• Earliest finish time (EF) for an activity

EF = ES + t

• Earliest start time (ES) for an activity

ES = Max [EF times of all immediately preceding

activities]

• Latest start time (LS) for an activity without delaying

the project

LS =LF – t

• Latest finish time (LF) for an activity without delaying

the project

LF = Min[LS times for all immediately following

activities]

Crash Rules
Step 1: Determine the project’s critical path(s).
Step 2: Find the cheapest activity or activities on the critical
path(s) to crash.
Step 3: Reduce the time for this activity until the first of (a)
it cannot be further reduced, (b) another path becomes
critical, or (c) the increase in direct costs exceeds the

58
savings that result from shortening the project. If more than
one path is critical, the time for an activity on each path may
have to be reduced simultaneously.
Step 4: Repeat this procedure until the increase in direct
costs is less than the savings generated by shortening the
project.

59
 Calculating Time Estimates
a) Optimistic time ( to ):

Shortest time during which an activity can be

completed.
b) Most likely time ( t m ):

Best estimate of average time.

c) Pessimistic time ( t ): p

Longest time an activity can take.

d) Activity’s time ( t e ) and variance (σ 2 ) with beta distribution

2
to + 4t m + t p t −t 
te = , σ =  p o
2

6  6 

Analyzing Probabilities

Probabilities can be assessed using the z-transformation

formula:
T − TE
z=
σ
T = specific time, TE = expected time (path mean),
σ = standard deviation of path mean. Assuming the activity
times are independent, the path standard deviation σ is the
square root of the sum of the activity time variances.

To determine the probability of completing a project in a

specified amount of time:
• Calculate the probability of each of the paths being
completed in that amount of time based on the value of
z. For any value of z that is greater than 3, the
probability that the corresponding path will be
completed in that amount of time can be considered to
be 100%.
• If all paths are independent, then the probability of
completing a project in the specified amount of time is
the product of the individual path probabilities.

60
 Hospital Project Completion Probabilities

How likely is it that the hospital project will be completed in

72 weeks?

72 − Expected path duration Probability of

z=
Path Path standard deviation completion in
72 weeks
A-F-K (72 – 28)/2.05 = 21.5 100%
A-I-K (72 – 33)/3.04 = 12.8 100%
A-C-G- (72 – 67)/3.94 = 1.27 90%
J-K
B-D-H- (72 – 69)/3.45 = 0.87 81%
J-K
B-E-J-K (72 – 43)/3.80 = 7.6 100%

61
** UPDATE paths and show new critical time after each path

62
63