EOQ Model: Case 1 X Q

DSC2006 Formulas
Process Performance Metrics

Inventory: I : Flow Units
Flow Time: T : Time Units
Flow Rate: R : Flow/Time
Capacity: Rp: Flow/Time
Capacity Utilization
Process Utilization
s
=R/
p =Flow Rate/Process Capacity
Cpk = min
US LS
,
3
3
Cpk
1.0
0
1.3
3
1.5
0
2.0
0
Lowest accepted
For existing Target
New Process
Resource Utilization
R
= R/
p =Flow Rate/Resource Capacity
Littles Law
I=R*T, Turnover ratio = 1/T
- A manager need only focus on two measures
because they directly determine the third
- For a given level of flow rate, the only way to
reduce flow time is to reduce inventory and vice
versa
Analysis of queues
Motorolas 6
}
Defect Rate
2700ppm
6.80ppm
1.98ppb
Inventory Management
Order size: Q
EOQ Model
- Only one product is involved.
- Ordering in batch from supplier.
- Constant demand rate.
- Constant lead time.
- Single delivery for each order.
- A single flat unit price from the supplier.
D: demand rate (units/year)
S: fixed ordering cost/order ($)
P: purchasing cost/unit ($/unit)
H: annual holding cost ($/unit,year)
Order frequency (N) =D/Q
Order Cycle (T) = Q/D
Average inventory = Q/2
Purchase cost/year: PD
Fixed ordering cost/year: S*D/Q
Holding cost/year: Q*H/2
Annual Total Controllable Cost (TCC) =
D
Q
S+ H
Q
2
Annual Total Cost (TC) =
D
Q
S + H + PD
Q
2
Optimal Results:
Quality Control
Lower and upper specification Limit
Proportion defective = Prob(x<LS) + Prob(x>US)
C p=
allowable process spread USLS

=
actual process spread
6
For process to be deemed capable Cp1.33

Mean =
Good for if process is centred; If not centred use:
2 DS
H
TCC*=
2 DSH
TC*=
2 DSH + PD
Reorder Point
L=Lead Time
Case 1: TL
Case 2:T<L
TCC(Q)=
63.4ppm
Motorolas 6 , US-LS 6
Actual defect rate of 3.4ppm to allow for a 1.5
drift
Q*=
pu
Imax= Q
ROP=L*D=L/T*Q
ROP=fractional part[L/t]*Q
Replenishment Strategy EPQ

-only 1 product -Constant demand/usage rate
-Produced in batches at constant rate (p)
-Constant lead time
-Usage (u) is continuous but production is periodic
Production cycle time = Q/u
Runtime =Q/p
Q*=
I max
D
H+ S
2
Q

2 DS
H
pu
Marginal Analysis
Q = order quantity [units]
D= demand [units]; random with mean and
standard deviation
SL = Service level = Prob(DQ)
w = unit purchase cost [$/unit]
p = regular selling price [$/unit]
v = price for leftover inventory [$/unit]
g = lost goodwill on unsatisfied demand [$/unit]
Case 1 D>Q:
Prob(D>Q)=1-F(Q)=1-SL
Net Marginal Benefit: Cs=(p-w)+g Underage
Cost
Case 2 DQ:
Prob(DQ)=F(Q)=SL
Net Marginal Cost: Ce=w-v Overage Cost
At optimal level Q* marginal benefit =
marginal cost
SL*=Cs/(Cs+Ce)
If D is normally distributed with mean , standard
deviation
Q*= +z (Use table) [e.g. if SL*=0.7673 z
=0.73]
If D is uniformly distributed between a and b
Q*=a+SL* x (b-a)
Revenue Management
Q = no. reserved for potential future demand
[units]
D = uncertain more valuable future demand for
the
perishable resource [units]; a random variable
with
mean and standard deviation
SL = Prob(D Q)
w = certain current value [$/unit]
p = potential future value [$/unit]
Case 1 D>Q:
Prob(D>Q)=1-F(Q)=1-SL
Net Marginal Benefit: Cs=p-w
Case 2 DQ:
Prob(DQ)=F(Q)=SL
Net Marginal Cost: Ce=w
At optimal level Q* marginal benefit =
marginal cost
SL*=Cs/(Cs+Ce)
If D is normally distributed with mean , standard
deviation
Q*= +z (Use table) [e.g. if SL*=0.7673 z
=0.73]
If D is uniformly distributed between a and b
Q*=a+SL* x (b-a)
Overbooking
X=No Shows
Q=No. of over book
Case 1 X>Q:
Prob(X>Q)=1-F(Q)=1-Prob(XQ)
Net Marginal Benefit: Cs=revenue for each
occupied room
Case 2 XQ:
Prob(XQ)
Net Marginal Cost: Ce=Penalty for bumping
P(XQ)*= Cs/(Cs+Ce)
Problems
Why overbook?
People who have reservations dont show up
without any penalty
Lost revenue of the resources unused
Risk of overbooking
Two many people show up and some have to be
bumped
Decisions to be made
How many units to overbook?
Tradeoff behind the decisions
Too many people show up, which results in
bumping customers and penalty cost
Too few people show up, which results in unused
resources and lost revenue
Aggregate planning
Ending inventory = Beginning inventory + outputdemand
Backorder = Previous backorder + output
demand
Average inventory =
Beginning inventory+ Ending

2
Supply Chain management

Distribution centres
Demand Aggregation: The Square-Root Law
Cost per retailer= TC(Q*) + HIs =
2 SDH
+ H (z )
Cost of 9 retailers= 9(
2 SDH
+ H (z
))
Cost of 1 aggregated DC =
2 SDH
+ H (z ))
Costs decrease in proportion to the square root of

Number aggregated
Advantages
Lower inventory cost
Ability to offer a large product selection
Drawbacks
Inventory further away from customers
High delivery cost and time, less responsive
Cannot customize for regional preferences
Just-In-Time
The basic philosophy of JIT: Eliminate waste
Seven types of waste (according to Taiichi
Ohno)
Producing defective products Producing too
much
Carrying inventory Idleness due to bottlenecks
Unnecessary processing Unnecessary

movement by workers Unnecessary movement
of materials
One form of waste is inventory.
Why do inventories exist?
Economies of scale, speculation, uncertainty (in
demand, supply, capacity and quality)
These characteristics prevent a smooth flow of
product result in kinks in the system
Make the problem go away.
Reduce setup times, remove uncertainty,
improve quality, etc.
Setup Reduction
Separate internal setup and external setup
Internal Setup: Tasks which can be done only
when the machine is stopped.
External Setup: Tasks which can be done while
the machine is still running E.g. retrieve new
tools
Consider changes that make more tasks
external
Inventory as Waste: Reducing Safety Stocks
2
2 2
Safety Stock: Is = z* = z
r
l
L + R
Self check-outs at supermarkets etc

Shortest processing time leads to a lower average
waiting time.
The Psychology of Waiting
Unoccupied time feels longer than occupied
time.
Preprocess waits feel longer than in-process
waits.
Anxiety makes waits seem longer.
Uncertain waits are longer than known waits.
Unexplained waits feel longer than explained
waits.
Unfair waits seem longer than equitable waits.
The more valuable the service, the longer the
customer will wait.
Solo waits feel longer than group waits.
Quality
Reduce average lead time Reduce demand

variance
Reduce lead time variance (most important)
Push vs. Pull Control Systems
Push systems:
Daily/weekly production plan generated
centrally
Production is Pushed through the system, in
order to meet forecasted demand
Pull systems:
Demand triggers a request for re-supply
Production is Pulled through the system
Works well for roughly constant demand
Smooth means repetitive: workers like
variation
Decreased variation tighter adherence to
standard
processes
Less individualization, less of a craftsman feel
Inflexible pace can lower worker motivation
Sometimes can lead to more formal resting of
workers new
ideas
Less Inventory less tolerance for variation
from the
mean output rate
Cant work harder for a while and then take a
short break
Higher stress
Limitations of JIT Good for stable demand
Cant handle large spikes in demand Cant
handle vastly different product mixes
Common Problems Associated with JIT
What is Operations Management?

-Management of systems or processes that
create goods and/or provide services.
-Manage to better match supply and demand
-Restructure operations to improve performance
and be competitive in the face of ever changing
conditions
-Find the right balance between multiple
measures of
Performance
Order Qualifiers
-Characteristics that potential customers perceive
as minimum standards
Order Winners
-Characteristics of an organizations goods or
services that cause them to be perceived better
than the competition
Causes of Variation
Chance Causes: Normal Variability
Day-to-day variation, typical, white noise
Assignable Causes: Abnormal Variability
Something unusual has happened
Change for the worse investigate and fix
Change for the better investigate and
reinforce
Types of Control Charts
Mean control chart Sample Mean:
n
x =
1
x
n i=1 i
Variation (Range) Sam. Range: R= maxi(xi)mini(xi)

If no buffer
Blocking
-Activities must stop because there is no place to
deposit the item just completed
Starving
- Activities must stop because there is no work
Manage Queue and Waiting
Process Flow Analysis
Characterize the waiting time (average,
distribution)
Characterize the lines (average, effect on the
servers, probability of getting too long)
Capacity Planning for Services
Calculate the right number of servers (toll
booths,
cashiers, hospital beds, customer support lines,
traffic light durations)
Improving the System
The Arrival Process
Reduce variability: schedule appointments, peak
load pricing.
Eliminate need: renewals by mail etc
The Service Process
Dedicated servers for small jobs
Improve processing rate (bar code scanners,
ATMs)
Transform customers into servers
Inventory Management
Reasons to Not Hold Inventory
Expense Obsolescence Delayed
responsiveness
Masking underlying problems
Class A typically contains about 10-20% of the

items and 60-70% of the annual dollar value Most
Impt
Class C contains about 50-60% of the items, but
only 10-15% of the dollar value Least Impt
Class B is between the two extremes
Robustness of the EOQ Model
Q = 2Q*, TCC(Q) = 1.25 TCC(Q*)
An error of 100% in Q results in an error of only
25%
Record Actual Inventory
Misplaced inventory Spoilage Theft
Product quality and yield Information delay
RFID
Wireless technology to transmit information from
small tags attached to objects in order to
automatically identify and track those items.
Revenue Management
Revenue Management (RM) is the science and art
of enhancing firm revenues while selling
essentially the same amount of product.
Three categories of decisions
Structural decisions Price decision Quantity
decision
Conditions for Applying RM
- Perishable Resource
- Well-defined market segments
- Uncertain, more-valuable future demands on
that resource
Decision(s) to be made
Protection level: quantity to be reserved for the
high paying customers
Booking limit: Total number of resources
protection level
Decision must be made before the uncertainty
is resolved.
Aggregate Planning
Intermediate-range capacity planning, usually
covering 2 to 12 months.
The Goal: Achieve a production plan that will
effectively utilize the organizations resources to
satisfy expected demand.
A big picture approach to planning
Aggregate plan is updated periodically (monthly)
and result in a rolling planning horizon
Why aggregate planning?
It takes time to implement plans
Accurately predicting the timing and volume of
individual item demand is very difficult
Aggregate Planning Inputs
Resources Demand forecast Policies on
workforce
changes Subcontracting Overtime Inventory

levels
Backorders Costs
Aggregate Planning Outputs
Total cost of a plan Projected levels of;
Inventory Output Employment
Subcontracting
Backordering
Aggregate Planning Strategies
Proactive: alter demand to match capacity
Pricing Promotion Backorders New demand
Reactive: alter capacity to match demand
Hire and layoff regular full time workers
Overtime/slack time Part-time workers
Subcontracting Inventories
Mixed: some of each
Basic Strategies
Level capacity strategy
Maintaining a steady rate of regular-time output
while meeting variations in demand by a
combination of options: inventories, overtime,
part-time works, subcontracting, and backorders.
Chase demand strategy

Matching capacity to demand; the planned output
for a period is set at the expected demand for
that period.
Chase vs. Level
Chase Approach:
Advantages
Investment in inventory is low Labor
utilization is high
Disadvantages
The cost of adjusting output rates and/or
workforce levels Potential damage to employee
morale.
Level Approach:
Advantages
Stable output rates and workforce
Disadvantages
Greater inventory costs Backorders
Procedure for Aggregate Planning
1.Determine demand for each period
2. Determine capacities for each period
3. Identify company or departmental policies that
are pertinent
4. Determine unit costs
5. Develop alternative plans and costs (using
Trial- and-Error)
6. Select the plan that best satisfies objectives.
Otherwise return to step 5.
Supply Chain Management
Bullwhip Effect
Distortion of demand information while it passes
from one stage to the next across the supply
chain.
Causes Demand forecast updating Worse if;
Order batching Price fluctuation Rationing
and shortage gaming
Solutions
Demand forecast; information sharing
Order batching; reduce fixed ordering cost
Price fluctuation; Everyday Low Price (EDLP)
Shortage gaming; penalize order cancellations,
Change the structure, decide together
An average company spends about 6% of
revenue on supply-related activities
Contracts
To induce performance improvement
To provide supply chain parties the incentive to
do things they would not otherwise
Requirements for a Successful Supply Chain
Trust among trading partners Effective
communications
Supply chain visibility A major trading partner
can connect to its supply chain to access data in
real time
Event-management capability The ability to
detect and respond to unplanned events
Performance metrics
Other Trends
Point of Sales (POS) Inventory Control
Vendor-Managed Inventory (VMI)
Third Party Logistics (3PL) Providers
Virtual Aggregation through Transshipments
Risk Management
Sustainability

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DSC2006 Formulas

Process Performance Metrics

Annual Total Cost (TC) =

allowable process spread USLS

For process to be deemed capable Cp1.33

Replenishment Strategy EPQ

Beginning inventory+ Ending

Supply Chain management

Costs decrease in proportion to the square root of

Unnecessary processing Unnecessary

Self check-outs at supermarkets etc

Reduce average lead time Reduce demand

What is Operations Management?

Variation (Range) Sam. Range: R= maxi(xi)mini(xi)

Class A typically contains about 10-20% of the

changes Subcontracting Overtime Inventory

Chase demand strategy

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