Operations Management

Module 3
Planning and Control

 Operating systems are characterized by complex relationships between

people, resources, market and material.
 There is the question of lead time
 If an order placed to suppliers increases by 20% there is a time which is
required for suppliers to adjust.
 Therefore, prior planning and strategies are important to ensure a continuous
flow of products and services to customers.
Hierarchical Approach To Planning

Level 1 - Estimation of Demand (We will see some methods shortly)

Once the Demand is estimated, the Business Plan is created. Typically this is for a
1 year horizon.
The Business Plan is strategic in nature and addresses the following questions:
Business Planning Decisions

 What is the likely demand for next financial year?

 Should we meet the entire demand or part of the projected demand
 What are the implications of this decision on the company’s competitive position in the market?
 How is it likely to impact other functions of the organization like Marketing and Finance?
 What resources should we commit during the planning horizon?

 This leads to a rough capacity plan for the planning period. The idea is to match the available
capacity to the projected demand that the organization is planning to satisfy. (Level 2)
 This requires a Material requirement plan and also the capacity requirement plan.
 Level 3 ….Scheduling Level (Execution Level)

 Advantage of this Method

Forecasting

 What is a Forecast?
 How does it help?
 Forecasting provides a basis for co-ordination of plans for activities across the
company.
 An Example from Real Life … Coke @ Rs 5
Types of Forecasts

 Technology Forecasts (Which company?)

 Economic Forecasts
 Demand Forecasts
Factors Affecting Demand Forecast

 Business Cycle
 Random Variation
 Customer’s Plan
 Product Life Cycle
 Competition Efforts and Prices
 Customer’s Attitude
 Quality
 Credit Policy
 Design of Goods or Services
 Sales Effort
 Advertising
Process of Forecasting

 Look at past data

 Look for Trends, Seasonality, Cyclicality and forecast
 Seasonality : Woolen clothes, Rasna, Cold Drinks. What will the pattern of
sales be out here?
 Cyclical : This is typically for a longer period.
Forecasting Models

 Simple Moving Average

 Simple Exponential Smoothening
 Double Moving Average
 Double Exponential Smoothening
 Simple Regression
 Semi Average
 Multiple Regression
 Box Jenkins
 Delphi Technique (Qualitative)
 Market Surveys (Qualitative)
Simple Moving Average Method

Construct a 3 month and 4 month moving average forecast. Also compute

the error of the forecast (MFE)
The Weighted Average Method

 In the earlier example, the weights assigned were the same for all months.
 Assign a weightage of 0.5 to the nearest month, 0.3 to the next and 0.2 to
the first.
Simple Exponential Smoothening Method

 Running Average of Demand

 Ft = Ft-1 + Alpha* (Dt-1-Ft-1)
 Let us try 1 example.
 Forecast for November (Take Alpha =0.2 and 0.8 and interpret
Regression

 Regression is a technique in which we estimate the value of a dependent

variable (Y) from an independent variable (X). In simple regression, there is
only one independent variable. In multiple Regression we look at many
independent variables.
 The simple Regression takes the form Y=a + bX
 Multiple Regression takes the form Y = a + b1X1 + b2X2 + b3X3 + ……
Simple Regression

 The coefficients a and b are estimated using the following formula:

 b= Sum (XY) – n* X bar Y bar/ Sum X square – n X bar square
 A= Y bar – b X bar
Text Book 12

 A firm believes that its annual profit depends on its expenditure on Research.
The information for the preceding 6 years is as follows:

Expenditure
Research Annual Profit
2004 3 22
2005 4 27
2006 6 36
2007 5 32
2008 12 45
2009 7 36
2010 8 7

Estimate Profit when expenditure is 11 units

Qualitative Demand Forecasting

 Expert Opinion
 Delphi Technique
Capacity

 Capacity can be defined in two ways:

 Extent of availability of resources available for various processes (Input side)
 Maximum output that a process can achieve (Output side)
Why is Capacity an Important Decision?

 Capacity Decisions are large and fixed in nature. Increase Fixed costs
 By proper planning (matching capacity to demand) organizations can gain by
economies of scale. Why does this happen? Why do Flipkart and Amazon have
lower operations cost in e-commerce?
 Effect of Learning Effects
What is Capacity Planning?

 Matching Capacity to forecasted demand

 However, decision on Capacity is just not linked to demand
 Example : Pre-empting competition
Capacity Planning Horizon

 Long Term

 Short term
How To Add Capacity

 Capacity decisions are typically made in lumpsum (large quantities)

 Not possible to add in small increments
 Also involve larger lead time to source and install
 Typically a cycle of overcapacity- appropriate level of capacity and
undercapacity
 There are two models:
 Reactive Mode (wait for the demand and then increase capacity)
 Pro- active mode : Capacity is added in anticipation of future demand
Class Activity

 Explain the Capacity decisions of the following companies:

 Apple
 ACC Cement
 Zara
 Class Activity : 30 Minutes ( 3 Groups)
Measures of Capacity

 Measures of Capacity depends on the type of underlying process.

 A high volume process …..output definition of capacity
 A high variety process ….input definition of capacity
Capacity Utilization

 Capacity Utilization = Capacity Put To Use / Total Capacity Available

 Another Famous Definition of Capacity is used by Lean Organization which
says
 Capacity = Work * Waste (Can Anyone Explain This?)
Problem 1

 A manufacturer of table fans has a factory that works on a single shift basis. A shift
lasts 8 hours but 30 minutes will be lost in normal breakages and allowances to be
given to workers. There are 300 working days in a year. There is a fabrication shop,
an assembly shop and a painting shop in the factory. Each unit requires 2 hours in
the fabrication shop and 45 minutes each in assembly and paint shops. The workers
are at 80% efficiency. Currently the shop is manufacturing 20,000 fans per annum.
Using this data compute the following with respect to the firm:
 A) If there are 24 workers in the fabrication shop and 12 each in each of the other
shops what will be the utilization of the workers at current level of operation?
 How many workers are required if the overall utilization of the factory is targeted
at 90%?
 What is the additional number of workers in each of the shops if annual production
increases to 24000 (assume a targeted utilization of 80 per cent in both the shops)
Problem 2

 An ortho- specialty hospital is conducting micro-surgeries at a capacity of

20surgeries per day. On an average each surgery takes 45 minutes of the
surgeon’s time, one hour of pre-operative staff and two hours of post
operative staff. A surgeon works for 4 hours a day while the staff work for 8
hours per day. The hospital currently estimates that surgeons have a
utilization of 94% and other staff have a utilization of 85%. The hospital plans
to increase its capacity by 20% and it has all infrastructure facilities to handle
the proposed expansion. It only needs to plan for human resources. It also
plans to bring down the utilization of surgeons to 85% and that of staff to 75%.
How many additional people (resources) will the hospital need as surgeons
and staff?
Problem 3

 A restaurant works in a busy locality in Kanpur. At the moment they have

adequate cooking capacity and space to seat the customers. They would like to
know the adequacy of the service manpower available to them. The order takers
spend on an average 15 minutes per arriving batch of customers and the servers
take 48 minutes.
 A) If there are 5 order takers and 12 servers, how many batches of customers
can the restaurant serve in a day?
 If a batch of customers arrives on an average every 4 minutes can they handle
the demand with the existing staff
 If the restaurant sees that during peak hours, a batch of customers arrives every
3 minutes, will they be able to meet the demand
 How many order takers and servers should they employ if they want to have a
capacity utilization of 75% (during non peak hours)
Problem 4

 A travel agency attends to various travel planning requirements of its clients. They work six
days a week and are open 930 am to 6 pm. They have a lunch break between 130 pm and 2
30 pm. Typically servicing a client takes 22 minutes. There are 5 travel consultants and
absenteeism is 10%.
a) If they receive service requests at the rate of 8 per hour, what is the utilization level of the
consultants?
b) Th want to expand operations so that they can handle 100 requests in a day. They would also
like to work with a targeted utilization of 80%. How many consultants will they need? They
have also made the following changes:
c) No changes in current operating conditions
d) Lunch break reduced to 30 minutes
e) They work one more hour starting at 9 am and close at 6 30 pm
f) Process improvements have brought down the average service time to 20 minutes per client
Problem 5

 Assume a Restaurant operates from 11 am to 11 pm seven days a week.

 A) How much capacity does the restaurant have on weekly basis and on a
yearly basis in hours?
 If the restaurant can serve a maximum of 40 customers per hour how much
weekly capacity does the customer have in terms of customers?
 How are the two definitions of capacity different?
Problem 6

 A barbershop has the following demand for haircuts on Saturday which is the
busiest day of the week.
Number of
Haircuts Probability
20 0.1
25 0.3
30 0.4
35 0.1
40 0.1

What is the average demand for haircuts on Saturday?

a)If the capacity is 35 haircuts, what is the average utilization of the shop?
b)If the capacity is 35 haircuts what is the capacity cushion of the shop
c)If it costs $50 per lost haircut due to customer satisfaction and $100 for
each unit of capacity provided, how much capacity should be built to
minimize costs?
Question For Discussion

 We have discussed different types of Processes. Pls explain them briefly.

 What is Capacity Utilization. Again explain
 Which type of processes will have highest capacity utilization and which will
have lowest. Explain.
Inventory Management and
Control

32
Inventory

 What is Inventory?
 Is Inventory an Asset or a Cost
 Why do organizations keep Inventory
Types of Inventory

 Seasonal Inventory
 Decoupling Inventory
 Cyclic Inventory
 Pipeline Inventory
 Safety Stock
Cost of Holding Inventory

Investment in store space and storage and retrieval systems

Software for maintaining the inventory status
Managerial and other administrative manpower to discharge various activities
related to stores
Insurance costs
Cost of obsolescence, pilferage, damages, and wastage
Is directly proportional to quantity stored
Cost of Ordering

 Relates to cost of placing an order

 Indent Costs
 Inspection Costs
 Purchase Order Generation Costs
 Fixed costs
Inventory Costs

 Ordering Cost , Co
 Ordering Cost = D/Q*Co, where D is Annual Demand and Q is order size
 Carrying Cost (Holding Cost) , Ch
 Q/2*Ch
 Question : How will increased order size impact these costs
Summary

 The cost of carrying and the cost of ordering are fundamentally two opposing
cost structures in inventory planning.
Real Life Example

 How does Walmart control Ordering Cost and Carrying Cost

 Class to be introduced to:
 Cross Docking (Also being used by e-commerce)
 VMI
Basic EOQ Model

 Demand is certain
 No restrictions on quantity that can be ordered
 No shortages
 No Lead Time (Instant Replenishment)
 No discounts on purchasing more than the EOQ
 Economic Order Quantity is that quantity which reduces total cost.
 It is theoretically the point at which Ordering Cost = Carrying Cost
 D/Q*Co = Q/2 Ch which implies Q (square) = 2*D*Co/Ch
 Lets try and derive this
Problems

 An auto component manufacturer requires a certain steel forging in large

quantities. The annual requirement is 40,000 pieces each costing Rs 450. The
ordering cost is Rs 600 per order and carrying cost is Rs 100 per unit per year
 What is the optimal order quantity
 What happens if you order more or less than this amount
 How frequently should the manufacturer place an order with the supplier
 Compute total ordering cost and total carrying cost.
Problem 2 (Lead Time)

 Excel Toys, a manufacturer of plastic toys for children, requires a constant

supply of high density polyethylene (HDPE) in resin form. HDPE is available in
resin form and costs app 2000 per ton. The manufacturer runs his factory for 250
days a year and daily consumption rate for HDPE is 4 tons. The suppliers
normally take a week to replenish the order. The ordering cost is 2000 per order
and carrying cost is 20%.
 Estimate cyclic and pipeline inventory
 What is the cost of the pan
 Suppose the supplier insists on a minimum order of 75 tons should Excel accept?
 Will recommendation change if minimum order quantity is 150 tons
 Suppose Excel is able to improve ordering costs by 20% due to process
improvements, what will be the new EOQ.
Introduction of More Dimensions

 Lead Time
 Reorder Level
 Discounts on Purchase
 Variability of Demand
Cycle Stock and Pipeline Stock

 Difference
 Problem
Purchase Discount

 We did not consider Purchase Cost initially. However if the supplier gives a
discount we now have a purchase advantage.
 We need to do a cost benefit analysis.
 A few problems
Problem

 A manufacturing organization has been consuming a certain item in large

quantities and is currently procuring the item from Supplier A. The price
offered by the supplier is `400 per piece. The ordering cost is `2,800 per
order and the carrying cost is `350. The annual demand for the item is
10,000. The supplier is currently not offering any discount. However, another
supplier, Supplier B, is willing to offer the following discount structure:
 Upto order of 999 – no discount
1000-1999 – discount of 2% on purchase price
>2000 – 5% of purchase price
Switching Cost is 15000. What should the company do?
Variability of Demand

 Concept of Safety Stock

 ROP = m(L) + Z × s(L)
 Q8 and Q10
 Inventory Control Systems

Perpetutal (Continuos) v/s Periodic Review Inventory

- Perpetual (Q) is the EOQ system (2 bin method)

- Periodic (P) (Fixed period review)
- Perpetual “when to order”
- Perpetual requires continuous tracking. Also less receptive to changes in demand. Can lead to
high stock levels. Why?
- Multiple items from the same supplier can also be a problem
- Periodic overcomes this but requires a higher level of safety stock
Problems from Text book

 9
 11
 12
Selective Control of Inventory

 ABC
 80-20
 The periodic review and the continuous review systems of inventory control
can be linked to the category of items. Since A-class items require closer
control and better response to changes in the demand pattern, periodic
review systems are more appropriate. In the case of “B” class items,
continuous review systems are appropriate. “C” class items can have simple
level-based rules for inventory control. C-class items are often available
readily off the shelf and it is possible to obtain them by ordering over the
phone. Hence, issuing blanket purchase orders for a year and following up
with specific requests for supply against the purchase order is often practiced
in the case of C-class items.
Problem on ABC

 15
Other methods

 XYZ (on basis of unit cost)

 FSN (Movement of inventory)
 VED (Criticality)
 Sources of supply (Indigenous, Indigenous local, imported)