OM Combined

Capacity and
SUPPLEMENT
Constraint
Management 7
Capacity
► The throughput, or the number of units
a facility can hold, receive, store, or
produce in a period of time
► Determines
fixed costs
► Determines if
demand will
be satisfied
► Three time horizons
Planning Over a Time Horizon
Figure S7.1
Options for Adjusting Capacity
Time Horizon
Long-range Design new production processes
planning Add (or sell existing)
long-lead-time equipment
*
Acquire or sell facilities
Acquire competitors
Intermediate-
range Subcontract Build or use inventory
planning Add or sell equipment More or improved training
(aggregate Add or reduce shifts Add or reduce personnel
planning)
Schedule jobs
Short-range
planning
(scheduling)
* Schedule personnel
Allocate machinery
Modify capacity Use capacity

* Difficult to adjust capacity as limited options exist
Design and Effective Capacity
► Design capacity is the maximum
theoretical output of a system
► Normally expressed as a rate
► Effective capacity is the capacity a firm
expects to achieve given current
operating constraints
► Often lower than design capacity
TABLE S7.1 Capacity Measurements
MEASURE DEFINITION EXAMPLE
Design capacity Ideal conditions exist Machines at Frito-Lay are designed to
during the time that produce 1,000 bags of chips/hr., and the plant
the system is operates 16 hrs./day.
available Design Capacity = 1,000 bags/hr. × 16 hrs.
= 16,000 bags/day
Effective capacity Design capacity Frito-Lay loses 3 hours of output per day
minus lost output (= 0.5 hrs./day on preventive maintenance,
because of planned 1 hr./day on employee breaks, and 1.5
resource hrs./day setting up machines for different
unavailability (e.g., products).
preventive Effective Capacity = 16,000 bags/day
maintenance, – (1,000 bags/hr.)
machine (3 hrs./day)
setups/changeovers, = 16,000 bags/day
changes in product – 3,000 bags/day
mix, scheduled = 13,000 bags/day
breaks)
Actual output Effective capacity On average, machines at Frito-Lay are not
minus lost output running 1 hr./day due to late parts and
during unplanned machine breakdowns.
resource idleness Actual Output = 13,000 bags/day
(e.g., absenteeism, – (1,000 bags/hr.)
machine breakdowns, (1 hr./day)
unavailable parts, = 13,000 bags/day
quality problems) – 1,000 bags/day
= 12,000 bags/day
Utilization and Efficiency
Utilization is the percent of design
capacity actually achieved
Utilization = Actual output/Design capacity
Efficiency is the percent of effective

capacity actually achieved
Efficiency = Actual output/Effective capacity
Bakery Example (S1 page 330)
▶Sara James bakery has a plant for processing
Deluxe breakfast rolls and want to understand its
capability. Last week the facility produced
148,000 rolls. The effective capacity is 175,000
rolls. The production line operates 7 days per
week, with 3 eight-hour shifts per day. The line
was designed to produce Deluxe rolls at a rate
of 1200/hour. Find design capacity, utilization
and efficiency
Design
Bakery Example Capacity
Actual production last week = 148,000 rolls
Effective capacity = 175,000 rolls
Design capacity = 1,200 rolls per hour
Bakery operates 7 days/week, 3 - 8 hour shifts
Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Bakery Example Utilization

Utilization = 148,000/201,600 = 73.4%

Bakery Example Efficiency

Utilization = 148,000/201,600 = 73.4%
Efficiency = 148,000/175,000 = 84.6%

Bakery Example (S2 page 331)
▶The manager of Sara James bakery wants to
increase the production of Deluxe breakfast
rolls. She will add a second production line with
same capacity. She hired new workers and due
to various inefficiencies, the output in the second
line is 130,000 rolls. Rest being same, calculate
new utilization and efficiency
Design
Design capacity = 201,600 rolls per line
Efficiency = 84.6%
Expected output of new line = 130,000 rolls
Design capacity = 201,600 x 2 = 403,200 rolls

Effective
Efficiency = 84.6%

Effective capacity = 175,000 x 2 = 350,000 rolls
Actual
Bakery Example Output
Efficiency = 84.6%

Actual output = 148,000 + 130,000 = 278,000 rolls
Utilization
Bakery Example Efficiency
Efficiency = 84.6%

Actual output = 148,000 + 130,000 = 278,000 rolls
Utilization = 278,000/403,200 = 68.95%
Efficiency = 278,000/350,000 = 79.43%
Capacity and Strategy
► Capacity decisions impact all 10

decisions of operations management
as well as other functional areas of
the organization
► Capacity decisions must be integrated
into the organization’s mission and
strategy
Capacity Considerations
1. Forecast demand accurately

2. Match technology increments and
sales volume
3. Find the optimum operating size
(volume)
4. Build for change
Economies and Diseconomies of
Scale
Figure S7.2
(sales per square foot)
Average unit cost
1,300 sq ft 8,000 sq ft
store 2,600 sq ft store
store
Economies Diseconomies
of scale of scale
1,300 2,600 8,000
Number of square feet in store
Copyright © 2017 Pearson Education, Inc. S7 - 20
Managing Demand
► Demand exceeds capacity
► Curtail demand by raising prices, scheduling
longer lead times
► Long-term solution is to increase capacity
► Capacity exceeds demand
► Stimulate market
► Product changes
► Adjusting to seasonal demands
► Produce products with complementary
demand patterns
Complementary Demand
Figure S7.3
Patterns
Combining the
two demand
patterns reduces
the variation
4,000 –
Sales in units
Snowmobile
3,000 – motor sales
2,000 –
1,000 – Jet ski

engine
sales
JFMAMJJASONDJFMAMJJASONDJ
Time (months)
Tactics for Matching Capacity
to Demand
1. Making staffing changes
2. Adjusting equipment
► Purchasing additional machinery
► Selling or leasing out existing equipment
3. Improving processes to increase throughput
4. Redesigning products to facilitate more throughput
5. Adding process flexibility to meet changing product
preferences
6. Closing facilities
Service-Sector Demand
and Capacity Management
► Demand management
► Appointment, reservations, FCFS rule
► Capacity
management
► Full time,
temporary,
part-time
staff
Bottleneck Analysis and the
Theory of Constraints
► Each work area can have its own unique
capacity
► Capacity analysis determines the
throughput capacity of workstations in a
system
► A bottleneck is a limiting factor or constraint
► A bottleneck has the lowest effective capacity in a
system
► The time to produce a unit or a specified
batch size is the process time
Bottleneck Analysis and the
► The bottleneck time is the time of the
slowest workstation (the one that takes
the longest) in a production system
► The throughput time is the time it takes
a unit to go through production from start
to end, with no waiting Figure S7.4
A B C
2 min/unit 4 min/unit 3 min/unit

Capacity Analysis (page 336)
► Two identical sandwich lines
► Lines have two workers and three operations
► All completed sandwiches are wrapped
First assembly line
Bread Fill Toaster

15 sec/sandwich 20 sec/sandwich 40 sec/sandwich
Wrap/
Order
Deliver
30 sec/sandwich
Bread Fill Toaster 37.5 sec/sandwich
15 sec/sandwich 20 sec/sandwich 40 sec/sandwich
Second assembly line

Capacity Bread
15 sec
Fill
20 sec
Toaster
40 sec
Order Wrap
Analysis 30 sec
Bread
15 sec
Fill
20 sec
Toaster
40 sec
37.5 sec
► The two lines are identical, so parallel

processing can occur
► At 40 seconds, the toaster has the longest
processing time and is the bottleneck for
each line
► At 40 seconds for two sandwiches, the
bottleneck time of the combined lines = 20
seconds
► At 37.5 seconds, wrapping and delivery is
the bottleneck for the entire operation
Capacity Bread
15 sec
Fill
20 sec
Toaster
40 sec
Order Wrap
Analysis 30 sec
Bread
15 sec
Fill
20 sec
Toaster
40 sec
37.5 sec
► Capacity per hour is 3,600 seconds/37.5

seconds/sandwich = 96 sandwiches per
hour
► Throughput time is 30 + 15 + 20 + 40 + 37.5
= 142.5 seconds
Capacity Analysis (page 338)
► Standard process for cleaning teeth
► Cleaning and examining X-rays can happen
simultaneously
Hygienist
cleaning
Takes Develops 24 min/unit Check

Check in Dentist
X-ray X-ray out
2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

exam
5 min/unit
Capacity Check
in
Takes
X-ray
Develops
X-ray
Hygienist
cleaning
24 min/unit
Dentist
Check
out
Analysis 2 min/unit 2 min/unit 4 min/unit X-ray

exam
5 min/unit
8 min/unit 6 min/unit
► All possible paths must be compared

► Bottleneck is the hygienist at 24 minutes
► Hourly capacity is 60/24 = 2.5 patients
► X-ray exam path is 2 + 2 + 4 + 5 + 8 + 6 = 27
minutes
► Cleaning path is 2 + 2 + 4 + 24 + 8 + 6 = 46
minutes
► Longest path involves the hygienist cleaning
the teeth, patient should complete in 46
minutes
► Five-step process for recognizing and
managing limitations
Step 1: Identify the constraints
Step 2: Develop a plan for overcoming the constraints
Step 3: Focus resources on accomplishing Step 2
Step 4: Reduce the effects of constraints by offloading
work or expanding capability
Step 5: Once overcome, go back to Step 1 and find
new constraints
Bottleneck Management
1. Release work orders to the system at the
pace of set by the bottleneck’s capacity
► Drum, Buffer, Rope
2. Lost time at the bottleneck represents lost
capacity for the whole system
3. Increasing the capacity of a nonbottleneck
station is a mirage
4. Increasing the capacity of a bottleneck
increases the capacity of the whole system
Break-Even Analysis
► Technique for evaluating process and

equipment alternatives
► Objective is to find the point in dollars
and units at which cost equals
revenue
► Requires estimation of fixed costs,
variable costs, and revenue
Break-Even Analysis
► Fixed costs are costs that continue even
if no units are produced
► Depreciation, taxes, debt, mortgage
payments
► Variable costs are costs that vary with
the volume of units produced
► Labor, materials, portion of utilities
► Contribution is the difference between
selling price and variable cost
Break-Even Analysis
► Revenue function begins at the origin
and proceeds upward to the right,
increasing by the selling price of each
unit
► Where the revenue function crosses
the total cost line is the break-even
point
Break-Even Analysis
–
Total revenue line
900 –
800 –
Break-even point Total cost line
700 – Total cost = Total revenue
Cost in dollars
600 –
500 –
Variable cost
400 –
300 –
200 –
100 – Fixed cost

| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Figure S7.5
Volume (units per period)
Break-Even Analysis
Assumptions
► Costs and revenue are linear
functions
► Generally not the case in the real
world
► We actually know these costs
► Very difficult to verify
► Time value of money is often
ignored
Break-Even Analysis
BEPx = break-even point x = number of units
in units produced
BEP$ = break-even point TR = total revenue = Px
in dollars F = fixed costs
P = price per unit V = variable cost per unit
(after all TC = total costs = F + Vx
discounts)
Break-even point occurs when
TR = TC F
or BEPx =
P–V
Px = F + Vx
Break-Even Analysis
BEPx = break-even point x = number of units
in units produced
BEP$ = break-even point TR = total revenue = Px
in dollars F = fixed costs
P = price per unit V = variable cost per unit
(after all TC = total costs = F + Vx
discounts)
F Profit = TR - TC
BEP$ = BEPx P = P
P–V = Px – (F + Vx)
F = Px – F – Vx
= (P – V)/P
= (P - V)x – F
F
=
1 – V/P
Example S5 page 341
▶Stephens INC wants to determine the
BEP in units and value for its new facility
▶Its fixed cost is ₹10000 and per unit
labour cost is ₹1.5 and material cost is
₹0.75. Its selling price is ₹4 per unit.

Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit
F $10,000
BEP$ = =
1 – (V/P) 1 – [(1.50 + .75)/(4.00)]
$10,000
= = $22,857.14
.4375
Break-Even Example
Fixed costs = $10,000 Material = $.75/unit
Direct labor = $1.50/unit Selling price = $4.00 per unit
F $10,000
BEP$ = =
1 – (V/P) 1 – [(1.50 + .75)/(4.00)]
$10,000
= = $22,857.14
.4375
F $10,000
BEPx = = = 5,714
P–V 4.00 – (1.50 + .75)
Break-Even Example
50,000 –
Revenue
40,000 –
Break-even
point Total
30,000 –
Dollars
costs
20,000 –
Fixed costs
10,000 –
| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Units
Break-Even Example
Multiproduct Case
Break-even
point in dollars
(BEP$)
where V = variable cost per unit

P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
expressed as a decimal
i = each product
Example S6 page 343
Le Bresto makes three products and wants to know BEP
in dollars. Fixed cost per month is 3000
ITEM ANNUAL PRICE COST

FORECAST
Sandwich 9000 5.00 3.00
Drinks 9000 1.50 0.50
Fries 7000 2.00 1.00

Multiproduct Example
Fixed costs = $3,000 per month
ANNUAL FORECASTED
ITEM SALES UNITS PRICE COST
Sandwich 9,000 $5.00 $3.00
Drink 9,000 1.50 .50
Baked potato 7,000 2.00 1.00
1 2 3 4 5 6 7 8 9
ANNUAL ANNUAL WEIGHTED
FORECASTED SELLING VARIABLE FORECASTED % OF SALES CONTRIBUTION
ITEM (i) SALES UNITS PRICE (Pi) COST (Vi) (Vi/Pi) 1 - (Vi/Pi) SALES $ (Wi) (COL 6 X COL 8)
Sandwich 9,000 $5.00 $3.00 .60 .40 $45,000 .621 .248
Drinks 9,000 1.50 0.50 .33 .67 13,500 .186 .125

Baked 7,000
potato 2.00 1.00 .50 .50 14,000 .193 .097
$72,500 1.000 .470

Multiproduct Example
Fixed costs = $3,000 per month
ANNUAL FORECASTED
ITEM SALES UNITS PRICE x 12
$3,000 COST
Sandwich 9,000 = $5.00 = $76,596
$3.00
.47
Drink 9,000 1.50 .50
Daily $76,596
Baked potato 7,000 2.00 1.00
sales = 312 days = $245.50
1 2 3 4 5 6 7 8 9
ANNUAL ANNUAL WEIGHTED
FORECASTED SELLING VARIABLE FORECASTED CONTRIBUTION
ITEM (i) SALES UNITS PRICE (P) COST (V) (V/P) 1 - (V/P) SALES $ % OF SALES (COL 5 X COL 7)
Sandwich 9,000 $5.00 $3.00 .60 .40 $45,000 .621 .248
Drinks 9,000 1.50 0.50 .33 .67 13,500 .186 .125

Baked 7,000
potato 2.00 1.00 .50 .50 14,000 .193 .097
$72,500 1.000 .470

Reducing Risk with
Figure S7.6 Incremental Changes
(a) Leading demand with (b) Leading demand with a
incremental expansion one-step expansion
New
New capacity
capacity
Demand
Demand
Expected Expected
demand demand
(c) Lagging demand with (d) Attempts to have an average

incremental expansion capacity with incremental
New expansion
capacity New
Demand
Expected Demand capacity Expected

demand demand
Reducing Risk with
Incremental Changes
(a) Leading demand with incremental
expansion
Figure S7.6
New
capacity
Demand
Expected
demand
1 2 3
Time (years)
Reducing Risk with
Incremental Changes
(b) Leading demand with a one-step
expansion
Figure S7.6
New
capacity
Demand
Expected
demand
1 2 3
Time (years)
Reducing Risk with
Incremental Changes
(c) Lagging demand with incremental
expansion
Figure S7.6
New
capacity
Expected
Demand
demand
1 2 3
Time (years)
Reducing Risk with
Incremental Changes
(d) Attempts to have an average capacity with
incremental expansion
Figure S7.6
New
capacity
Expected
Demand
demand
1 2 3
Time (years)
Applying Expected Monetary
Value (EMV) and Capacity
Decisions
► Determine states of nature
► Future demand
► Market favorability
► Assign probability values to states
of nature to determine expected
value
EMV Applied to Capacity
Decision
▶Southern Hospital Supplies capacity
expansion
EMV (large plant) = (.4)($100,000) + (.6)(–$90,000)
= –$14,000
EMV (medium plant) = (.4)($60,000) + (.6)(–$10,000)
= +$18,000
EMV (small plant) = (.4)($40,000) + (.6)(–$5,000)
= +$13,000
EMV (do nothing) = $0
Strategy-Driven Investments
► Operations managers may have to

decide among various financial
options
► Analyzing capacity alternatives
should include capital investment,
variable cost, cash flows, and net
present value
Net Present Value (NPV)
In general:
F = P(1 + i)N
where F = future value
P = present value
i = interest rate
N = number of years
Solving for P:
F
P=
(1 + i)N
Net Present Value (NPV)
In general:
F = P(1 + i)N
where F = future value
P While
= present value this works fine, it
i is cumbersome for
= interest rate
N = number oflarger
years values of N
Solving for P:
F
P=
(1 + i)N
NPV Using Factors
F
P= N = FX
(1 + i)
where X = a factor from Table S7.2 defined
as = 1/(1 + i)N and F = future
value
TABLE S7.2 Present Value of $1

YEAR 6% 8% 10% 12% 14%
1 .943 .926 .909 .893 .877
2 .890 .857 .826 .797 .769
3 .840 .794 .751 .712 .675
4 .792 .735 .683 .636 .592
Portion of
5 .747 .681 .621 .567 .519 Table S7.2
Present Value of an Annuity
An annuity is an investment that
generates uniform equal payments
S = RX
where X = factor from Table S7.3
S = present value of a series of uniform
annual receipts
R = receipts that are received every year
of the life of the investment
TABLE S7.3 Present Value of and Annuity of $1

YEAR 6% 8% 10% 12% 14%
1 .943 .926 .909 .893 .877
2 1.833 1.783 1.736 1.690 1.647
3 2.673 2.577 2.487 2.402 2.322
4 3.465 3.312 3.170 3.037 2.914
5 4.212 3.993 3.791 3.605 3.433
Portion of
Table S7.3
▶River Road Medical Clinic equipment investment
$7,000 in receipts per year for 5 years

Interest rate = 6%
From Table S7.3
X = 4.212
S = RX
S = $7,000(4.212) = $29,484
Limitations
1. Investments with the same NPV may have
different projected lives and salvage
values
2. Investments with the same NPV may have
different cash flows
3. Assumes we know future interest rates
4. Payments are not always made at the end
of a period
Location Strategies
8
Location Provides Competitive
Advantage for FedEx
▶Central hub concept

▶Enables service to more locations with
fewer aircraft
▶Enables matching of aircraft flights with
package loads
▶Reduces mishandling and delay in transit
because there is total control of packages
from pickup to delivery
The Strategic Importance of
Location
► One of the most important decisions
a firm makes
► Increasingly global in nature
► Significant impact on fixed and
variable costs
► Decisions made relatively
infrequently
Location
► Long-term decisions
► Once committed to a location, many
resource and cost issues are difficult
to change
Location
The objective of location strategy is
to maximize the benefit of location
to the firm
Options include
1. Expanding existing facilities
2. Maintain existing and add sites
3. Closing existing and relocating
Location and Costs
► Location decisions require careful
consideration
► Once in place, location-related costs
are fixed in place and difficult to
reduce
► Effort spent determining optimal
facility location is a good investment
Factors That Affect Location
Decisions
▶Globalization adds to complexity
▶Drivers of globalization
▶Market economics
▶Communication
▶Rapid, reliable transportation
▶Ease of capital flow
▶Differing labor costs
▶Identify key success factors (KSFs)
Location Decisions
Country Decision Key Success Factors
1. Political risks, government
rules, attitudes, incentives
2. Cultural and economic issues
3. Location of markets
4. Labor talent, attitudes,
productivity, costs
5. Availability of supplies,
communications, energy
6. Exchange rates and currency
Figure 8.1 risks
Location Decisions
Region/ Key Success Factors
Community
Decision 1. Corporate desires
2. Attractiveness of region
MN
3. Labor availability and costs
WI 4. Costs and availability of utilities
MI 5. Environmental regulations
IL IN
OH 6. Government incentives and fiscal
policies
7. Proximity to raw materials and
customers
Figure 8.1
8. Land/construction costs
Location Decisions
Site Decision Key Success Factors
1. Site size and cost
2. Air, rail, highway, and
waterway systems
3. Zoning restrictions
4. Proximity of services/
supplies needed
5. Environmental impact
issues
6. Customer density and
Figure 8.1
demographics
TABLE 8.1
Competitiveness of 144 Selected
Global Countries
COUNTRY 2015 RANKING
Competitiveness Switzerland
Singapore
1
2
Index of U.S.
Finland
3
4
Countries Germany
Japan
5
6
Canada 15
Israel 27
China 28
Russia 53
Mexico 61
Vietnam 68
Haiti 137
Chad 143
Guinea 144
Factors That Affect
Location Decisions
► Labor productivity
► Wage rates are not the only cost
► Lower productivity may increase total cost
Labor cost per day

= Labor cost per unit
Productivity (units per day)
South Carolina Mexico
$70 $25
= $1.17 per unit = $1.25 per unit
60 units 20 units
Factors That Affect
Location Decisions
► Exchange rates and currency risks
► Can have a significant impact on costs
► Rates change over time
► Costs
► Tangible – easily measured costs such as
utilities, labor, materials, taxes
► Intangible – not as easy to quantify and
include education, public transportation,
community, quality-of-life
Factors That Affect
Location Decisions
► Exchange rates and currency risks
► Can have a significant impact on costs
► Rates change over time
Location decisions
► Costs
based on costs
► Tangible – easily measured costs such as
alone
utilities, labor, materials, taxes
can create
difficult ethical
► Intangible – not as easy to quantify and
situations
include education, public transportation,
community, quality-of-life
Factors That Affect
Location Decisions
► Political risk, values, and culture
► National, state, local governments' attitudes
toward private and intellectual property,
zoning, pollution, employment stability may
be in flux
► Worker attitudes toward turnover, unions,
absenteeism
► Globally cultures have different attitudes
toward punctuality, legal, and ethical issues
Ranking Corruption
Rank Country 2015 CPI Score (out of 100)
1 Demark 91 Least
2 Finland 90 Corrupt
3 Sweden 89
4 New Zealand 88
5 Netherlands, Norway, 87
7 Switzerland 86
8 Singapore 85
9 Canada 83
10 Germany, UK 81
16 USA 76
18 Japan 75
17 USA 74
30 Taiwan 62 Most
37 South Korea 56 Corrupt
83 China 37
119 Russia 29
Factors That Affect
Location Decisions
► Proximity to markets
► Very important to services
► JIT systems or high transportation costs may
make it important to manufacturers
► Proximity to suppliers
► Perishable goods, high transportation costs,
bulky products
Factors That Affect
Location Decisions
► Proximity to competitors (clustering)
► Often driven by resources such as natural,
information, capital, talent
► Found in both manufacturing and service
industries
Clustering of Companies
TABLE 8.3 Clustering of Companies
REASON FOR
INDUSTRY LOCATIONS CLUSTERING
Wine making Napa Valley (U.S.) Natural resources of land
Bordeaux region and climate
(France)
Software firms Silicon Valley, Talent resources of bright
Boston, Bangalore, graduates in
Israel scientific/technical areas,
venture capitalists nearby
Clean energy Colorado Critical mass of talent and
information, with 1,000
companies
REASON FOR
Theme parks Orlando, Florida A hot spot for
(Disney World, entertainment, warm
Universal Studios, weather, tourists, and
and Sea World) inexpensive labor
Electronics firms Northern Mexico NAFTA, duty free export to
(Sony, IBM, HP, U.S.
Motorola, and
Panasonic)
Computer hardware Singapore, Taiwan High technological
manufacturers penetration rate and per
capita GDP,
skilled/educated workforce
with large pool of engineers
REASON FOR
Fast food chains Sites within 1 mile of Stimulate food sales, high
(Wendy’s, each other traffic flows
McDonald’s, Burger
King, Pizza Hut)
General aviation Wichita, Kansas Mass of aviation skills
aircraft (Cessna,
Learjet, Boeing,
Raytheon)
Athletic footwear, Portland, Oregon 300 companies, many
outdoor wear owned by Nike, deep talent
pool and outdoor culture
Factor-Rating Method
► Popular because a wide variety of factors
can be included in the analysis
► Six steps in the method
1. Develop a list of relevant factors called key
success factors
2. Assign a weight to each factor
3. Develop a scale for each factor
4. Score each location for each factor
5. Multiply score by weights for each factor and
total the score for each location
6. Make a recommendation based on the highest
point score
Factor-Rating Example
TABLE 8.4 Weights, Scores, and Solution
SCORES
(OUT OF 100) WEIGHTED SCORES
KEY SUCCESS
WEIGHT FRANCE DENMARK FRANCE DENMARK
FACTOR
Labor availability
.25 70 60 (.25)(70) = 17.5 (.25)(60) = 15.0
and attitude
People-to-car ratio .05 50 60 (.05)(50) = 2.5 (.05)(60) = 3.0
Per capita income .10 85 80 (.10)(85) = 8.5 (.10)(80) = 8.0
Tax structure .39 75 70 (.39)(75) = 29.3 (.39)(70) = 27.3
Education and
.21 60 70 (.21)(60) = 12.6 (.21)(70) = 14.7
health
Totals 1.00 70.4 68.0
Locational
Cost-Volume Analysis
► An economic comparison of location
alternatives
► Three steps in the method
1. Determine fixed and variable costs for each
location
2. Plot the cost for each location
3. Select location with lowest total cost for
expected production volume
Locational Cost-Volume
Analysis Example
Three locations:
Selling price = $120
Expected volume = 2,000 units
Fixed Variable Total
City Cost Cost Cost
Athens $30,000 $75 $180,000
Brussels $60,000 $45 $150,000
Lisbon $110,000 $25 $160,000
Total Cost = Fixed Cost + (Variable Cost x Volume)

Analysis Example
Crossover point – Athens/Brussels
30,000 + 75(x) = 60,000 + 45(x)
30(x) = 30,000
x = 1,000
Crossover point – Brussels/Lisbon
60,000 + 45(x) = 110,000 + 25(x)

20(x) = 50,000
x = 2,500
Analysis Example
Figure 8.2
–
$180,000 –
–
$160,000 –
$150,000 –
–
$130,000 –
Annual cost
–
$110,000 –
–
–
$80,000 –
–
$60,000 –
–
–
$30,000 – Athens Lisbon
Brussels
lowest lowest
– lowest cost
cost cost
$10,000 –
| | | | | | |
–
0 500 1,000 1,500 2,000 2,500 3,000
Volume
Center-of-Gravity Method
► Finds location of distribution center
that minimizes distribution costs
► Considers
► Location of markets
► Volume of goods shipped to those
markets
► Shipping cost (or distance)
► Place existing locations on a
coordinate grid
► Grid origin and scale are arbitrary
► Maintain relative distances
► Calculate x and y coordinates for
'center of gravity'
► Assumes cost is directly proportional
to distance and volume shipped
x-coordinate of the
center of gravity
y-coordinate of the
center of gravity
where xi = x-coordinate of location i

yi = y-coordinate of location i
Qi = Quantity of goods moved to or from
location i
TABLE 8.5 Demand for Quain's Discount Department Stores

NUMBER OF CONTAINERS
STORE LOCATION SHIPPED PER MONTH
Chicago 2,000
Pittsburgh 1,000
New York 1,000
Atlanta 2,000
North-South Figure 8.3
New York (130, 130)

Chicago (30, 120)
120 –
Pittsburgh (90, 110)
90 –
60 –
x1 = 30
y1 = 120
30 –
Q1 = 2,000
Atlanta (60, 40)
–
| | | | | |
East-West
30 60 90 120 150
Arbitrary
origin
(30)(2000) + (90)(1000) + (130)(1000) + (60)(2000)

x-coordinate =
2000 + 1000 + 1000 + 2000
= 66.7
(120)(2000) + (110)(1000) + (130)(1000) + (40)(2000)

y-coordinate =
2000 + 1000 + 1000 + 2000
= 93.3
North-South Figure 8.3
New York (130, 130)

Chicago (30, 120)
120 –
Pittsburgh (90, 110)
90 – + Center of gravity (66.7, 93.3)
60 –
30 –
Atlanta (60, 40)
–
| | | | | |
East-West
30 60 90 120 150
Arbitrary
origin
Transportation Model
► Finds amount to be shipped from

several points of supply to several
points of demand
► Solution will minimize total production
and shipping costs
► A special class of linear programming
problems
Worldwide Distribution of
Volkswagens and Parts
Figure 8.4
Service Location Strategy
1. Purchasing power of customer-drawing area
2. Service and image compatibility with
demographics of the customer-drawing area
3. Competition in the area
4. Quality of the competition
5. Uniqueness of the firm’s and competitors’
locations
6. Physical qualities of facilities and neighboring
businesses
7. Operating policies of the firm
8. Quality of management
Location Strategies
TABLE 8.6 Location Strategies – Service vs. Goods-Producing Organizations
SERVICE/RETAIL/PROFESSIONAL GOODS-PRODUCING
REVENUE FOCUS COST FOCUS
Volume/revenue Tangible costs
Drawing area; purchasing power Transportation cost of raw material
Competition; advertising/pricing Shipment cost of finished goods
Energy and utility cost; labor; raw
Physical quality material; taxes, and so on
Parking/access; security/lighting;
appearance/ image Intangible and future costs
Attitude toward union
Cost determinants Quality of life
Rent Education expenditures by state
Management caliber Quality of state and local
Operation policies (hours, wage government
rates)
Location Strategies
TABLE 8.6 Location Strategies – Service vs. Goods-Producing Organizations
SERVICE/RETAIL/PROFESSIONAL GOODS-PRODUCING
TECHNIQUES TECHNIQUES
Regression models to determine Transportation method
importance of various factors Factor-rating method
Factor-rating method Locational cost–volume analysis
Traffic counts Crossover charts
Demographic analysis of drawing area
Purchasing power analysis of area
Center-of-gravity method
Geographic information systems
ASSUMPTIONS ASSUMPTIONS
Location is a major determinant of Location is a major determinant of cost
revenue Most major costs can be identified
High customer-contact issues are critical explicitly for each site
Costs are relatively constant for a given Low customer contact allows focus on
area; therefore, the revenue the identifiable costs
function is critical Intangible costs can be evaluated
How Hotel Chains Select Sites
► Location is a strategically important decision
in the hospitality industry
► La Quinta started with 35 independent
variables and worked to refine a regression
model to predict profitability
► The final model had only four variables
► Price of the inn
► Median income levels
► State population per inn
► Location of nearby colleges
How Hotel Chains Select Sites
► Location is a strategically important decision
in the hospitality industry
► La Quinta started with 35 independent
variables and worked to refine a regression
model to predict profitability
R2 = .51
► The final model had only four variables
51% of the
► Price of the inn
profitability is
► Median income levels predicted by
► State population per inn just these
four variables!
► Location of nearby colleges
Geographic Information
Systems (GIS)
► Important tool to help in location analysis
► Enables more complex demographic analysis
► Available data bases include
► Detailed census data
► Detailed maps
► Utilities
► Geographic features
► Locations of major services
Geographic Information
Systems (GIS)
1. https://nobelsystemsblog.com/gis-data-
business/
2. https://www.gislounge.com/free-gis-
applications/
3. https://www.traveltimeplatform.com/blog/l
ocation-analysis-councils
Layout Strategies
9
Innovations at McDonald's
► Indoor seating (1950s)

► Drive-through window (1970s)
► Adding breakfast to the menu (1980s)
► Adding play areas (late 1980s)
► Redesign of the kitchens (1990s)
► Self-service kiosk (2004)
► Now three separate dining sections
Innovations at McDonald's
► Indoor seating (1950s)

► Drive-through windowSix
(1970s)
out of the
► Adding breakfast to the seven are
menu (1980s)
layout
► Adding play areas (late decisions!
1980s)
► Redesign of the kitchens (1990s)
► Self-service kiosk (2004)
► Now three separate dining sections
McDonald's New Layout
▶Seventh major innovation
▶Redesigning all 30,000 outlets around
the world
▶Three separate dining areas
▶Linger zone with comfortable chairs and Wi-
Fi connections
▶Grab and go zone with tall counters
▶Flexible zone for kids and families
▶Facility layout is a source of competitive
advantage
Strategic Importance of Layout
Decisions
The objective of layout strategy

is to develop an effective and
efficient layout that will meet the
firm’s competitive requirements
Layout Design Considerations
► Higher utilization of space, equipment, and
people
► Improved flow of information, materials, or
people
► Improved employee morale and safer
working conditions
► Improved customer/client interaction
► Flexibility
Types of Layout
1. Office layout
2. Retail layout
3. Warehouse layout
4. Fixed-position layout
5. Process-oriented layout
6. Work-cell layout
7. Product-oriented layout
Types of Layout
1. Office layout: Positions workers, their
equipment, and spaces/offices to
provide for movement of information
2. Retail layout: Allocates display space
and responds to customer behavior
3. Warehouse layout: Addresses trade-
offs between space and material
handling
Types of Layout
4. Fixed-position layout: Addresses the

layout requirements of large, bulky
projects such as ships and buildings
5. Process-oriented layout: Deals with
low-volume, high-variety production
(also called job shop or intermittent
production)
Types of Layout
6. Work cell layout: Arranges machinery

and equipment to focus on production
of a single product or group of related
products
7. Product-oriented layout: Seeks the
best personnel and machine
utilizations in repetitive or continuous
production
Layout Strategies
TABLE 9.1 Layout Strategies
OBJECTIVES EXAMPLES
Office Locate workers requiring Allstate Insurance

frequent contact close to one Microsoft Corp.
another
Retail Expose customer to high- Kroger’s Supermarket

margin items Walgreen’s
Bloomingdale’s
Warehouse Balance low-cost storage with Federal-Mogul’s warehouse

(storage) low-cost material handling The Gap’s distribution center
Project (fixed Move material to the limited Ingall Ship Building Corp.
position) storage areas around the site Trump Plaza
Pittsburgh Airport
Layout Strategies
TABLE 9.1 Layout Strategies
OBJECTIVES EXAMPLES
Job Shop Manage varied material flow for Arnold Palmer Hospital
(process each product Hard Rock Cafe
oriented) Olive Garden
Work Cell Identify a product family, build Hallmark Cards

(product teams, cross-train team Wheeled Coach Ambulances
families) members
Repetitive/ Equalize the task time at each Sony’s TV assembly line

Continuous workstation Toyota Scion
(product
oriented)
Good Layouts Consider
► Material handling equipment
► Capacity and space requirements
► Environment and aesthetics
► Flows of information
► Cost of moving between various work
areas
Office Layout
► Grouping of workers, their equipment,
and spaces to provide comfort, safety,
and movement of information
► Movement of information is main
distinction
► Typically in state of flux due to
frequent technological changes
Relationship Chart
Figure 9.1
Office Layout
► Three physical and social aspects
► Proximity
► Privacy
► Permission
► Two major trends
► Information technology
► Dynamic needs for space and services
Retail Layout
▶Objective is to maximize profitability

per square foot of floor space
▶Sales and profitability vary directly
with customer exposure
Five Helpful Ideas for
Supermarket Layout
1. Locate high-draw items around the periphery of
the store
2. Use prominent locations for high-impulse and
high-margin items
3. Distribute power items to both sides of an aisle
and disperse them to increase viewing of other
items
4. Use end-aisle locations
5. Convey mission of store through careful
positioning of lead-off department
Store Layout
Figure 9.2
Slotting
▶Manufacturers pay slotting fees to
retailers to get the retailers to display
(slot) their product
▶Contributing factors
▶Limited shelf space
▶An increasing number of new products
▶Better information about sales through
POS data collection
▶Closer control of inventory
Servicescapes
1. Ambient conditions - background
characteristics such as lighting, sound,
smell, and temperature
2. Spatial layout and functionality - which
involve customer
circulation path planning,
aisle characteristics, and
product grouping
3. Signs, symbols, and
artifacts - characteristics
of building design that
carry social significance
Warehouse and Storage Layouts
▶Objective is to find the optimum

trade-offs between handling costs
and costs associated with warehouse
space
▶Maximize the total "cube" of the
warehouse – utilize its full volume
while maintaining low material
handling costs
Warehousing and Storage
Layouts
Material Handling Costs
► All costs associated with the transaction
► Incoming transport
► Storage
► Finding and moving material
► Outgoing transport
► Equipment, people, material, supervision,
insurance, depreciation
► Minimize damage and spoilage
Warehousing and Storage
Layouts
▶Warehouse density tends to vary inversely
with the number of different items stored
▶Automated Storage and Retrieval Systems
(ASRSs) can
significantly improve
warehouse productivity
▶Dock location is a key
design element
Cross-Docking
▶Materials are moved directly from receiving to
shipping and are not placed in storage in the
warehouse
▶Requires tight
scheduling and
accurate shipments,
bar code or RFID
identification used for
advanced shipment
notification as
materials are unloaded
Random Stocking
► Typically requires automatic identification
systems (AISs) and effective information
systems
► Allows more efficient use of space
► Key tasks
1. Maintain list of “open” locations
2. Maintain accurate records
3. Sequence items to minimize travel, “pick” time
4. Combine picking orders
5. Assign classes of items to particular areas
Customizing
▶Value-added activities performed at
the warehouse
▶Enable low cost and rapid response
strategies
▶Assembly of components
▶Loading software
▶Repairs
▶Customized labeling and packaging
Fixed-Position Layout
▶Product remains in one place
▶Workers and equipment come to site
▶Complicating factors
▶Limited space at site
▶Different materials
required at different
stages of the project
▶Volume of materials
needed is dynamic
Alternative Strategy
▶As much of the project as possible is
completed off-site in a product-oriented
facility
▶This can
significantly
improve
efficiency but
is only possible
when multiple
similar units need to be created
Process-Oriented Layout
▶Like machines and equipment are
grouped together
▶Flexible and capable of handling a
wide variety of products or services
▶Scheduling can be difficult and setup,
material handling, and labor costs can
be high
Surgery ER triage room Emergency room admissions
Patient A - broken leg
Patient B - erratic heart

pacemaker
Laboratories
Radiology ER Beds Pharmacy Billing/exit
Figure 9.3
▶Arrange work centers so as to
minimize the costs of material handling
▶Basic cost elements are
▶Number of loads (or people) moving
between centers
▶Distance loads (or people) move between
centers
where n = total number of work centers or departments

i, j = individual departments
Xij = number of loads moved from
department i to department j
Cij = cost to move a load between
department i and department j
Process Layout Example
Arrange six departments in a factory to
minimize the material handling costs. Each
department is 20 x 20 feet and the building
is 60 feet long and 40 feet wide.
1. Construct a "from-to matrix"
2. Determine the space requirements
3. Develop an initial schematic diagram
4. Determine the cost of this layout
5. Try to improve the layout
6. Prepare a detailed plan
Figure 9.4
Number of loads per week

Department Assembly Painting Machine Receiving Shipping Testing
(1) (2) Shop (3) (4) (5) (6)
Assembly (1) 50 100 0 0 20
Painting (2) 30 50 10 0
Machine Shop (3) 20 0 100
Receiving (4) 50 0
Shipping (5) 0
Testing (6)
Figure 9.5 Area A Area B Area C
Assembly Painting Machine Shop

Department Department Department
(1) (2) (3)
40'
Receiving Shipping Testing

(4) (5) (6)
Area D Area E Area F

60'
Figure 9.6
Interdepartmental Flow Graph
100
Assembly 50 Painting 30 Machine

(1) (2) Shop (3)
10
100

(4) (5) (6)
50
Cost = $50 + $200 + $40

(1 and 2) (1 and 3) (1 and 6)
+ $30 + $50 + $10
(2 and 3) (2 and 4) (2 and 5)
+ $40 + $100 + $50
(3 and 4) (3 and 6) (4 and 5)
= $570
Revised Interdepartmental Flow Graph
Figure 9.7
30
Painting 50 Assembly 100 Machine

(2) (1) Shop (3)
50 100

(4) (5) (6)
50
Cost = $50 + $100 + $20

(1 and 2) (1 and 3) (1 and 6)
+ $60 + $50 + $10
(2 and 3) (2 and 4) (2 and 5)
+ $40 + $100 + $50
(3 and 4) (3 and 6) (4 and 5)
= $480
Figure 9.8 Area A Area B Area C
Painting Assembly Machine Shop

(2) (1) (3)
40'

(4) (5) (6)
Area D Area E Area F

60'
Computer Software
▶Graphical approach only works for small
problems
▶Computer programs are available to
solve bigger problems
► CRAFT ► Factory Flow
► ALDEP ► Proplanner
► CORELAP
Computer Software
▶Proplanner flow path calculator
▶Generate material flow diagrams
▶Calculate material handling distances,
times, costs
▶Color-coded flow lines
▶Helps identify excessive material handling
Computer Software
▶Proplanner flow path calculator
▶Generate material flow diagrams
▶Calculate material handling distances,
times, costs
▶Color-coded flow lines
▶Helps identify excessive material
handling
Computer Software
▶Three dimensional visualization software
allows managers to view possible layouts
and assess process, material
handling,
efficiency,
and safety
issues
Work Cells
▶Reorganizes people and machines
into groups to focus on single
products or product groups
▶Group technology identifies products
that have similar characteristics for
particular cells
▶Volume must justify cells
▶Cells can be reconfigured as designs
or volume changes
Advantages of Work Cells
1. Reduced work-in-process inventory
2. Less floor space required
3. Reduced raw material and finished goods
inventories
4. Reduced direct labor cost
5. Heightened sense of employee
participation
6. Increased equipment and machinery
utilization
7. Reduced investment in machinery and
equipment
Requirements of Work Cells
▶Identification of families of products
▶A high level of training, flexibility and
empowerment of employees
▶Being self-contained, with its own
equipment and resources
▶Test (poka-yoke) at each station in
the cell
Improving Layouts Using
Work Cells
Figure 9.9 (a)
Material
Current layout - workers in

small closed areas.
Improved layout - cross-trained

workers can assist each other. May
be able to add a third worker as
additional output is needed.
Improving Layouts Using
Work Cells
Figure 9.9 (b)
Current layout - straight lines

make it hard to balance tasks Improved layout - in U shape,
because work may not be workers have better access.
divided evenly Four cross-trained workers
were reduced to three.
U-shaped line may reduce employee movement

and space requirements while enhancing
communication, reducing the number of workers,
and facilitating inspection
Staffing and Balancing Work
Cells
Determine the takt time
Total work time available
Takt time =
Units required to
satisfy customer demand
Determine the number

of operators required
Total operation time required

Workers required =
Takt time
Staffing Work Cells Example
600 mirrors per day required
Mirror production scheduled for 8 hours per day
From a work balance 60
chart total operation 50

time = 140 seconds
Standard time required

40
30
20
10
Figure 9.10
0
Assemble Paint Test Label Pack for
shipment
Operations
Staffing Work Cells Example
600 mirrors per day required
Mirror production scheduled for 8 hours per day
From a work balance
chart total operation
time = 140 seconds
Takt time = (8 hrs x 60 mins) / 600 units

= .8 min = 48 seconds
Total operation time required
Workers required = Takt time
= 140 / 48 = 2.92
Work Balance Charts
▶Used for evaluating operation times
in work cells
▶Can help identify bottleneck
operations
▶Flexible, cross-trained employees
can help address labor bottlenecks
▶Machine bottlenecks may require
other approaches
Focused Work Center and
Focused Factory
▶Focused Work Center
▶Identify a large family of similar products
that have a large and stable demand
▶Moves production from a general-purpose,
process-oriented facility to a large work cell
▶Focused Factory
▶A focused work cell in a separate facility
▶May be focused by product line, layout,
quality, new product introduction, flexibility,
or other requirements
Repetitive and Product-
Oriented Layout
Organized around products or families of
similar high-volume, low-variety products
1. Volume is adequate for high equipment utilization
2. Product demand is stable enough to justify high
investment in specialized equipment
3. Product is standardized or approaching a phase of
life cycle that justifies investment
4. Supplies of raw materials and components are
adequate and of uniform quality
Product-Oriented Layouts
► Fabrication line
► Builds components on a series of machines
► Machine-paced
► Require mechanical or engineering changes to
balance
► Assembly line
► Puts fabricated parts together at a series of
workstations
► Paced by work tasks
► Balanced by moving tasks
► Fabrication line
► Builds components on a series of machines
► Machine-paced
► Require mechanical or engineering changes to
balance
► Assembly line Both types of lines
►
must
Puts fabricated parts together at be balanced
a series of
workstations so that the time to
perform the work at
► Paced by work tasks each station is the
► Balanced by moving tasks same
Advantages
1. Low variable cost per unit
2. Low material handling costs
3. Reduced work-in-process inventories
4. Easier training and supervision
5. Rapid throughput
Disadvantages
1. High volume is required
2. Work stoppage at any point ties up the whole
operation
3. Lack of flexibility in product or production rates
McDonald's Assembly Line
Figure 9.11
Assembly-Line Balancing
▶Objective is to minimize the imbalance
between machines or personnel while
meeting required output
▶Starts with the precedence relationships
▶Determine cycle time
▶Calculate theoretical
minimum number of
workstations
▶Balance the line by
assigning specific
tasks to workstations
Wing Component Example
TABLE 9.2 Precedence Data for Wing Component
ASSEMBLY TIME TASK MUST FOLLOW
TASK (MINUTES) TASK LISTED BELOW
A 10 – This means that
B 11 A tasks B and E
cannot be done
C 5 B until task A has
D 4 B
been completed
E 11 A
F 3 C, D
G 7 F
H 11 E
I 3 G, H
Total time 65
Precedence Data for Wing
TABLE 9.2 Component 480 available mins
TASK MUST
per day
ASSEMBLY TIME FOLLOW TASK 40 units required
TASK (MINUTES) LISTED BELOW
A 10 –
B 11 A
C 5 B
D 4 B Figure 9.12
E 11 A 5
F 3 C, D C
G 7 F 10 11 3 7
H 11 E A B F G
4
I 3 G, H 3
D I
Total time 65 11 11
E H
Precedence Data for Wing
TABLE 9.2 Component 480 available mins
TASK MUST
per day
ASSEMBLY TIME FOLLOW TASK 40 units required
TASK (MINUTES) LISTED BELOW
A 10 –
Production time available
B 11 A per day
C 5 Cycle
B time = Units required per day
D 4 B Figure 9.12
= 480 / 40
E 11 A 5
F 3 C, D = 12 minutes per unit
C
G 7 F 10 11 3 7
H 11 E A B F G
Minimum number 4
I 3 G, H 3
of workstations D
Total time 65 11 11 I
= 65E/ 12 H
= 5.42, or 6 stations
Layout Heuristics That May Be Used to Assign Tasks
TABLE 9.3
to Workstations in Assembly-Line Balancing
1. Longest task time From the available tasks, choose the
task with the largest (longest) task time
2. Most following tasks From the available tasks, choose the
task with the largest number of following
tasks
3. Ranked positional From the available tasks, choose the
weight task for which the sum of following task
times is the longest
4. Shortest task time From the available tasks, choose the
task with the shortest task time
5. Least number of From the available tasks, choose the
following tasks task with the least number of subsequent
tasks
480 available mins
Figure 9.13 per day
40 units required
Cycle time = 12 mins
Minimum
Station 5 workstations = 5.42 or 6
2
C
10 11 3 7
A B F G
4 3
D Station 3
Station 4 I
11 11
Station 6
Station Station 6
1 E H
Station Station
3 5
Precedence Data for Wing 480 available mins
TABLE 9.2 Component per day
TASK MUST
ASSEMBLY TIME FOLLOW TASK
40 units required
TASK (MINUTES) LISTED BELOW Cycle time = 12 mins
A 10 –
Minimum
B 11 A
workstations = 5.42 or 6
C 5 B
D 4 B Figure 9.12
E 11 A 5
F 3 C, D ∑ Task times C
Efficiency
G
= 7 10 11 3
F workstations) x (Largest cycle 7
(Actual number of time)
H 11 E A B F G
I
= 65 minutes
3
/ ((6 stations)
G, H
x (12 minutes))4 3
= 90.3% D I
Total time 65 11 11
E H
Idle Time = ((6 stations) × (12 minutes)) – 65 minutes = 7 minutes
Managing Quality
6
Managing Quality Provides a
Competitive Advantage
Arnold Palmer Hospital
► Delivers over 12,000 babies annually
► Virtually every type of quality tool is
employed
► Continuous improvement
► Employee empowerment
► Benchmarking
► Just-in-time
► Quality tools
Quality and Strategy
► Managing quality supports

differentiation, low cost, and
response strategies
► Quality helps firms increase sales
and reduce costs
► Building a quality organization is a
demanding task
Two Ways Quality
Improves Profitability
Figure 6.1
Sales Gains via

• Improved response
• Flexible pricing
• Improved reputation
Improved Increased
Quality Profits
Reduced Costs via
• Increased productivity
• Lower rework and scrap costs
• Lower warranty costs
The Flow of Activities
Organizational Practices
Leadership, Mission statement, Effective operating
procedures, Staff support, Training
Yields: What is important and what is to be
accomplished
Quality Principles
Customer focus, Continuous improvement, Benchmarking,
Just-in-time, Tools of TQM
Yields: How to do what is important and to be
accomplished
Employee Fulfillment
Empowerment, Organizational commitment
Yields: Employee attitudes that can accomplish
what is important
Customer Satisfaction
Winning orders, Repeat customers
Figure 6.2 Yields: An effective organization with
a competitive advantage
Defining Quality
An operations manager’s objective

is to build a total quality
management system that identifies
and satisfies customer needs
Defining Quality
The totality of features and

characteristics of a product or service
that bears on its ability to satisfy stated
or implied needs
American Society for Quality

Different Views
► User based: better performance,
more features
► Manufacturing based: conformance
to standards, making it right the first
time
► Product based: specific and
measurable attributes of the product
Implications of Quality
1. Company reputation
► Perception of new products
► Employment practices
► Supplier relations
2. Product liability
► Reduce risk
3. Global implications
► Improved ability to compete
Malcolm Baldrige National
Quality Award
► Established in 1988 by the U.S.
government
► Designed to promote TQM practices
► Recent winners include
MidwayUSA, Charter School of San Diego, Mid-
America Transplant Services, Hill Country Memorial,
PricewaterhouseCoopers Public Sector Practice,
Elevations Credit Union, Lockheed Martin Missiles
and Fire Control, MESA Products Inc.
Baldrige Criteria
Applicants are evaluated on:
CATEGORIES POINTS
Leadership 120
Strategic Planning 85
Customer Focus 85
Measurement, Analysis, and Knowledge 90
Management
Workforce Focus 85
Operations Focus 85
Results 450
ISO 9000 International Quality
Standards
► International recognition
► Encourages quality management
procedures, detailed documentation, work
instructions, and recordkeeping
► 2015 revision gives greater emphasis to
risk-based thinking
► Over one million certifications in 206
countries
► Critical for global business
ISO 9000 International Quality
Standards
► Management principles
1) Top management leadership
2) Customer satisfaction
3) Continual improvement
4) Involvement of people
5) Process analysis
6) Use of data-driven decision making
7) A systems approach to management
8) Mutually beneficial supplier relationships
Costs of Quality
► Prevention costs - reducing the
potential for defects
► Appraisal costs - evaluating products,
parts, and services
► Internal failure costs - producing
defective parts or service before
delivery
► External failure costs - defects
discovered after delivery
Costs of Quality
Total Total Cost

Cost
External Failure
Internal Failure
Prevention
Appraisal
Quality Improvement
Takumi
A Japanese character
that symbolizes a
broader dimension than
quality, a deeper process
than education, and a
more perfect method
than persistence
Leaders in Quality
TABLE 6.1 Leaders in the Field of Quality Management
LEADER PHILOSOPHY/CONTRIBUTION
W. Edwards Deming Deming insisted management accept responsibility for building
good systems. The employee cannot produce products that on
average exceed the quality of what the process is capable of
producing. His 14 points for implementing quality improvement
are presented in this chapter.
Joseph M. Juran A pioneer in teaching the Japanese how to improve quality,
Juran believed strongly in top-management commitment,
support, and involvement in the quality effort. He was also a
believer in teams that continually seek to raise quality standards.
Juran varies from Deming somewhat in focusing on the
customer and defining quality as fitness for use, not necessarily
the written specifications.
Leaders in Quality
TABLE 6.1 Leaders in the Field of Quality Management
LEADER PHILOSOPHY/CONTRIBUTION
Armand Feigenbaum His 1961 book Total Quality Control laid out 40 steps to quality
improvement processes. He viewed quality not as a set of tools
but as a total field that integrated the processes of a company.
His work in how people learn from each other’s successes led to
the field of cross-functional teamwork.
Philip B. Crosby Quality Is Free was Crosby’s attention-getting book published in
1979. Crosby believed that in the traditional trade-off between
the cost of improving quality and the cost of poor quality, the cost
of poor quality is understated. The cost of poor quality should
include all of the things that are involved in not doing the job right
the first time. Crosby coined the term zero defects and stated,
“There is absolutely no reason for having errors or defects in any
product or service.”
Ethics and Quality
Management
► Operations managers must deliver
healthy, safe, quality products and
services
► Poor quality risks injuries, lawsuits,
recalls, and regulation
► Ethical conduct must dictate response
to problems
► All stakeholders must be considered
Total Quality Management
► Encompasses entire organization from
supplier to customer
► Stresses a commitment by
management to have a continuing
companywide drive toward excellence
in all aspects of products and services
that are important to the customer
Deming's Fourteen Points
TABLE 6.2 Deming's 14 Points for Implementing Quality Improvement

1. Create consistency of purpose
2. Lead to promote change
3. Build quality into the product; stop depending on inspections to catch
problems
4. Build long-term relationships based on performance instead of
awarding business on price
5. Continuously improve product, quality, and service
6. Start training
7. Emphasize leadership
Deming's Fourteen Points
TABLE 6.2 Deming's 14 Points for Implementing Quality Improvement

8. Drive out fear
9. Break down barriers between departments
10. Stop haranguing workers
11. Support, help, and improve
12. Remove barriers to pride in work
13. Institute a vigorous program of education and self-improvement
14. Put everyone in the company to work on the transformation
Seven Concepts of TQM
1) Continuous improvement
2) Six Sigma
3) Employee empowerment
4) Benchmarking
5) Just-in-time (JIT)
6) Taguchi concepts
7) Knowledge of TQM tools
Continuous Improvement
► Never-ending process of continuous

improvement
► Covers people, equipment, suppliers,
materials, procedures
► Every operation can be improved
Shewhart's PDCA Model
Figure 6.3
4. Act 1. Plan
Implement Identify the
the plan, pattern and
document make a plan
3. Check 2. Do
Is the plan Test the
working? plan
Continuous Improvement
► Kaizen describes the ongoing process

of unending improvement
► TQM and zero defects also used to
describe continuous improvement
Six Sigma
► Two meanings
► Statistical definition of a process that is
99.9997% capable, 3.4 defects per
million opportunities (DPMO)
► A program designed to reduce defects,
lower costs, save time, and improve
customer satisfaction
► A comprehensive system for achieving
and sustaining business success
Six Sigma
►
Lower limits Upper limits
Two meanings
2,700 defects/million
► Statistical definition of a process that is
99.9997% capable, 3.4 defects per
3.4 defects/million
million opportunities (DPMO)
► A program designed to reduce defects,
lower costs, save time, and improve
customer satisfaction Mean
±3σ
► A comprehensive system for achieving
σ
and sustaining business±6success
Figure 6.4
Six Sigma Program
► Originally developed by Motorola,
adopted and enhanced by Honeywell
and GE
► Highly structured approach to process
improvement
► A strategy
►
►
A discipline – DMAIC
A set of 7 tools 6σ
Six Sigma
1. Defines the project’s purpose, scope, and outputs,
then identifies the required process information
keeping in mind the customer’s definition of quality
2. Measures the process and collects data
3. Analyzes the data ensuring
repeatability and reproducibility DMAIC Approach
4. Improves by modifying or
redesigning existing
processes and procedures
5. Controls the new process
to make sure performance
levels are maintained
Implementing Six Sigma
► Emphasize defects per million opportunities
as a standard metric
► Provide extensive training
► Focus on top management leadership
(Champion)
► Create qualified process improvement
experts (Black Belts, Green Belts, etc.)
► Set stretch objectives
Implementing Six Sigma
► Emphasize defects per million opportunities
as a standard metric
► Provide extensive training
► Focus on top management leadership
(Champion)
► Create qualified process improvement
experts (Black Belts, Green Belts, etc.)
This cannot be accomplished without a
► Set stretch objectives
major commitment from top level
management
Employee Empowerment
► Getting employees involved in product and
process improvements
► 85% of quality problems are due
to materials and process
► Techniques
1) Build communication networks
that include employees
2) Develop open, supportive supervisors
3) Move responsibility to employees
4) Build a high-morale organization
5) Create formal team structures
Quality Circles
► Group of employees who meet
regularly to solve problems
► Trained in planning, problem
solving, and statistical methods
► Often led by a facilitator
► Very effective when done properly
Benchmarking
Selecting best practices to use as a
standard for performance
1. Determine what to benchmark
2. Form a benchmark team
3. Identify benchmarking partners
4. Collect and analyze benchmarking
information
5. Take action to match or exceed the
benchmark
Best Practices for Resolving
Customer Complaints
Table 6.3
BEST PRACTICE JUSTIFICATION
Make it easy for clients to complain It is free market research
Respond quickly to complaints It adds customers and loyalty
Resolve complaints on first contact It reduces cost
Use computers to manage complaints Discover trends, share them, and align
your services
Recruit the best for customer service It should be part of formal training and
jobs career advancement
Internal Benchmarking
▶When the organization is large enough
▶Data more accessible
▶Can and should be established in a
variety of areas
Just-in-Time (JIT)
► 'Pull' system of production scheduling
including supply management
► Production only when signaled
► Allows reduced inventory levels
► Inventory costs money and hides
process and material problems
► Encourages improved process and
product quality
Just-in-Time (JIT)
Relationship to quality:
► JIT cuts the cost of quality

► JIT improves quality
► Better quality means less
inventory and better, easier-to-
employ JIT system
Taguchi Concepts
► Engineering and experimental design
methods to improve product and
process design
► Identify key component and process
variables affecting product variation
► Taguchi Concepts
► Quality robustness
► Target-oriented quality
► Quality loss function
Quality Robustness
► Ability to produce products uniformly
in adverse manufacturing and
environmental conditions
► Remove the effects of adverse
conditions
► Small variations in materials and
process do not destroy product quality
Quality Loss Function
► Shows that costs increase as the
product moves away from what the
customer wants
► Costs include customer
dissatisfaction, warranty
and service, internal
scrap and repair, and costs to
society
► Traditional conformance
specifications are too simplistic
Quality Loss Function
High loss
Unacceptable
Loss (to
producing Poor Target-oriented quality
organization, yields more product in
customer, Fair the "best" category
and society) Good
Best
Low loss
Target-oriented quality
brings product toward
the target value
Frequency
Conformance-oriented
quality keeps products
within 3 standard
deviations
Lower Target Upper
Specification Figure 6.5
TQM Tools
► Tools for Generating Ideas
► Check Sheet
► Scatter Diagram
► Cause-and-Effect Diagram
► Tools to Organize the Data
► Pareto Chart
► Flowchart (Process Diagram)
TQM Tools
► Tools for Identifying Problems
► Histogram
► Statistical Process Control Chart
Seven Tools of TQM
(a) Check Sheet: An organized
method of recording data
Hour
Defect 1 2 3 4 5 6 7 8
A /// / / / / /// /
B // / / / // ///
C / // // ////
Figure 6.6
Seven Tools of TQM
(b) Scatter Diagram: A graph of the
value of one variable vs. another
variable
Productivity
Absenteeism
Figure 6.6
Seven Tools of TQM
(c) Cause-and-Effect Diagram: A tool
that identifies process elements
(causes) that may effect an outcome
Cause
Materials Methods
Effect
Manpower Machinery
Figure 6.6
Cause-and-Effect Diagrams
Material Method
(ball) (shooting process)
Grain/Feel Aiming point
(grip)
Size of ball
Air pressure Bend knees
Hand position
Balance
Lopsidedness
Follow-through
Missed
Training
free-throws
Rim size
Conditioning Motivation Rim height
Consistency Rim alignment Backboard

stability
Concentration
Machine
Manpower (hoop &
(shooter) Figure 6.7
backboard)
Seven Tools of TQM
(d) Pareto Chart: A graph to identify and
plot problems or defects in descending
order of frequency
Frequency
Percent
A B C D E
Figure 6.6
Pareto Charts
Data for October
– 100
70 –
– 93
– 88
60 –
54
Frequency (number)
Cumulative percent
50 – – 72
40 –
Number of
30 –
occurrences
20 –
12
10 –
4 3 2
0 –
Room svc Check-in Pool hours Minibar Misc.
72% 16% 5% 4% 3%
Causes and percent of the total
Seven Tools of TQM
(e) Flowchart (Process Diagram): A chart
that describes the steps in a process
Figure 6.6
Flow Charts
MRI Flowchart
1. Physician schedules MRI 7. If unsatisfactory, repeat
2. Patient taken to MRI 8. Patient taken back to room
3. Patient signs in 9. MRI read by radiologist
4. Patient is prepped 10. MRI report transferred to
5. Technician carries out MRI physician
6. Technician inspects film 11. Patient and physician
discuss
8
80%
1 2 3 4 5 6 7 11
9 10
20%
Seven Tools of TQM
(f) Histogram: A distribution showing the
frequency of occurrences of a variable
Distribution
Frequency
Repair time (minutes)

Figure 6.6
Seven Tools of TQM
(g) Statistical Process Control Chart: A chart
with time on the horizontal axis to plot
values of a statistic
Upper control limit
Target value
Lower control limit
Time
Figure 6.6
Control Charts
Plot the percent of free throws missed
40%
Upper
control limit
Coach’s
20% target
value
Lower
0% | | | | | | | | |
control
1 2 3 4 5 6 7 8 9 limit
Game number
Figure 6.8
Statistical Process Control
(SPC)
► Uses statistics and control charts to tell
when to take corrective action
► Drives process improvement
► Four key steps
► Measure the process
► When a change is indicated, find the
assignable cause
► Eliminate or incorporate the cause
► Restart the revised process
Inspection
► Involves examining items to see if an
item is good or defective
► Detect a defective product
► Does not correct deficiencies in
process or product
► It is expensive
► Issues
► When to inspect
► Where in process to inspect
When and Where to Inspect
1. At the supplier’s plant while the supplier is
producing
2. At your facility upon receipt of goods from your
supplier
3. Before costly or irreversible processes
4. During the step-by-step production process
5. When production or service is complete
6. Before delivery to your customer
7. At the point of customer contact
Inspection
► Many problems
► Worker fatigue
► Measurement error
► Process variability
► Cannot inspect quality into a product
► Robust design, empowered
employees, and sound processes
are better solutions
Source Inspection
► Also known as source control

► The next step in the
process is your
customer
► Ensure perfect
product to your
customer
Source Inspection
► Poka-yoke is the concept of

foolproof devices or techniques
designed to pass only acceptable
products
► Checklists ensure
consistency and
completeness
Service Industry Inspection
TABLE 6.4 Examples of Inspection in Services
ORGANIZATION WHAT IS INSPECTED STANDARD
Alaska Airlines Last bag on carousel Less than 20 minutes after
arrival at the gate
Airplane door opened Less than 2 minutes after
arrival at the gate
Jones Law Office Receptionist performance Phone answered by the
second ring
Billing Accurate, timely, and correct
format
Attorney Promptness in returning calls
Hard Rock Hotel Reception desk Use customer’s name
Doorman Greet guest in less than 30
seconds
Room All lights working, spotless
bathroom
Minibar Restocked and charges
accurately posted to bill
Arnold Palmer Hospital Billing Accurate, timely, and correct
format
Pharmacy Prescription accuracy,
inventory accuracy
Lab Audit for lab-test accuracy
Nurses Charts immediately updated
Data entered correctly and
Admissions completely
Olive Garden Busboy Serves water and bread within
Restaurant 1 minute
Busboy Clears all entrée items and
crumbs prior to dessert
Waiter Knows and suggest specials,
desserts
Nordstrom Department Display areas Attractive, well-organized,
Store stocked, good lighting
Stockrooms Rotation of goods, organized,
clean
Salesclerks Neat, courteous, very
knowledgeable
Attributes Versus Variables
► Attributes
► Items are either good or bad, acceptable
or unacceptable
► Does not address degree of failure
► Variables
► Measures dimensions such as weight,
speed, height, or strength
► Falls within an acceptable range
► Use different statistical techniques
TQM In Services
► Service quality is more difficult to
measure than the quality of goods
► Service quality perceptions depend on
1) Intangible differences between
products
2) Intangible expectations customers
have of those products
Service Quality
The operations manager must
recognize:
► The tangible component of services
is important
► The service process is important
► The service is judged against the
customer’s expectations
► Exceptions will occur
Service Specifications
Determinants of Service
Quality
Table 6.5
Reliability involves consistency of performance and dependability
Responsiveness concerns the willingness or readiness of employees to provide service
Competence means possession of the required skills and knowledge to perform the
service
Access involves approachability and ease of contact
Courtesy involves politeness, respect, consideration, and friendliness
Communication means keeping customers informed and listening to them
Credibility involves trustworthiness, believability, and honesty
Security is the freedom from danger, risk, or doubt
Understanding/knowing the customer involves making the effort to understand the
customer's needs
Tangibles include the physical evidence of the service
Service Recovery Strategy
► Managers should have a plan for
when services fail
► Marriott's LEARN routine
► Listen
► Empathize
► Apologize
► React
► Notify
1. https://www.youtube.com/watch?v=X2zlR
zddLco
2. https://hbr.org/1990/01/robust-quality
3. https://www.youtube.com/watch?v=DkLY
wG01SP4
Inventory
Management
12
Inventory Management at
Amazon.com
► Amazon.com started as a “virtual”

retailer – no inventory, no warehouses,
no overhead – just computers taking
orders to be filled by others
► Growth has forced Amazon.com to
become a world leader in warehousing
and inventory management
Amazon.com
1. Each order is assigned by computer to the
closest distribution center that has the
product(s)
2. A “flow meister” at each distribution center
assigns work crews
3. Technology helps workers pick the correct
items from the shelves with almost no errors
4. Items are placed in crates on a conveyor, bar
code scanners scan each item 15 times to
virtually eliminate errors
Amazon.com
5. Crates arrive at central point where items
are boxed and labeled with new bar code
6. Gift wrapping is done by hand at 30
packages per hour
7. Completed boxes are packed, taped,
weighed and labeled before leaving
warehouse in a truck
8. Order arrives at customer within 1 - 2 days
Inventory Management
The objective of inventory

management is to strike a balance
between inventory investment and
customer service
Importance of Inventory
▶One of the most expensive assets

of many companies representing as
much as 50% of total invested capital
▶Less inventory lowers costs but
increases chances of running out
▶More inventory raises costs but
always keeps customers happy
Functions of Inventory
1. To provide a selection of goods for
anticipated demand and to separate
the firm from fluctuations in demand
2. To decouple or separate various
parts of the production process
3. To take advantage of quantity
discounts
4. To hedge against inflation
Types of Inventory
▶Raw material
▶Purchased but not processed
▶Work-in-process (WIP)
▶Undergone some change but not completed
▶A function of cycle time for a product
▶Maintenance/repair/operating (MRO)
▶Necessary to keep machinery and processes
productive
▶Finished goods
▶Completed product awaiting shipment
The Material Flow Cycle
Cycle time
95% 5%
Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time
Figure 12.1
Managing Inventory
1) How inventory items can be classified

(ABC analysis)
2) How accurate inventory records can
be maintained
ABC Analysis
▶Divides inventory into three classes
based on annual dollar volume
▶Class A - high annual dollar volume
▶Class B - medium annual dollar volume
▶Class C - low annual dollar volume
▶Used to establish policies that focus on
the few critical parts and not the many
trivial ones
Percentage of annual dollar usage ABC Analysis
Figure 12.2
A Items
80 –
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |
10 20 30 40 50 60 70 80 90 100
Percentage of inventory items
ABC Analysis
ABC Calculation
(1) (2) (3) (4) (5) (6) (7)
PERCENT
OF PERCENT
ITEM NUMBER ANNUAL ANNUAL OF ANNUAL
STOCK OF ITEMS VOLUME UNIT DOLLAR DOLLAR
NUMBER STOCKED (UNITS) x COST = VOLUME VOLUME CLASS
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A
#12760 1,550 17.00 26,350 11.3% B
#10867 30% 350 42.86 15,001 6.4% 23% B
#10500 1,000 12.50 12,500 5.4% B
#12572 600 14.17 8,502 3.7% C
#14075 2,000 .60 1,200 .5% C
#01036 50% 100 8.50 850 .4% 5% C
#01307 1,200 .42 504 .2% C
#10572 250 .60 150 .1% C
8,550 $232,057 100.0%
ABC Analysis
▶Other criteria than annual dollar volume
may be used
▶High shortage or holding cost
▶Anticipated engineering changes
▶Delivery problems
▶Quality problems
ABC Analysis
▶Policies employed may include
1. More emphasis on supplier development
for A items
2. Tighter physical inventory control for
A items
3. More care in forecasting A items
Record Accuracy
► Accurate records are a
critical ingredient in
production and inventory
systems
► Periodic systems require
regular checks of inventory
► Two-bin system
► Perpetual inventory tracks receipts
and subtractions on a continuing basis
► May be semi-automated
Record Accuracy
► Incoming and outgoing

record keeping must be
accurate
► Stockrooms should be secure
► Necessary to make precise decisions
about ordering, scheduling, and
shipping
Cycle Counting
▶Items are counted and records updated
on a periodic basis
▶Often used with ABC analysis
▶Has several advantages
1. Eliminates shutdowns and interruptions
2. Eliminates annual inventory adjustment
3. Trained personnel audit inventory accuracy
4. Allows causes of errors to be identified and
corrected
5. Maintains accurate inventory records
Cycle Counting Example
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C
items
Policy is to count A items every month (20 working days), B items
every quarter (60 days), and C items every six months (120 days)
CYCLE
ITEM COUNTING NUMBER OF ITEMS
CLASS QUANTITY POLICY COUNTED PER DAY
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day
C 2,750 Every 6 months 2,750/120 = 23/day

77/day
Control of Service Inventories
▶Can be a critical component of
profitability
▶Losses may come from shrinkage or
pilferage
▶Applicable techniques include
1. Good personnel selection, training, and
discipline
2. Tight control of incoming shipments
3. Effective control of all goods leaving facility
Inventory Models
▶Independent demand - the demand for
item is independent of the demand for any
other item in inventory
▶Dependent demand - the demand for
item is dependent upon the demand for
some other item in the inventory
Inventory Models
▶Holding costs - the costs of holding or
“carrying” inventory over time
▶Ordering cost - the costs of placing an
order and receiving goods
▶Setup cost - cost to prepare a machine
or process for manufacturing an order
▶May be highly correlated with setup time
Holding Costs
TABLE 12.1 Determining Inventory Holding Costs
COST (AND RANGE)
AS A PERCENT OF
CATEGORY INVENTORY VALUE
Housing costs (building rent or depreciation, 6% (3 - 10%)
operating costs, taxes, insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost (receiving, warehousing, security) 3% (3 - 5%)
Investment costs (borrowing costs, taxes, and 11% (6 - 24%)
insurance on inventory)
Pilferage, space, and obsolescence (much 3% (2 - 5%)
higher in industries undergoing rapid change like
tablets and smart phones)
Overall carrying cost 26%
Holding Costs
TABLE 12.1 Determining Inventory Holding Costs
COST (AND RANGE)
AS A PERCENT OF
CATEGORY INVENTORY VALUE
Housing costs (building rent or depreciation, 6% (3 - 10%)
operating costs, taxes, insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost (receiving, warehousing, security) 3% (3 - 5%)
Investment costs (borrowing costs, taxes, and 11% (6 - 24%)
insurance on inventory)
Pilferage, space, and obsolescence (much 3% (2 - 5%)
higher in industries undergoing rapid change like
PCs and cell phones)
Overall carrying cost 26%
Inventory Models for
Independent Demand
Need to determine when and
how much to order
1. Basic economic order quantity

(EOQ) model
2. Production order quantity model
3. Quantity discount model
Basic EOQ Model
Important assumptions
1. Demand is known, constant, and independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup (or ordering)
and holding
6. Stockouts can be completely avoided
Inventory Usage Over Time
Figure 12.3
Total order received

Average
Order Usage rate inventory
quantity = Q
Inventory level
on hand
(maximum
Q
inventory
level) 2
Minimum
inventory 0
Time
Minimizing Costs
Objective is to minimize total costs
Table 12.4(c)
Total cost of
holding and
setup (order)
Minimum
total cost
Annual cost
Holding cost
Setup (order) cost
Optimal order Order quantity

quantity (Q*)
Minimizing Costs
▶By minimizing the sum of setup (or
ordering) and holding costs, total costs are
minimized
▶Optimal order size Q* will minimize total
cost
▶A reduction in either cost reduces the
total cost
▶Optimal order quantity occurs when
holding cost and setup cost are equal
Minimizing Costs
Q = Number of units per order
Q* = Optimal number of units per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Annual setup cost = (Number of orders placed per year)
x (Setup or order cost per order)
Annual demand Setup or order

=
Number of units in each order cost per order
Minimizing Costs
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
Annual setup cost = (Number of orders placed per year)
x (Setup or order cost per order)
Annual demand Setup or order

=
Number of units in each order cost per order
Minimizing Costs
Annual holding cost = (Average inventory level)
x (Holding cost per unit per year)
Order quantity
= (Holding cost per unit per year)
2
Minimizing Costs
Optimal order quantity is found when annual setup

cost equals annual holding cost
Solving for Q*
An EOQ Example 3
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year
An EOQ Example 4
Determine expected number of orders
D = 1,000 units Q* = 200 units
S = $10 per order
Expected Demand
number of = N = =
orders Order quantity
1,000
N= = 5 orders per year
200
An EOQ Example
Determine optimal time between orders
S = $10 per order N = 5 orders/year
Expected Number of working days per year

time between = T =
orders Expected number of orders
250
T= = 50 days between orders
5
An EOQ Example 5
Determine the total annual cost
S = $10 per order N = 5 orders/year
H = $.50 per unit per year T = 50 days
Total annual cost = Setup cost + Holding cost

The EOQ Model
When including actual cost of material P
Total annual cost = Setup cost + Holding cost + Product cost

Robust Model
▶The EOQ model is robust
▶It works even if all parameters and
assumptions are not met
▶The total cost curve is relatively flat in
the area of the EOQ
An EOQ Example 6
D = 1,000 units 1,500 units Q*1,000 = 200 units
S = $10 per order T = 50 days
H = $.50 per unit per year Q*1,500 = 244.9 units
N= 5 orders/year
Ordering old Q* Ordering new Q*
An EOQ Example
D = 1,000 units 1,500 units Q*1,000
Only=2% 200less
units
than
S = $10 per order the
T =total cost of
50 days
H = $.50 per unit per year $125
Q*1,500 whenunits
= 244.9 the
N= 5 orders/year order quantity was
200
Ordering old Q* Ordering new Q*
Reorder Points
▶EOQ answers the “how much” question
▶The reorder point (ROP) tells “when” to order
▶Lead time (L) is the time between placing and
receiving an order
Demand Lead time for a new

ROP = per day order in days
ROP = d x L
D
d=
Number of working days in a year
Reorder Point Curve
Figure 12.5
Q*
Stock is replenished as order arrives
Inventory level (units)
Slope = units/day = d
ROP
(units)
Time (days)
Lead time = L
Reorder Point Example 7
Demand = 8,000 iPhones per year
250 working day year
Lead time for orders is 3 working days, may take 4
D
d=
Number of working days in a year
= 8,000/250 = 32 units
ROP = d x L
= 32 units per day x 3 days = 96 units
= 32 units per day x 4 days = 128 units
Production Order Quantity Model
1. Used when inventory builds up over a
period of time after an order is placed
2. Used when units are produced and
sold simultaneously Figure 12.6
Part of inventory cycle during which

Inventory level
production (and usage) is taking place

Demand part of cycle with no
production (only usage takes place)
Maximum
inventory
t Time
Q = Number of units per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
Annual inventory = (Average inventory level) x Holding cost

holding cost per unit per year
Annual inventory = (Maximum inventory level)/2

level
Maximum = Total produced during – Total used during

inventory level the production run the production run
= pt – dt
Maximum = Total produced during – Total used during

inventory level the production run the production run
= pt – dt
However, Q = total produced = pt ; thus t = Q/p
Maximum Q Q d
inventory level =p p –d p =Q 1– p
Maximum inventory level Q d

Holding cost = (H) = 1– H
2 2 p
Production Order Quantity
Example 8
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year
Note:
D 1,000
d=4= =
Number of days the plant is in operation 250
When annual data are used the equation becomes:

Quantity Discount Models
▶Reduced prices are often available when larger
quantities are purchased
▶Trade-off is between reduced product cost and
increased holding cost
TABLE 12.2 A Quantity Discount Schedule
PRICE RANGE QUANTITY ORDERED PRICE PER UNIT P

Initial price 0 to 119 $100
Discount price 1 200 to 1,499 $ 98
Discount price 2 1,500 and over $ 96
Total annual cost = Setup cost + Holding cost + Product cost
where Q = Quantity ordered P = Price per unit

D = Annual demand in units I = Holding cost per unit per year
S = Ordering or setup cost per order expressed as a percent of price P
Because unit price varies, holding cost is expressed

as a percent (I) of unit price (P)
Steps in analyzing a quantity discount
1. Starting with the lowest possible purchase
price, calculate Q* until the first feasible
EOQ is found. This is a possible best order
quantity, along with all price-break
quantities for all lower prices.
2. Calculate the total annual cost for each
possible order quantity determined in Step
1. Select the quantity that gives the lowest
total cost.
Example 9 page 544
▶Chris Beehner stocks toy flying drones. The
store has been offered a quantity discount as in
table. The order cost is $200, annual demand is
5200 units and annual inventory carrying cost is
28% of unit cost
Quantity Discount Example
Calculate Q* for every discount
starting with the lowest price
2(5,200)($200)
Q$96* = = 278 drones/order
(.28)($96)
Infeasible – calculate Q*
for next-higher price
2(5,200)($200)
Q$98* = = 275 drones/order
(.28)($98)
Feasible
Quantity Discount Example
TABLE 12.3 Total Cost Computations for Chris Beehner Electronics
ANNUAL ANNUAL ANNUAL
ORDER UNIT ORDERING HOLDING PRODUCT TOTAL ANNUAL
QUANTITY PRICE COST COST COST COST
275 $98 $3,782 $3,773 $509,600 $517,155
1,500 $96 $693 $20,160 $499,200 $520,053
Choose the price and quantity that gives the

lowest total cost
Buy 275 drones at $98 per unit
Figure 12.7
Initial
Price Discount Price 1 Discount Price 2
550,000 –
TC for No Discount
540,000 –
Annual Total Cost
TC for Discount 1
530,000 –
Not Feasible TC for Discount 2
520,053 –
517,155 –
Feasible
510,000 –
Not Feasible
Possible Order
500,000 – Quantities
120 1,500
Order Quantity
Quantity Discount Variations
▶All-units discount is the most popular form
▶Incremental quantity discounts apply only to
those units purchased beyond the price
break quantity
▶Fixed fees may encourage larger
purchases
▶Aggregation over items or time
▶Truckload discounts, buy-one-get-one-free
offers, one-time-only sales
Probabilistic Models and
Safety Stock
▶Used when demand is not constant or certain
▶Use safety stock to achieve a desired service
level and avoid stockouts
ROP = d x L + ss
Annual stockout costs = The sum of the units short

for each demand level x The probability of that
demand level x The stockout cost/unit
x The number of orders per year
Safety Stock Example 10
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year
NUMBER OF UNITS PROBABILITY
30 .2
40 .2
ROP  50 .3
60 .2
70 .1
1.0
Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year
SAFETY ADDITIONAL TOTAL

STOCK HOLDING COST STOCKOUT COST COST
20 (20)($5) = $100 $0 $100
10 (10)($5) = $ 50 (10)(.1)($40)(6) = $240 $290
0 $ 0 (10)(.2)($40)(6) + (20)(.1)($40)(6) = $960 $960
A safety stock of 20 frames gives the lowest total cost

ROP = 50 + 20 = 70 frames
Probabilistic Demand
Figure 12.8
Minimum demand during lead time

Inventory level
Maximum demand during lead time
Mean demand during lead time

ROP = 350 + safety stock of 16.5 = 366.5
ROP 
Normal distribution probability of
demand during lead time
Expected demand during lead time (350 kits)
Safety stock 16.5 units
0 Place Lead Receive

order
time
order
Time
Use prescribed service levels to set safety
stock when the cost of stockouts cannot be
determined
ROP = demand during lead time + ZσdLT
where Z = Number of standard deviations

σdLT = Standard deviation of demand during lead
time
Probability of Risk of a stockout

no stockout (5% of area of
95% of the time normal curve)
Mean ROP = ? kits Quantity

demand
350
Safety
stock
0 z
Number of
standard deviations
Probabilistic Example
µ = Average demand = 350 kits
σdLT = Standard deviation of
demand during lead time = 10 kits
Stockout policy = 5% (service level = 95%)
Using Appendix I, for an area under the curve of

95%, the Z = 1.645
Safety stock = ZσdLT = 1.645(10) = 16.5 kits
Reorder point = Expected demand during lead time +

Safety stock
= 350 kits + 16.5 kits of safety stock
= 366.5 or 367 kits
Other Probabilistic Models
▶When data on demand during lead time
is not available, there are other models
available
1. When demand is variable and lead time is
constant
2. When lead time is variable and demand is
constant
3. When both demand and lead time are
variable
Demand is variable and lead time is constant
ROP = (Average daily demand

x Lead time in days) + ZσdLT
where σdLT = σd Lead time

σd = Standard deviation of demand per day
Average daily demand (normally distributed) = 15
Lead time in days (constant) = 2
Standard deviation of daily demand = 5
Service level = 90%
Z for 90% = 1.28
From Appendix I
ROP = (15 units x 2 days) + ZσdLT

= 30 + 1.28(5)( 2)
= 30 + 9.02 = 39.02 ≈ 39
Safety stock is about 9 computers

Lead time is variable and demand is constant
ROP = (Daily demand x Average lead time

in days) + Z x (Daily demand) x σLT
where σLT = Standard deviation of lead time in days

Daily demand (constant) = 10
Average lead time = 6 days
Standard deviation of lead time = σLT = 1
Service level = 98%, so Z (from Appendix I) = 2.055
ROP = (10 units x 6 days) + 2.055(10 units)(1)

= 60 + 20.55 = 80.55
Reorder point is about 81 cameras

Both demand and lead time are variable
ROP = (Average daily demand

x Average lead time) + ZσdLT
where σd = Standard deviation of demand per day

σLT = Standard deviation of lead time in days
σdLT = (Average lead time x σd2)
+ (Average daily demand)2σ2LT
Average daily demand (normally distributed) = 150
Standard deviation = σd = 16
Average lead time 5 days (normally distributed)
Standard deviation = σLT = 1 day
Service level = 95%, so Z = 1.645 (from Appendix I)
Single-Period Model
▶Only one order is placed for a product
▶Units have little or no value at the end of the
sales period
Cs = Cost of shortage = Sales price/unit – Cost/unit

Co = Cost of overage = Cost/unit – Salvage value
Cs
Service level =
Cs + Co
Single-Period Example 15
Average demand = µ = 120 papers/day
Standard deviation = σ = 15 papers
Cs = cost of shortage = $1.25 – $.70 = $.55
Co = cost of overage = $.70 – $.30 = $.40
Cs
Service level =
Cs + Co
.55 Service
= level
.55 + .40 57.9%
.55
= = .579 µ = 120
.95
Optimal stocking level
Single-Period Example
From Appendix I, for the area .579, Z ≅ .20
The optimal stocking level
= 120 copies + (.20)(σ)

= 120 + (.20)(15) = 120 + 3 = 123 papers
The stockout risk = 1 – Service level
= 1 – .579 = .422 = 42.2%

Fixed-Period (P) Systems
▶Fixed-quantity models require
continuous monitoring using perpetual
inventory systems
▶In fixed-period systems orders
placed at the end of a fixed period
▶Periodic review, P system
▶Inventory counted only at end of period
▶Order brings inventory up to target
level
▶Only relevant costs are ordering and
holding
▶Lead times are known and constant
▶Items are independent of one another
Figure 12.9
Target quantity (T)
Q4
Q2
On-hand inventory
Q1 P
Q3
Time
Fixed-Period Systems
▶Inventory is only counted at each
review period
▶May be scheduled at convenient times
▶Appropriate in routine situations
▶May result in stockouts between
periods
▶May require increased safety stock

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Capacity and

Modify capacity Use capacity

Efficiency is the percent of effective

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Actual production last week = 148,000 rolls

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Actual production last week = 148,000 rolls

Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

Utilization = 148,000/201,600 = 73.4%

Efficiency = 148,000/175,000 = 84.6%

Design capacity = 201,600 x 2 = 403,200 rolls

Design capacity = 201,600 x 2 = 403,200 rolls

Design capacity = 201,600 x 2 = 403,200 rolls

Design capacity = 201,600 x 2 = 403,200 rolls

► Capacity decisions impact all 10

1. Forecast demand accurately

1,000 – Jet ski

2 min/unit 4 min/unit 3 min/unit

Bread Fill Toaster

15 sec/sandwich 20 sec/sandwich 40 sec/sandwich

Second assembly line

► The two lines are identical, so parallel

► Capacity per hour is 3,600 seconds/37.5

Takes Develops 24 min/unit Check

2 min/unit 2 min/unit 4 min/unit X-ray 8 min/unit 6 min/unit

Analysis 2 min/unit 2 min/unit 4 min/unit X-ray

► All possible paths must be compared

► Technique for evaluating process and

100 – Fixed cost

Copyright © 2017 Pearson Education, Inc. S7 - 41

where V = variable cost per unit

ITEM ANNUAL PRICE COST

Copyright © 2017 Pearson Education, Inc. S7 - 46

Sandwich 9,000 $5.00 $3.00 .60 .40 $45,000 .621 .248

Drinks 9,000 1.50 0.50 .33 .67 13,500 .186 .125

$72,500 1.000 .470

Sandwich 9,000 $5.00 $3.00 .60 .40 $45,000 .621 .248

Drinks 9,000 1.50 0.50 .33 .67 13,500 .186 .125

$72,500 1.000 .470

(c) Lagging demand with (d) Attempts to have an average

Expected Demand capacity Expected

► Operations managers may have to

TABLE S7.2 Present Value of $1

TABLE S7.3 Present Value of and Annuity of $1

$7,000 in receipts per year for 5 years

▶Central hub concept

Labor cost per day

South Carolina Mexico

People-to-car ratio .05 50 60 (.05)(50) = 2.5 (.05)(60) = 3.0

Per capita income .10 85 80 (.10)(85) = 8.5 (.10)(80) = 8.0

Tax structure .39 75 70 (.39)(75) = 29.3 (.39)(70) = 27.3

Total Cost = Fixed Cost + (Variable Cost x Volume)

Crossover point – Brussels/Lisbon

60,000 + 45(x) = 110,000 + 25(x)

where xi = x-coordinate of location i

TABLE 8.5 Demand for Quain's Discount Department Stores

New York (130, 130)

(30)(2000) + (90)(1000) + (130)(1000) + (60)(2000)