1.

Demand, Supply, Manufacturing

Planning & Control (Manufacturing Excellence)
2. Industrial & Operational
Management
Modules: 13,14,15,16,17,19,20,21,22
 Objectives of the course
• Introduce Manufacturing Strategies.
• To learn the Importance of reducing waste and
improving quality in manufacturing.
• Discuss the importance of supply chain management
and Inventory Control.
• Application of Six Sigma methodology for Quality
Improvement.
 Learning Objective

To make the participants become efficient and

effective in manufacturing and supply chain
management.
 MPC Class Schedule
Session 1 Introduction & Manufacturing
Strategies (Competing through
manufacturing)
Session 2 Process Selection and Design &
Process capability

Session 3 Forecasting & Demand

Management
Session 4 Inventory Control

Session 5 Materials Requirement Planning

(MRP)
Session 6 Capacity Planning/ Sales &
Operations Planning &
Key concept of JIT/ERP/QMT
 What is Operations Management?
Defined

Operations management (OM) is

defined as the design, operation, and
improvement of the systems that
create and deliver the firm’s primary
products and services
 Why Study Operations Management?
Systematic Approach
to Org. Processes

Business Education Operations Career Opportunities

Management

Cross-Functional
Applications
 OM in the Organization Chart
Finance Operations / Supply Marketing
Chain

Director

Planning Sourcing Manufacturing Logistics

Manager Manager Manager Manager

Product (QA / QC, Design, Lab), Tech Services

(Engineering, Projects, EHS, Maintenance), etc.
 What is a Production System?
Defined

A production system is defined as a

user of resources to transform inputs
into some desired outputs
 Transformations
• Physical--manufacturing

• Locational--transportation

• Exchange--retailing

• Storage--warehousing

• Physiological--health care

• Informational--telecommunications
 What is a Service and What is a Good?
• “If you drop it on your foot, it won’t hurt
you.” (Good or service?)

• “Services never include goods and

goods never include services.” (True or
false?)
Core Services
Defined

Core services are basic things that

customers want from products they
purchase
Core Services Performance Objectives

Quality

Operations
Flexibility Speed
Management

Price (or cost

Reduction)
 Manufacturing Planning & Control

Manufacturing planning and control (MPC) is a system

that is concerned with planning and controlling all
aspects of manufacturing including
• managing materials,
• scheduling,
• machines
• people and
• coordinating suppliers and key customers
 Manufacturing Planning & Control

• The development of an effective manufacturing planning

and control system is key to the success of any goods
producing company.
• Truly effective MPC systems coordinate supply chains—joint
efforts across company boundaries.
• MPC systems design is not a one-time effort and need to
continuously adapt and respond to changes in the company
environment, strategy, customer requirements, particular
problems, and new supply chain opportunities.
 Manufacturing Planning & Control
System Defined
• The essential task of the MPC system is
– to manage efficiently the flow of material
– to manage the utilization of people and equipment
– to respond to customer requirements by utilizing the capacity of our
suppliers, that of internal facilities, and (in some cases) that of
customers to meet customer demand.
• Important ancillary activities involve
– the acquisition of information from customers on product needs
– providing customers with information on delivery dates and product
status.
 Manufacturing Planning & Control
System Defined
• MPC system provides the information upon which managers
make effective decisions.
• MPC system does not make decisions nor manage the
operations—managers perform those activities.
• The MPC system provides the support for them to do so
wisely.
 Manufacturing Planning & Control
Support Activities
Can be broken roughly into three time horizons:
• long term- provides information to make decisions on the
appropriate amount of capacity (including equipment,
buildings, suppliers, and so forth) to meet the market
demands of the future.
• medium term- matches supply and demand in terms of both
volume and product mix. Focus is more on providing the
exact material and production capacity needed to meet
customer needs. Provides customers with information on
expected delivery times and
 Manufacturing Planning & Control
Support Activities
communicating to suppliers the correct quantities and
delivery times for the material they supply.
• short term- detailed scheduling of resources is required to
meet production requirements. This involves time, people,
material, equipment, and facilities. Key to this activity is
people working on the right things.
Manufacturing Planning and Control
System Framework

Enterprise Resource Planning (ERP) System

Resource Sales and operations Demand
planning planning management

Master production
scheduling Front End

Detailed capacity Detailed material

planning requirement planning
Engine

Material and
capacity plans

Shop-floor Supplier Back End

systems systems
 Strategy - Definition

• Strategy – Long term plan of action to

achieve goal(s).

• Strategic management is a process of

specifying an organizations objectives,
developing policies and plans to achieve
these objectives.
 Manufacturing Strategy

Strategy Process Example

Customer Needs More Product

Corporate Strategy Increase Org. Size

Manufacturing
Increase Production Capacity
Strategy

Decisions on Processes
and Infrastructure Build New Factory
 Competitive Dimensions
• Cost or Price
– Make the Product or Deliver the Service Cheap
• Quality
– Make a Great Product or Deliver a Great Service
• Delivery Speed
– Make the Product or Deliver the Service Quickly
• Delivery Reliability
– Deliver It When Promised
• Coping with Changes in Demand
– Change Its Volume
• Flexibility and New Product Introduction Speed
– Change It
• Other Product-Specific Criteria
– Support It
 Dealing with Trade-offs
For example, if we reduce costs by reducing product quality
inspections, we might reduce product quality.
Cost
For example, if we improve
customer service problem
solving by cross-training Flexibility Delivery
personnel to deal with a
wider-range of problems, Quality
they may become less
efficient at dealing with
commonly occurring
problems.
 Order Qualifiers and Winners
Defined

•Order qualifiers are the basic criteria

that permit the firms products to be
considered as candidates for purchase
by customers.

•Order winners are the criteria that

differentiates the products and services
of one firm from another
 Strategy Design Process
(Balanced Scorecard)

Strategy Map What it is about!

Financial Perspective Improve Shareholder Value

Customer Perspective Customer Value Proposition

Internal Perspective Improve Process Capability

Learning and Growth Perspective A Motivated and

Knowledgeable Workforce
 Balanced Scorecard
FINANCIAL
Objectives Indicators

How should we appear

to our stakeholders?

CUSTOMER VISION & STRATEGY INTERNAL

Objectives Indicators Objectives Indicators Objectives Indicators
How should the What must we excel at?
How should we appear
organization look
to our customers?
in the future?

LEARNING & GROWTH

Objectives Indicators
To what extent are we
able to change,
improve and
innovate?
 Framework of / Steps in Developing a
Manufacturing Strategy

• 1. Segment the market according to the product

group
• 2. Identify product requirements, demand patterns,
and profit margins of each group
• 3. Determine order qualifiers and winners for each
group
• 4. Convert order winners into specific performance
requirements
 Productivity measures

Productivity is a common measure on how well

resources are being used. In the broadest
sense, it can be defined as the following ratio:

Outputs
Inputs
 Total Factor Productivity

Total Measure Productivity = Outputs

Inputs

or
= Goods and services produced
All resources used
 Partial Factor Productivity

• Partial measures of productivity =

• Output or Output or Output or Output

Labor Capital Materials Energy
 Multifactor Measure Productivity

• Multifactor measures of productivity =

• Output .
Labor + Capital + Energy

or

• Output .
Labor + Capital + Materials
 Example of Productivity Measurement

• You have just determined that your service

employees have used a total of 2400 hours of
labor this week to process 560 warranty claims.
Last week the same crew used only 2000 hours
of labor to process 480 claims.
• Which productivity measure should be used?
• Answer: Could be classified as a Total Measure
or Partial Measure.
• Is productivity increasing or decreasing?
• Answer: Last week’s productivity = 480/2000 = 0.24,
and this week’s productivity is = 560/2400 = 0.23. So,
productivity is decreasing slightly.
Session 2

Manufacturing Process
Selection and Design
&
Process Capability
Definition of Process
Characteristics of Process
Strategic Process Decisions
Decision on Process Structures
 Different kinds of Processes
• Conversion (ex. Iron to steel)

• Fabrication (ex. Fabrics to Garments)

• Assembly (ex. Parts to components)

• Testing (ex. For quality of products)

Manufacturing Process Structure
 Few High
Low Multiple Major Volume,
Volume, Products, Products, High
One of a Low Higher Standard-
Kind Volume Volume ization
I. Commercial Flexibility (High)
Job Printer Unit Cost (High)
Shop Restaurant These are
the major
II. Heavy stages of
Batch Equipment product
III. and
Assembly Automobile process
Line Assembly life cycles
McDonalds
IV.
Continuous Sugar
Refinery Flexibility (Low)
Flow Unit Cost (Low)
Strategies for Manufacturing Processes
Strategies for Manufacturing Processes
Strategies for Manufacturing Processes
Process Structures for Services Industries
Process Structures for Services Industries
Process Structures for Services Industries
Process Structures for Services Industries
 Break-Even Analysis

• A standard approach to choosing among

alternative processes or equipment
• Model seeks to determine the point in units
produced (and sold) where we will start
making profit on the process or equipment
• Model seeks to determine the point in units
produced (and sold) where total revenue and
total cost are equal
 Break-Even Analysis (Continued)
Break-even Demand=

Purchase cost of process or equipment

Price per unit - Cost per unit
or
Total fixed costs of process or equipment
Unit price to customer - Variable costs per unit

This formula can be used to find any of its

components algebraically if the other
parameters are known
 Break-Even Analysis (Continued)

 Example: Suppose you want to purchase a new

computer that will cost $5,000. It will be used to process
written orders from customers who will pay $25 each for
the service. The cost of labor, electricity and the form used
to place the order is $5 per customer. How many customers
will we need to serve to permit the total revenue to break-
even with our costs?
 Break-even Demand:
= Total fixed costs of process or equip.
Unit price to customer – Variable costs
=5,000/(25-5)
=250 customers
 Manufacturing Process Flow Design

• A process flow design can be defined as a

mapping of the specific processes that raw
materials, parts, and subassemblies follow as
they move through a plant

• The most common tools to conduct a process

flow design include assembly drawings,
assembly charts, and operation and route
sheets
Process Analysis

• Process Analysis

• Process Flowcharting

• Types of Processes

• Process Performance Metrics

• Process Variation

• Process Capability
 Process Analysis Terms
• Process: Is any part of an organization that takes
inputs and transforms them into outputs
• Cycle Time: Is the average successive time between
completions of successive units
• Utilization: Is the ratio of the time that a resource is
actually activated relative to the time that it is
available for use
 Process Flowcharting Defined

• Process flowcharting is the use of a diagram to present

the major elements of a process

• The basic elements can include tasks or operations,

flows of materials or customers, decision points, and
storage areas or queues

• It is an ideal methodology by which to begin analyzing

a process
Flowchart
Symbols Purpose and Examples
Tasks or operations Examples: Giving an
admission ticket to a
customer, installing a
engine in a car, etc.

Decision Points Examples: How much

change should be given to
a customer, which wrench
should be used, etc.
Flowchart
Symbols Purpose and Examples
Storage areas or Examples: Sheds, lines of
queues people waiting for a
service, etc.

Flows of materials or Examples: Customers

customers moving to a seat, mechanic
getting a tool, etc.
Example: Flowchart
 Types of Processes

Single-stage Process

Stage 1

Multi-stage Process

Stage 1 Stage 2 Stage 3

 Types of Processes (Continued)

A buffer refers to a storage area between stages

where the output of a stage is placed prior to
being used in a downstream stage

Multi-stage Process with Buffer

Buffer

Stage 1 Stage 2
Process Performance Metrics
Process Performance Metrics
Process Performance Metrics
Process Performance Metrics
Process Performance Metrics
Process Performance Metrics
Process Performance Metrics
 Process Performance Metrics (Cont..)

• Cycle time = Average time between

completion of units

• Throughput rate = 1 .
Cycle time
 Cycle Time Example

Suppose you had to produce 600 units in 80 hours to meet

the demand requirements of a product. What is the
cycle time to meet this demand requirement?

Answer: There are 4,800 minutes (60

minutes/hour x 80 hours) in 80 hours. So the
average time between completions would have
to be: Cycle time = 4,800/600 units = 8 minutes.
 Process Throughput Time Reduction

• Perform activities in parallel

• Change the sequence of activities
• Reduce interruptions
Business Process Reengineering (BPR)
Industrial Engineering
Industrial Engineering
 Basic Forms of Variation

Assignable variation
Example: A poorly trained
is caused by factors
employee that creates
that can be clearly variation in finished
identified and product output.
possibly managed

Common variation is Example: A molding

process that always leaves
inherent in the
“burrs” or flaws on a
production process
molded item.
 Taguchi’s View of Variation
Traditional view is that quality within the LS and US is good
and that the cost of quality outside this range is constant, where
Taguchi views costs as increasing as variability increases, so seek
to achieve zero defects and that will truly minimize quality costs.
High High

Incremental Incremental
Cost of Cost of
Variability Variability

Zero Zero

Lower Target Upper Lower Target Upper

Spec Spec Spec Spec Spec Spec

Traditional View Taguchi’s View

 Process Capability

• Process limits

• Specification limits

• How do the limits relate to one another?

 Process Capability

The ability of a process to meet product

design/technical specifications
Conducted only when the process is normally
distributed

Cp TELLS U ONLY ABOUT THE SMARTNESS

OF CURVE
Cpk TELLS U ABOUT THE POSITIONING /
LOCATION OF THE CURVE
 Session 3

Forecasting & Demand

Management
 Topics to be Discussed
• Demand Management
• Qualitative Forecasting Methods
• Simple & Weighted Moving Average
Forecasts
• Exponential Smoothing
• Simple Linear Regression
• Web-Based Forecasting
 Scope of Demand Management
• Demand Management covers how a firm integrates
information from and about its customers, internal and
external to the firm, into the manufacturing planning and
control systems.
• It deals about how a firm integrates information from its
customers with information about the firms goals and
capabilities, to determine what should be produced in the
future.
• Demand Management is concerned with processing,
influencing, and anticipating demand
Demand Management, Forecast & Plans

• In DM, FORECASTS of the quantities and timing of

customer demand are developed.

What do we actually plan to deliver to customers each

period is the output of the process. This is based on
marketing quotas, special sales incentives, etc. These
amounts will be based on inputs from many different
sources and not just quantitative forecasts.
Why Forecast and Plans are important

• A manufacturing manager cannot be held

responsible for not getting a forecast
right,

• A manufacturing manager can and should

be held responsible for making their
plans.
Responsibility of the MPC
• Providing the means for making as good a
set of executable plans as possible and then
Providing the information to execute them.

and when conditions change

• The control function should change the
plans and
• The new plans should be executed faithfully.
 Forecasting
• Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, ?

b) 2.5, 4.5, 6.5, 8.5, 10.5, ?

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, ?

 Forecasting

• Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, 3.7

b) 2.5, 4.5, 6.5, 8.5, 10.5, 12.5

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, 9.0

 Definition of the Forecasting Process
• The Art and Science of Predicting Future Events
– Forecasting vs. Predicting
– Based on Past Data
– Economic vs. Demand Forecasting
• Process of predicting a future event based on historical data
• Underlying basis of all business decisions
– Production
– Inventory
– Personnel
– Facilities
• Forecasting is the process of projecting the values of one or more
variables into the future.
 Why do we need to forecast?
In general, forecasts are almost always wrong. So,

Throughout the day we forecast very different

things such as weather, traffic, stock market, state
of our company from different perspectives.

Virtually every business attempt is based on

forecasting. Not all of them are derived from
sophisticated methods. However, “Best" educated
guesses about future are more valuable for
purpose of Planning than no forecasts and hence
no planning.
Importance of Forecasting in OM
Departments throughout the organization depend on
forecasts to formulate and execute their plans.

Finance needs forecasts to project cash flows and

capital requirements.

Human resources need forecasts to anticipate hiring

needs.

Production needs forecasts to plan production

levels, workforce, material requirements,
inventories, etc.
Importance of Forecasting in OM
Demand is not the only variable of interest to
forecasters.

Manufacturers also forecast worker

absenteeism, machine availability, material
costs, transportation and production lead
times, etc.

Besides demand, service providers are also

interested in forecasts of population, of other
demographic variables, of weather, etc.
 Elements of Demand Forecasting

• Dynamic in Nature
• Consider Uncertainty
• Rely on Information contained in Past Data
• Applied to various time horizons
– short term
– medium term forecasts
– long term forecasts
 Steps in the Forecasting Process
• Determine the Use of the Forecast
• Select the Items to be Forecasted
• Determine a Suitable Time Horizon
• Select an appropriate Set of Forecasting Models
• Gather Relevant Data
• Conduct the Analysis
• Validate the Model - Assess its Accuracy
• Make the Forecast
• Implement the Results
 Independent Demand:
What a firm can do to manage it?

• Can take an active role to influence

demand

• Can take a passive role and simply respond

to demand
 Factors Influencing Demand
• EXTERNAL FACTORS over which management has little or no
control:
• Economic conditions
• Government regulation
• What the competition does
• Consumer behavior
– The Leading, Coincident and Lagging Indicators provide
forecasters with data on the external factors.
– Market Research also does this.

• INTERNAL FACTORS that management can control:

• Price
• Promotion
• Product
• Quality
• Reputation
 OPERATIONS FORECASTING
• OPERATIONS MANAGERS are primarily concerned
with forecasting demand…
…for capacity planning.
(Effective capacity, capacity cushion, etc.)
…for production scheduling.
(Lot sizes, aggregate planning, etc.)
…to plan inventory needs.
(Order quantities, safety stock, etc.)
…to better match supply and demand.
 Operations Forecasting
Most operations forecasting is time-series. (Historic
data is correlated with time.)
– Independent variable is time.
• Time is independent of the data being forecast.
– Dependent variable is demand.
• EG: Using the past years of monthly demand data for your
product or service to make a forecast for next month’s
demand.
 Forecasting and Demand Planning
• Poor forecasting can result in poor inventory and staffing decisions,
resulting in part shortages, inadequate customer service, and many
customer complaints.
• Many firms integrate forecasting with value chain and capacity
management systems to make better operational decisions.
• Accurate forecasts are needed throughout the value chain, and are used
by all functional areas of the organization, including accounting, finance,
marketing, operations, and distribution.
• One of the biggest problems with forecasting systems is that they are
driven by different departmental needs and incentive systems.
• Demand planning software systems integrate marketing, inventory,
sales, operations planning, and financial data.
 Basic Approach to Demand Forecasting

• Understand the objectives of forecasting

• Integrate demand planning and forecasting
• Identify major factors that influence the demand
forecast
• Understand and identify customer segments
• Determine the appropriate forecasting technique
• Establish performance and error measures for the
forecast
 Role of Forecasting in a Supply Chain

• The basis for all strategic and planning decisions in a

supply chain
• Used for both push and pull processes
• Examples:
– Production: scheduling, inventory, aggregate
planning
– Marketing: sales force allocation, promotions, new
production introduction
– Finance: plant/equipment investment, budgetary
planning
– Personnel: workforce planning, hiring, layoffs
• All of these decisions are interrelated
 Characteristics of Forecasts
• All forecasts are wrong (rarely correct). The
best we can hope for is to reduce the amount
of error. Forecasts should include expected
value and measure of error.
• Long-term forecasts are less accurate than
short-term forecasts (forecast horizon is
important)
• Aggregate forecasts are more accurate than
disaggregate forecasts
 Benefits of Forecasts
• Forecasts reduce the uncertainty in our
decision making.
• Forecasts aid us in planning.
• They allow us to plan for contingencies.
 Types of Forecasts by Time Horizon
Quantitative
• Short-range forecast methods
– Usually < 3 months
• Job scheduling, worker assignments

• Medium-range forecast Detailed

use of
– 3 months to 2 years system
• Sales/production planning

• Long-range forecast
– > 2 years
• New product planning
Design Qualitative
of system Methods
 Characteristics of Long Term Forecasts

• Single or multi-year horizon

• Monthly or annual time bucket

• Aggregate units

– Input to “long term” decisions

• Accuracy generally more important than short term forecasts

• Tend to use expensive & time consuming methods

 WHICH METHOD FOR LONG-TERM
DEMAND FORECASTING?
• Long Term (Beyond 2 years)
• Causal & Qualitative (judgment) Models are typically used.
Purposes include…
– Location decisions
– Capacity decisions
– Layout and Process decisions
• Most forecasting for strategic decisions is long-term
forecasting.
 WHICH METHOD TO USE FOR
MEDIUM-TERM DEMAND FORECASTING?

Medium Term (3 months–2 years)

– Purpose:
• capacity planning
– Causal Models are the best to use.
• Regression is common.
– Qualitative (Judgment) models are also helpful.
• Executive opinion, Market Research, Sales force estimates
 WHICH METHOD TO USE FOR
SHORT-TERM DEMAND FORECASTING?
Short Term: (Up to three months)
– Purpose:
• Production scheduling
• Inventory planning
– Method:
• Time Series Forecasting is the most commonly
used forecasting technique.
• It is inexpensive and easy to do.
– Some judgment models can be used.
• Sales-force estimates, executive opinion
• Again, good judgment is ALWAYS important.
 Demand Forecasting Summary
Time Horizon

Short Term Medium Term Long Term

Application (0–3 months) (3 months–2 yrs) (over 2 years)
• Individual • Total sales • Total sales
Forecast products or • Groups of
Focus services products or
services
• Inventory Mgt. • Staff planning • Facility location
• Final assembly • Production • Capacity
Decision scheduling planning planning
• Workforce • Aggregate Prod. • Process
Area scheduling scheduling management
• Master Prod. • Purchasing
scheduling • Distribution

Forecasting • Time series • Causal • Causal

Technique • Causal • Judgment • Judgment
• Judgment
 Long term/short term characteristics
Long term forecasts Short term forecasts

– Single or multi-year horizon – Weekly or monthly horizon

– Monthly or annual time bucket – Daily & weekly time bucket

– Aggregate units (e.g., product/ – Detailed units (e.g., SKU)

service categories)
– Input to “short term” decisions
– Input to “long term” decisions
– Inexpensive & quick methods
– Expensive & time consuming • Accuracy importance
methods • Trumpet of doom
• Accuracy importance
• Trumpet of doom
Forecasting During the Life Cycle
Introduction Growth Maturity Decline

Qualitative models Quantitative models

- Executive judgment
- Time series analysis
- Market research
- Regression analysis
-Survey of sales force
-Delphi method
Sales

Time
 Types of Forecasts
• Qualitative (Judgmental)

• Quantitative
– Time Series Analysis
– Causal Relationships
– Simulation
 JUDGMENT METHODS (QUALITATIVE)
• Judgment methods rely on the opinions of experts, or on
the judgment and experience of people in the best
position to know.
• Much of market research is qualitative.
– Surveys of customer preferences and intentions to buy

• Judgment methods are best for medium or long-term

forecasting.
– Some qualitative methods can take considerable time
to obtain, and they can be expensive.
 JUDGMENT METHODS
• Sales force estimates: Forecasts are made by a company’s sales-force
members who have first-hand interaction with customers.
• Executive opinion (Executive intuition): The opinions, experience, and
technical knowledge of experienced managers are summarized to
arrive at a single forecast.
• Market research: A systematic approach to determining consumer
interest in a service or product through data-gathering surveys.
(Quantitative methods are often applied to this data.)
• Delphi method: A process of gaining consensus from a group of
experts, usually external to the organization, while maintaining
individual anonymity. (Survey-feedback-survey method)
– Experts are drawn from across the industry, government, public and
private organizations.
 Using Judgment Forecasting
• Judgment forecasting is clearly needed when
numerical data are not available for quantitative
forecasting approaches.
– It should also be used, even when quantitative data is
available, as an additional forecasting tool.
– Good judgment quite often is better than all the statistics in
the world.
• Guidelines for the use of any type of forecasting:
– Adjust forecasts when you have access to important
contextual knowledge.
• Make adjustments to compensate for specific events, such as
advertising campaigns, the actions of competitors, changes in the
economic situation, and international developments.
 Qualitative Methods

Executive Judgment Grass Roots

Qualitative Market Research

Historical analogy
Methods

Delphi Method Panel Consensus

 Delphi Method

l. Choose the experts to participate representing a variety of

knowledgeable people in different areas
2. Through a questionnaire (or E-mail), obtain forecasts (and any
premises or qualifications for the forecasts) from all
participants
3. Summarize the results and redistribute them to the
participants along with appropriate new questions
4. Summarize again, refining forecasts and conditions, and again
develop new questions
5. Repeat Step 4 as necessary and distribute the final results to all
participants
 Quantitative Forecasting Models

• Both Pattern Based and Correlational Models

rest on the assumption that the relationships
of the past will continue into the Future
• Both can Mathematically Characterize the
Probabilistic Nature of the Forecast
• Both Use Information from Relevant Time
Frames
 Components of Demand
• Average demand for a period of time
• Trend
• Seasonal element
• Cyclical elements
• Random variation
• Autocorrelation
 Pattern Based Analyses
• Definition
– Identifying an underlying pattern in historical data,
describe it in mathematical terms, and then
extrapolate it into the future
• Uses a “Time Series” of Past Data
 Time Series Methods
• TIME-SERIES is a commonly used statistical
approach that relies on historical data for short-
term forecasting.
– Types of Time Series forecasting models:
(Listed in order of increasing complexity)
• NAIVE FORECASTING
• MOVING AVERAGES
• TREND PROJECTIONS (Good for long-term)
• EXPONENTIAL SMOOTHING
• BOX JENKINS
 CAUSAL METHODS
• Causal methods are used when historical data are available and a
relationship between the variable and other external or internal
factors can be identified.
– Causal methods use historical data on independent variables, such as
promotional campaigns, economic conditions, and competitors’ actions, to
predict demand (dependent variable)
– May be short, medium, or long term, depending on the model.
• LINEAR & NON-LINEAR REGRESSION (Short & Medium term)
• ECONOMETRICS (Good for long term)
• INTENTION-TO-BUY & ANTICIPATION SURVEYS (Short-term)
• INPUT-OUTPUT MODELS (Good for long-term)
• LEADING INDICATORS (Only for long-term)
– These are indicators that precede economic change. (unemployment, inventory
changes, building permits, money supply, etc.)
 Linear Regression
• Linear Regression is a causal method in which one variable
(dependent variable) is related to one or more independent
variables using a linear equation.
– Dependent variable: The variable to be forecasted.
• In demand forecasting, demand would be the dependent variable
• Data plot must be linear in order to use Linear Regression
– Independent variables are assumed to have a correlation with the
dependent variable being forecast.
• The Independent Variable is some variable to which demand appears to
be related. It can be time or some other variable.
• If the Independent variable is time, then linear regression becomes a
Time-Series method of forecasting.
– NO “Cause and Effect” should be assumed, even though it is called
a Causal Method!
 Time Series Analysis
• Time series forecasting models try to predict the
future based on past data
• One can pick models based on:
1. Time horizon to forecast
2. Data availability
3. Accuracy required
4. Size of forecasting budget
5. Availability of qualified personnel
 Basic Time-Series Patterns
There are five basic patterns of most time series.
a. Horizontal: Over time the data fluctuates around a constant
mean.
b. Trend: The systematic increase (or decrease) in the data over
time.
c. Seasonal: A repeatable pattern of increases and decreases in
demand that relates to a specific period, such as the time of day,
week, month, or season.
d. Cyclical: Less predictable, gradual increases and decreases over
longer periods of time (years or decades), such as the business
cycle. No consistent time frame.
e. Random: A variation in demand that has no pattern.
The data cannot be used for forecasting.
 Patterns of Demand
Horizontal Trend

Seasonal Cyclical
 Rules for Time-Series Forecasting

• RULE 1: Plot your data to see if it has a pattern.

If the data has a pattern, you

can select an appropriate
forecasting model. Demand

Sales history by month.

If the data has no pattern,

you cannot do forecasting!
Demand

Sales history by month.

 Rules for Time-Series Forecasting
• RULE 2: The number of periods of data depends
on how much confidence you want in the results
and the technique being used.
– The number of periods you need varies with the
forecasting technique. Some methods require less
data; some require lots of data.
• RULE 3: Time-Series Forecasting is SHORT-TERM
forecasting.
– Generally, you don’t forecast beyond the first unknown
period unless your historic data has a clear pattern.
(minimal variation/noise)
• Time-Series forecasting beyond the first unknown period
greatly increases forecast error and unreliability.
 TIME-SERIES METHODS

• NAÏVE FORECASTING: A time-series method whereby the forecast

for the next period is the known demand for the current period.
– It takes the most recent known period value and projects it to
the first forecast period.
• SIMPLE MOVING AVERAGES is a time-series method that averages
demand over a specified period “n” of time.
– It computes the average for the last “n” periods and uses that as
the forecast for the next period.
– By averaging, it removes the effects of random fluctuations, and
it is most useful when demand has no pronounced trend or
seasonal influences.
 Simple Moving Averages
The moving average method involves the use of as many periods
of past demand as desired or deemed appropriate. The stability of
the demand series generally determines how many periods.

This is a 4-period moving average.

WEEK DEMAND AVERAGE

1 20
2 23
3 21
4 24 22
5 25 23.25
6 ?

22 becomes the forecast for week #5 23.25 becomes

the forecast for week #6.
 Simple Moving Average Formula
• The simple moving average model assumes an average is
a good estimator of future behavior
• The formula for the simple moving average is:

A t-1 + A t-2 + A t-3 +...+A t- n

Ft =
n
Ft = Forecast for the coming period
N = Number of periods to be averaged
A t-1 = Actual occurrence in the past period for
up to “n” periods
Comparison of 3- and 6-Week Moving Average Forecasts

3-week moving 6-week moving

Arrivals
average forecast average forecast
Patient

Actual Data Historic Data

Week
A longer averaging period soothes the fluctuations.
 Simple Moving Average Problem (1)

A t-1 + A t-2 + A t-3 +...+A t- n

Week Demand Ft =
1 650 n
2 678
3 720 Question: What are the 3-
4 785 week and 6-week moving
5 859 average forecasts for
6 920
7 850
demand?
8 758 Assume you only have 3
9 892 weeks and 6 weeks of
10 920 actual demand data for the
11 789
respective forecasts
12 844
Calculating the moving averages gives us:

Week Demand 3-Week 6-Week

1 650 F4=(650+678+720)/3
2 678 =682.67
3 720 F7=(650+678+720
+785+859+920)/6
4 785 682.67
=768.67
5 859 727.67
6 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
©The McGraw-Hill Companies, Inc., 2004
 Plotting the moving averages and comparing them shows how
the lines smooth out to reveal the overall upward trend in this
example

Demand 3-Week 6-Week

950
900
850
800
Dem and

750
700 Note how the 3-
650 Week is smoother
600 than the Demand,
550
500 and 6-Week is even
1 2 3 4 5 6 7 8 9 10 11 12 smoother
Week
 Simple Moving Average Problem (2) Data

Question: What is the 3

week moving average
Week Demand forecast for this data?
1 820 Assume you only have 3
2 775
weeks and 5 weeks of
3 680
actual demand data
4 655
5 620 for the respective
6 600 forecasts
7 575
Simple Moving Average Problem (2) Solution

Week Demand 3-Week 5-Week

1 820 F4=(820+775+680)/3
=758.33
2 775
F6=(820+775+680
3 680 +655+620)/5
=710.00
4 655 758.33
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00
 Double Moving Averages
(Averaging the averages)

n= 4 periods for the average

zzzWEEK DEMAND SINGLE DOUBLE
AVG AVG
1 20
2 25
3 34
4 19 25
5 22 25
6 12 22
7 36 22 23
8 14 21 23
9 19 20 21
10 24 23 22
11 22 20 21
12 18 21 21
13 27 23 22

Averages are rounded to the nearest whole numbers.

 WEIGHTED MOVING AVERAGES
Weighted moving average method: A time-series method in which
each historical data point can have its own weight. (The sum of the
weights equals 1.0)
It allows the forecaster to give more weight to the more recent data or
the more relevant data.
Important in trend or cyclical data

WEEK DEMAND Wt. Wt. AVERAGE

1 20 .1
2 23 .2
3 21 .3
4 24 .4 22.5

(20*0.1)+(23*0.2)+(21*0.3)+(24*0.4)=22.5
 Weighted Moving Average Formula

While the moving average formula implies an equal

weight being placed on each value that is being averaged,
the weighted moving average permits an unequal
weighting on prior time periods

The formula for the moving average is:

Ft = w 1 A t -1 + w 2 A t - 2 + w 3 A t -3 + ...+ w n A t - n
n
wt = weight given to time period “t”
occurrence (weights must add to one)
w
i=1
i =1
 Weighted Moving Average Problem (1) Data
Question: Given the weekly demand and weights, what is the forecast for the 4th
period or Week 4?

Week Demand Weights:

1 650
2 678 t-1 .5
3 720 t-2 .3
4 t-3 .2

Note that the weights place more emphasis on the most recent data,
that is time period “t-1”
 Weighted Moving Average Problem (1) Solution

Week Demand Forecast

1 650
2 678
3 720
4 693.4

F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
 Weighted Moving Average Problem (2) Data

Question: Given the weekly demand information

and weights, what is the weighted moving
average forecast of the 5th period or week?

Week Demand Weights:

1 820 t-1 .7
2 775 t-2 .2
3 680
t-3 .1
4 655
 Weighted Moving Average Problem (2) Solution

Week Demand Forecast

1 820
2 775
3 680
4 655
5 672

F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672
 Other Time Series Methods
• EXPONENTIAL SMOOTHING is a complex form of weighted moving
averages. It is good for trends and cyclical data.
– It is the most frequently used formal forecasting method because of its
simplicity and the small amount of data needed to support it.
• Double and Triple Exponential Smoothing are used for highly fluctuating
data.
• BOX JENKINS
• This is probably the most complex but often the most accurate of the
time-series methods for all data patterns.
• If you really want to know: It is named after the statisticians George Box and Gwilym
Jenkins. It applies autoregressive integrated moving average (ARIMA) models to find
the best fit of a time series to past values of this time series, in order to make
forecasts.
 Exponential Smoothing Model

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

Where :
Ft  Forcast va lue for the coming t time period
Ft - 1  Forecast v alue in 1 past time period
At - 1  Actual occurance in the past t tim e period
a  Alpha smoothing constant
• Premise: The most recent observations might have the
highest predictive value
• Therefore, we should give more weight to the more
recent time periods when forecasting
Exponential Smoothing Problem (1) Data
Week Demand Question: Given the weekly
1 820 demand data, what are the
2 775 exponential smoothing
forecasts for periods 2-10 using
3 680
a=0.10 and a=0.60?
4 655
Assume F1=D1
5 750
6 802
7 798
8 689
9 775
10
Answer: The respective alphas columns denote the forecast
values. Note that you can only forecast one time period into the
future.

Week Demand 0.1 0.6

1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 820.00
4 655 801.95 817.30
5 750 787.26 808.09
6 802 783.53 795.59
7 798 785.38 788.35
8 689 786.64 786.57
9 775 776.88 786.61
10 776.69 780.77
 Exponential Smoothing Problem (1) Plotting
Note how that the smaller alpha results in a smoother line in this
example

850
800
Demand
De m and

750
700 0.1
650
600 0.6
550
500
1 2 3 4 5 6 7 8 9 10
Week
 Exponential Smoothing Problem (2) Data

Question: What are the

Week Demand exponential smoothing
1 820 forecasts for periods 2-5
2 775 using a =0.5?
3 680
4 655 Assume F1=D1
5
 Exponential Smoothing Problem (2) Solution

F1=820+(0.5)(820-820)=820 F3=820+(0.5)(775-820)=797.75

Week Demand 0.5

1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
 Seasonal Patterns
• An easy way to account for seasonal effects is to use
one of the techniques already described, but to limit
the data used to those time periods in the same season.
– EG: May, June, July, August for the past five years.

• If the weighted moving-average method is used, higher

weights are placed on the more recent periods
belonging to the same season.

• Multiplicative seasonal method is a method whereby

seasonal factors are multiplied by an estimate of
average demand to arrive at a seasonal forecast.
 Seasonal Adjustments
• Applied to Moving Averages and Time
Series Regression
• First, Calculate a Seasonal Index (SI) Factor
for Each Relevant Time Period (day, week,
month, quarter)
• Each Seasonal Period’s SI is Calculated by
Averaging the Ratio of its Actual Demand to
the Forecast Demand for all Corresponding
Periods
 Seasonal Adjustments

• Forecast for Future Periods is Calculated by

Multiplying the Unadjusted Moving Average or
Time Series Forecast for a given Period by the
Corresponding Seasonal Index for that Period
• i.e. if the SMA forecast for the month of
March is 27 and the SI for March is 1.125, then
• Emar = 27*1.125 = 30.375
Seasonal Adjustment Example
Seasonal Adjustments

Sales Demand

Monthly Overall SI Adjusted

Month 1993 1994 Seasonal Index
Average Average Forecast

Jan 80 100 90.00 94.00 0.96 86.17

Feb 75 85 80.00 94.00 0.85 68.09
Mar 80 90 85.00 94.00 0.90 76.86
Apr 90 110 100.00 94.00 1.06 106.38
May 115 131 123.00 94.00 1.31 160.95
Jun 110 120 115.00 94.00 1.22 140.69
Jul 100 110 105.00 94.00 1.12 117.29
Aug 90 110 100.00 94.00 1.06 106.38
Sep 85 95 90.00 94.00 0.96 86.17
Oct 75 85 80.00 94.00 0.85 68.09
Nov 75 85 80.00 94.00 0.85 68.09
Dec 80 80 80.00 94.00 0.85 68.09

Average 87.92 100.08

Expected Demand for 1995 = 1153.23

 Seasonal Adjustments Example Graph
Seasonal Adjusted Forecasting 1993

1994
170
SI Adjusted
Forecast
150
Overall
Average
130

110

90

70

50
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
 Evaluating Forecast Accuracy

• Use of Residuals Analyses

– Residuals are the Difference Between the Forecast
and the Actual Demand for a Given Period
• Assessed by Several Measures
– Mean Absolute Deviation - MAD
– Mean Squared Error - MSE
– Tracking Signal
 The MAD Statistic to Determine Forecasting Error

1 MAD  0.8 standard deviation

n

A
t=1
t - Ft
1 standard deviation  1.25 MAD
MAD =
n

• The ideal MAD is zero which would mean

there is no forecasting error

• The larger the MAD, the less the accurate

the resulting model
 MAD Problem Data

Question: What is the MAD value given

the forecast values in the table below?

Month Sales Forecast

1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
 MAD Problem Solution

Month Sales Forecast Abs Error

1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10

40
n
Note that by itself, the
A
t=1
t - Ft
40 MAD only lets us know
MAD = = = 10 the mean error in a set of
n 4 forecasts
 Evaluating Forecast Accuracy
Mean Absolute Deviation - MAD

• Exponentially Smoothed MAD

– MADt = aMAD|Dt - Forecastt| + (1- aMAD)MADt-1
Evaluating Forecast Accuracy
Mean Squared Error - MSE
• MSE = ((Di - Forecasti)2)/n
Time Time
Actual Squared
Period Series Series
Demand Error
Forecast Residual
1 12 12.16 -0.16 0.03
2 13 12.13 0.87 0.76
3 10 12.09 -2.09 4.39
4 11 12.06 -1.06 1.13
5 10 12.03 -2.03 4.12
6 14 12.00 2.00 4.01
7 16 11.97 4.03 16.28
8 15 11.93 3.07 9.40
9 13 11.90 1.10 1.21
10 8 11.87 -3.87 14.97
11 10 11.84 -1.84 3.37
12 12 11.80 0.20 0.04
13 9 11.77 -2.77 7.69
14 13 11.74 1.26 1.59
15 13 11.71 1.29 1.67

MSE = 4.71
RMSE = 2.17
 Tracking Signal Formula

• The Tracking Signal or TS is a measure that indicates

whether the forecast average is keeping pace with
any genuine upward or downward changes in
demand.
• Depending on the number of MAD’s selected, the TS
can be used like a quality control chart indicating
when the model is generating too much error in its
forecasts.
• The TS formula is:

RSFE Running sum of forecast errors

TS = =
MAD Mean absolute deviation
 Evaluating Forecast Accuracy
Tracking Signal
• Tracking Signal = Running Sum of Forecast
Error / MAD = RSFE/MAD
Time Time
Actual Tracking
Period Series Series RSFE MAD
Demand Signal
Forecast Residual
1 12 12.16 -0.16 -0.16 0.03 -5.00
2 13 12.13 0.87 0.72 0.20 3.58
3 10 12.09 -2.09 -1.38 0.58 -2.38
4 11 12.06 -1.06 -2.44 0.68 -3.61
5 10 12.03 -2.03 -4.47 0.95 -4.72
6 14 12.00 2.00 -2.47 1.16 -2.13
7 16 11.97 4.03 1.57 1.73 0.90
8 15 11.93 3.07 4.63 2.00 2.32
9 13 11.90 1.10 5.73 1.82 3.15
10 8 11.87 -3.87 1.86 2.23 0.84
11 10 11.84 -1.84 0.03 2.15 0.01
12 12 11.80 0.20 0.22 1.76 0.13
13 9 11.77 -2.77 -2.55 1.96 -1.30
14 13 11.74 1.26 -1.29 1.82 -0.71
15 13 11.71 1.29 0.00 1.72 0.00
 Old man winters
Winters method used to forecast one period into the future
See how method detects patterns & adapts to market changes over time

Old Man Winters in Action

600.00

500.00

400.00
Volum e

Actual
300.00
Forecast
200.00

100.00

0.00
0 20 40 60 80 100
Tim e
 Key to Winters method
• Winters is an exponential smoothing method

• Smoothing is based on a key idea

– For each component (which are?), a portion of
difference between estimate & actual is due to
randomness & certain portion due to real change
 Smoothing in action...
• New estimate = old estimate + (some percentage)(error)

• Smoothes out peaks & valleys (i.e., randomness) of actual

 Bernie’s insight…
…or what is focus forecasting?
• An intuitive & successful idea

• Regularly use a # of different methods to generate forecasts

• Maintain historical accuracy information on each method

• Use the most accurate method to generate “official”

forecasts
 Filtering
• An important feature of computer-based forecasting systems

– Large amounts of data – impractical to manually review all

1. For data input errors (e.g., typos, scanner errors)

– If |“actual” - forecast| > limit, then report

2. For unacceptable forecast errors (e.g., warranting management

attention)
– If average absolute error > limit, then report

– If average error (i.e., bias) > limit, then report

 Demand Management
(Bill of Materials- BOM)

Independent Demand:
Finished Goods

A Dependent Demand:
Raw Materials,
Component parts,
B(4) C(2) Sub-assemblies, etc.

D(2) E(1) D(3) F(2)

 Customer Order Decoupling Point
• Can be looked at as the point at which demand changes from
independent to dependent. It is the point at which the firm, as
opposed to the customer, becomes responsible for determining the
timing and quantity of material to be purchased, made, or finished.

• Engineered to order Suppliers

• Made to order Raw Materials inventory
• Assemble to order WIP
• Made to stock Finished Goods
 Decoupling Points & Lead Time

Make-to-Stock (MTS)
Short Finished Goods
Components/Subassemblies
Lead Time

Assemble to Order (ATO)

Raw Materials
Make to Order (MTO)
Long Suppliers Engineer to Order
 Demand Uncertainty…
how is it dealt with?
• MTS – Safety stocks of end items.
• ATO – Forecast product mix and calculate expected
components and sub-assemblies. Safety stock carried in
these items.
• MTO – Uncertainty involves the level of company resources
that will be required to complete the engineering and
produce the product once the requirements are
determined. May carry some raw materials.
 Web-Based Forecasting: CPFR
• Collaborative Planning, Forecasting, and Replenishment (CPFR) a
Web-based tool used to coordinate demand forecasting, production
and purchase planning, and inventory replenishment between
supply chain trading partners.
• Used to integrate the multi-tier or n-Tier supply chain, including
manufacturers, distributors and retailers.
• CPFR’s objective is to exchange selected internal information to
provide for a reliable, longer term future views of demand in the
supply chain.
• CPFR uses a cyclic and iterative approach to derive consensus
forecasts.
 Web-Based Forecasting:
Steps in CPFR
1. Creation of a front-end partnership agreement.
2. Joint business planning
3. Development of demand forecasts
4. Sharing forecasts
5. Inventory replenishment
 Correlational Forecasting

• Assumes an Outcome is Dependent an

Existing Relationship Between the Demand
Variable and Some other Independent
Variable(s)
– Demand Variable is Dependent Variable
– Other Related Variables are Independent
Variables
– Generally Expressed as a Multiple Linear
Regression Model
• Y =  + X1+ X2+ X2+ . . . nXn+ i
 Simple Linear Regression Model
Y

The simple linear a

regression model seeks
to fit a line through
various data over time 0 1 2 3 4 5 x
(Time)

Yt = a + bx Is the linear regression model

Yt is the regressed forecast value or dependent

variable in the model, a is the intercept value of the
the regression line, and b is similar to the slope of the
regression line. However, since it is calculated with
the variability of the data in mind, its formulation is
not as straight forward as our usual notion of slope.
 Simple Linear Regression Formulas for
Calculating “a” and “b”

a = y - bx

 xy - n(y)(x)
b= 2 2
 x - n(x )
 Simple Linear Regression Problem Data

Question: Given the data below, what is the simple linear

regression model that can be used to predict sales in future
weeks?

Week Sales
1 150
2 157
3 162
4 166
5 177
Answer: First, using the linear regression formulas, we can
compute “a” and “b”

Week Week*Week Sales Week*Sales

1 1 150 150
2 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum

b=
 xy - n( y)(x) 2499 - 5(162.4)(3) 63
=  = 6.3
 x - n(x )
2 2
55  5(9 ) 10

a = y - bx = 162.4 - (6.3)(3) = 143.5

The resulting regression
model is: Yt = 143.5+6.3x
Now if we plot the regression generated forecasts
against the actual sales we obtain the following
chart: 180
175
170
165
160 Sales
Sales

155 Forecast
150
145
140
135
1 2 3 4 5
Period
 Statistical Assumptions of Multiple
Linear Regression
• The Error Term (the residual i) is Normally
Distributed
• There is no Serial Correlation Among Error Terms
• Magnitude of the Error Term is Independent of the
Size of Any of the Independent Variables - Xi
• Assumptions Can be Tested Through Analyses of the
Residuals - i
 Major Statistical Problems of Multiple
Linear Regression
• Multicolinarity
• Use of Time-Lagged Independent Variables
• Both of These Problems Result in Models with
Potentially Valid Predictions, but the Reliability of
the  Coefficients is Questionable
 Finding The Right Technique
1. Select a variety of forecasting techniques
2. Use historic data with each technique to forecast demand for the
most recent known demand period.
3. See which forecasting technique gives you the most accurate
forecast.
4. Use that technique to forecast the unknown period of demand.
5. Repeat this selection process each time you need to forecast
demand. Use the latest demand data.
This process is called FOCUS FORECASTING.
 Forecasting As a Process
The forecast process itself, typically done on a monthly basis,
consists of structured steps. They often are facilitated by
someone who might be called a demand manager, forecast
analyst, or demand/supply planner.

It is not simply a matter of running a computer model!

Update Prepare Consensus

historic Initial meetings &
data Forecasts collaboration

Finalize Review by
Revise
and Operating
Communicate Committee forecasts
6 5 4
 Some Principles For The Forecasting Process

 Forecasting is being done in virtually every company. The

challenge is to do it better than the competition.
 Better forecasts result in better customer service and lower costs, as well as
better relationships with suppliers and customers.
 The forecast must make sense based on the big picture, economic
outlook, market share, and so on. Context is critical.
 The best way to improve forecast accuracy is to focus on reducing
forecast error.
 Whenever possible, forecast aggregate levels. Forecast in detail
only where necessary.
 Use Judgment! Far more can be gained by people collaborating,
communicating well, and using judgment, than by using the most
advanced forecasting technique or model.
 Question Bowl

Which of the following is a classification of a basic

type of forecasting?
a. Transportation method
b. Simulation
c. Linear programming
d. All of the above
e. None of the above

Answer: b. Simulation (There are four types including Qualitative,

Time Series Analysis, Causal Relationships, and Simulation.)
 Question Bowl

Which of the following is an example of a “Qualitative”

type of forecasting technique or model?
a. Grass roots
b. Market research
c. Panel consensus
d. All of the above
e. None of the above

Answer: d. All of the above (Also includes Historical

Analogy and Delphi Method.)
 Question Bowl

Which of the following is an example of a “Time

Series Analysis” type of forecasting technique or
model?
a. Simulation
b. Exponential smoothing
c. Panel consensus
d. All of the above
e. None of the above
Answer: b. Exponential smoothing (Also includes Simple Moving Average,
Weighted Moving Average, Regression Analysis, Box Jenkins, Shiskin Time Series,
and Trend Projections.)
 Question Bowl

Which of the following is a reason why a firm should

choose a particular forecasting model?
a. Time horizon to forecast
b. Data availability
c. Accuracy required
d. Size of forecasting budget
e. All of the above

Answer: e. All of the above (Also should include “availability of

qualified personnel” .)
 Question Bowl

Which of the following are ways to choose weights in

a Weighted Moving Average forecasting model?
a. Cost
b. Experience
c. Trial and error
d. Only b and c above
e. None of the above

Answer: d. Only b and c above

 Question Bowl

Which of the following are reasons why the Exponential

Smoothing model has been a well accepted forecasting
methodology?
a. It is accurate
b. It is easy to use
c. Computer storage requirements are small
d. All of the above
e. None of the above

Answer: d. All of the above

 Question Bowl

The value for alpha or α must be between which of

the following when used in an Exponential
Smoothing model?
a. 1 to 10
b. 1 to 2
c. 0 to 1
d. -1 to 1
e. Any number at all

Answer: c. 0 to 1
 Question Bowl

Which of the following are sources of error in

forecasts?
a. Bias
b. Random
c. Employing the wrong trend line
d. All of the above
e. None of the above

Answer: d. All of the above

 Question Bowl

Which of the following would be the “best” MAD values in

an analysis of the accuracy of a forecasting model?
a. 1000
b. 100
c. 10
d. 1
e. 0

Answer: e. 0
 Question Bowl

If a Least Squares model is: Y=25+5x, and x is equal

to 10, what is the forecast value using this model?
a. 100
b. 75
c. 50
d. 25
e. None of the above

Answer: b. 75 (Y=25+5(10)=75)
 Question Bowl

Which of the following are examples of seasonal

variation?
a. Additive
b. Least squares
c. Standard error of the estimate
d. Decomposition
e. None of the above

Answer: a. Additive (The other type is of seasonal

variation is Multiplicative.)
 Concluding Principles
• Data capture must not be limited to sales but
should include domain info such as knowledge,
trends, systems performance
• Forecasting models should not be more
complicated than necessary. Simple models work
just as good.
• Forecast from different sources must be reconciled
and made consistent with firm plans and
constraints.
 Concluding Principles

• Input data and output forecasts should be routinely

monitored for quality and appropriateness.
• Information on sources of variation should be
incorporated into the forecasting system.
• Forecast from different sources must be reconciled
and made consistent with firm plans and
constraints.
Thank You
 Session 4

Inventory Control
 TOPICS TO BE
DISCUSSED
• Inventory System Defined
• Inventory Costs
• Single-Period Inventory Model
• Multi-Period Inventory Models: Basic Fixed-Order
Quantity Models
• Multi-Period Inventory Models: Basic Fixed-Time
Period Model
• Independent vs. Dependent Demand
• Miscellaneous Systems and Issues
Inventory System Defined
• Inventory is the stock of any item or resource used in an
organization and can include: raw materials, finished
products, component parts, supplies, and work-in-
process
• An inventory system is the set of policies and controls
that monitor levels of inventory and determines what
levels should be maintained, when stock should be
replenished, and how large orders should be
• Inventory management system strikes a balance
between inventory investment and customer service
 Purposes of Inventory
1. To maintain independence of operations
– Speculation: Changing Costs Over Time
– Costs of Maintaining Control System
2. To meet variation in product demand (i.e. Demand Uncertainty) by
smoothing to account for seasonality and/or Bottlenecks
3. To allow flexibility in production scheduling
4. To provide a safeguard for variation in raw material delivery time
(i.e. uncertainty in delivery lead-times)
5. To take advantage of economic purchase-order size or Economies
of Scale
 Characteristics of Inventory Systems

• Demand
– May Be Known or Uncertain
– May be Changing or Unchanging in Time
• Lead Times - time that elapses from placement of
order until it’s arrival. Can assume known or
unknown.
• Review Time. Is system reviewed periodically or is
system state known at all times?
 Characteristics of Inventory Systems
• Treatment of Excess Demand.
• Backorder all excess demand
• Lose all excess demand
• Backorder some and lose some
• Inventory who’s quality changes over time
• perishability
• obsolescence
Types of Inventory (WRT Operational Stage)
 Raw material
 Purchased but not processed
 Work-in-process
 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
Types of Inventories (WRT Order Stage)
• Pipeline
– Inventories in transit
• Speculative
– Goods purchased in anticipation of price increases
• Regular/Cyclical/Seasonal
– Inventories held to meet normal operating needs
• Safety
– Extra stocks held in anticipation of demand and lead time
uncertainties
• Obsolete/Dead Stock
– Inventories that are of little or no value due to being out of date,
spoiled, damaged, etc.
 Nature of Demand
• Perpetual demand
– Continues well into the foreseeable future
• Seasonal demand
– Varies with regular peaks and valleys throughout the year
• Lumpy demand Accurately forecasting
– Highly variable (3  Mean) demand is singly the
• Regular demand most important factor
– Not highly variable (3 < Mean) in good inventory
management
• Terminating demand
– Demand goes to 0 in foreseeable future
• Derived demand
– Demand is determined from the demand of another item of which it
is a part
 Inventory Costs
• Holding (or carrying) costs
– the costs of holding or “carrying” inventory over time
(i.e. costs for storage, handling, insurance, etc.)
• Setup (or production change) costs
– cost to prepare a machine or process for
manufacturing an order (i.e. cost for arranging
specific equipment setups, etc.)
• Ordering costs
– the costs of placing an order and receiving goods.
• Shortage costs
– Costs of canceling an order, etc.
 Relevant Inventory Costs
• Holding Costs - Costs proportional to the
quantity of inventory held.
• Includes:
1. Physical Cost of Space (3%)
2. Taxes and Insurance (2 %)
3. Breakage Spoilage and Deterioration (1%)
4. Opportunity Cost of alternative investment. (18%)
Here these holding issues total: 24%
• Therefore, in inventory systems, the holding cost
would be taken as:
– h  .24*Cost of product
 Holding Costs
Cost (and range)
as a Percent of
Category Inventory Value
Housing costs (building rent or 6% (3 - 10%)
depreciation, operating costs, taxes,
insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost 3% (3 - 5%)
Investment costs (borrowing costs, taxes, 11% (6 - 24%)
and insurance on inventory)
Pilferage, space, and obsolescence 3% (2 - 5%)
Overall carrying cost 26%
 Holding Costs
Cost (and range)
as a Percent of
Category Inventory Value
Housing costs (building rent or 6% (3 - 10%)
depreciation, operating costs, taxes,
insurance)
Material handling costs (equipment lease or 3% (1 - 3.5%)
depreciation, power, operating cost)
Labor cost 3% (3 - 5%)
Investment costs (borrowing costs, taxes, 11% (6 - 24%)
and insurance on inventory)
Pilferage, space, and obsolescence 3% (2 - 5%)
Overall carrying cost 26%
 Relevant Costs (continued)
• Ordering Cost (or Production Cost).
Includes both fixed and variable components

slope = c

K C(x) = K + cx for x > 0; 0 for x = 0.

 Relevant Costs (continued)

• Penalty or Shortage Costs. All costs that

accrue when insufficient stock is available
to meet demand. These include:
– Loss of revenue due to lost demand
– Costs of book-keeping for backordered demands
– Loss of goodwill for being unable to satisfy
demands when they occur.
 Relevant Costs (continued)
• When computing Penalty or Shortage Costs
inventory managers generally assume cost is
proportional to number of units of excess
demand that will go unfulfilled.
 Inventory Systems
• Single-Period Inventory Model
– One time purchasing decision (Example: vendor
selling t-shirts at a football game)
– Seeks to balance the costs of inventory overstock
and under stock
• Multi-Period Inventory Models
– Fixed-Order Quantity Models
• Event triggered (Example: running out of stock)
– Fixed-Time Period Models
• Time triggered (Example: Monthly sales call by
sales representative)
 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
Average demand =  = 120 papers/day
Standard deviation =  = 15 papers
Cs = cost of shortage = $1.25 - $.70 = $.55
Co = cost of overage = $.70 - $.30 = $.40

Cs
Service level =
Cs + Co
Service
.55 level
= 57.8%
.55 + .40
.55
= = .578  = 120
.95 Optimal stocking level
 Single Period Example

For the area .578, Z  .20

The optimal stocking level

= 120 copies + (.20)()

= 120 + (.20)(15) = 120 + 3 = 123 papers

The stockout risk = 1 – service level

= 1 – .578 = .422 = 42.2%

 Single Period Model Example

• Our college basketball team is playing in a tournament

game this weekend. Based on our past experience we
sell on average 2,400 shirts with a standard deviation of
350. We make $10 on every shirt we sell at the game,
but lose $5 on every shirt not sold. How many shirts
should we make for the game?
Cu = $10 and Co = $5; P ≤ $10 / ($10 + $5) = .667

Z.667 = .432 (use NORMSDIST(.667))

therefore we need 2,400 + .432(350) = 2,551 shirts
 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
 Fixed-Period (P) Systems
 Orders placed at the end of a fixed period
 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 from one another
 Fixed-Period (P) Systems
Target quantity (T)

Q4
Q2
On-hand inventory

Q1 P
Q3

Time
A Fixed Interval Inventory Reorder System
A Fixed Order Quantity Inventory
Reorder System
 Fixed-Period (P) Example
3 jackets are back ordered No jackets are in stock
It is time to place an order Target value = 50

Order amount (Q) = Target (T) - On-hand inventory –

Earlier orders not yet received +
Back orders
Q = 50 - 0 - 0 + 3 = 53 jackets
 Multi-Period Models:
Fixed-Order Quantity Model Assumptions

• Demand for the product is constant and uniform throughout

the period
• Lead time (time from ordering to receipt) is constant
• Price per unit of product is constant
• Inventory holding cost is based on average inventory
• Ordering or setup costs are constant
• All demands for the product will be satisfied (No back orders
are allowed)
 Basic Fixed-Order Quantity Model and
Reorder Point Behavior
1. You receive an order quantity Q. 4. The cycle then repeats.

Number
of units
on hand Q Q Q

R
2. Your start using L L
them up over time. 3. When you reach down to a
Time level of inventory of R, you place
R = Reorder point your next Q sized order.
Q = Economic order quantity
L = Lead time
 Inventory Usage Over Time

Usage rate Average

Order inventory
Inventory level

quantity = Q on hand
(maximum
Q
inventory
level) 2

Minimum
inventory

0
Time
 Independent vs. Dependent Demand

Independent Demand (Demand for the final end-

product or demand not related to other items)
Finished
product

Dependent Demand
(Derived demand
items for
component parts,
E(1 subassemblies,
) raw materials, etc)
Component parts
Inventory Models for Independent
Demand

Need to determine when and

how much to order

1. Basic economic order quantity

2. Production order quantity
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 and holding
6. Stock-outs can be completely avoided
 Minimizing Costs
Objective is to minimize total costs
Total cost of
holding and
setup (order)

Minimum
total cost
Annual cost

Holding cost

Setup (or order)

cost
Optimal order Order quantity
quantity (Q*)
 The EOQ Model
Q = Number of pieces per order
Q* = Optimal number of pieces 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

D
= (S)
Q D
Annual setup cost = S
Q
 D
Annual setup cost = S
The EOQ Model Q
Q
Annual holding cost = H
2
Q = Number of pieces per order
Q* = Optimal number of pieces 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 holding cost = (Average inventory level)

x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2

Q
= (H)
2
 D
Annual setup cost = S
The EOQ Model Annual holding cost =
Q
Q
H
2
Q = Number of pieces per order
Q* = Optimal number of pieces 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

Optimal order quantity is found when annual setup cost

equals annual holding cost

D Q
S = H
Q 2
Solving for Q*
2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year

2DS
Q* =
H
2(1,000)(10)
Q* = = 40,000 = 200 units
0.50
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand D
number of = N = =
orders Order quantity Q*
1,000
N= = 5 orders per year
200
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year

Number of working
Expected days per year
time between = T =
orders N
250
T= = 50 days between orders
5
 An EOQ Example
Determine optimal number of needles to order
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = S + H
Q 2
1,000 200
TC = ($10) + ($.50)
200 2

TC = (5)($10) + (100)($.50) = $50 + $50 = $100

 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
Management underestimated demand by 50%
D = 1,000 units 1,500 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

D Q
TC = S + H
Q 2
1,500 200
TC = ($10) + ($.50) = $75 + $50 = $125
200 2

Total annual cost increases by only 25%

 An EOQ Example
Actual EOQ for new demand is 244.9 units
D = 1,000 units 1,500 units Q* = 244.9 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

D Q
TC = S + H
Q 2 Only 2% less
1,500 244.9 than the total
TC = ($10) + ($.50) cost of $125
244.9 2
when the
TC = $61.24 + $61.24 = $122.48 order quantity
was 200
 Basic Fixed-Order Quantity (EOQ) TC=Total annual
cost
Model Formula D =Demand
Total Annual Annual Annual C =Cost per unit
Annual = Purchase + Ordering + Holding Q =Order quantity
Cost Cost Cost Cost S =Cost of placing
an order or setup
cost
R =Reorder point
L =Lead time
H=Annual holding

D Q and storage cost

TC = DC + S + H per unit of inventory

Q 2
 Reorder Point Curve
Q*
Inventory level (units)

Resupply takes place as order arrives

Slope = units/day = d

ROP
(units)

Time (days)
Lead time = L
 Reorder Points
 EOQ answers the “how much” question
 The reorder point (ROP) tells “when” to
order
Demand Lead time for a
ROP = per day new order in days
=dxL
D
d = Number of working days in a year
 Deriving the EOQ
Using calculus, we take the first derivative of the total
cost function with respect to Q, and set the derivative
(slope) equal to zero, solving for the optimized (cost
minimized) value of Qopt

2D S 2(A nnual D em and)(O rder or Setup Cost)

Q O PT = =
H A nnual H olding Cost
_
We also need a
reorder point to tell us R eo rd er p o in t, R = d L
when to place an
order _
d = average daily demand (constant)
L = Lead time (constant)
 Reorder Point Example
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days
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
 EOQ Example (1) Problem Data
Given the information below, what are the EOQ and reorder point?

Annual Demand = 1,000 units

Days per year considered in average
daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
 EOQ Example (1) Solution
2D S 2(1,000 )(10)
Q O PT = = = 89.443 units or 90 units
H 2.50

1,000 units / year

d = = 2.74 units / day
365 days / year

_
R eorder point, R = d L = 2.74units / day (7days) = 19.18 or 20 u n its

In summary, you place an optimal order of 90 units. In

the course of using the units to meet demand, when
you only have 20 units left, place the next order of 90
units.
 EOQ Example (2) Problem Data

Determine the economic order quantity

and the reorder point given the following…
Annual Demand = 10,000 units
Days per year considered in average daily
demand = 365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per
unit
Lead time = 10 days
Cost per unit = $15
 EOQ Example (2) Solution
2D S 2 (1 0 ,0 0 0 )(1 0 )
Q OPT = = = 3 6 5 .1 4 8 u n its, o r 3 6 6 u n its
H 1 .5 0

10,000 units / year

d= = 27.397 units / day
365 days / year

_
R = d L = 27.397 units / day (10 days) = 273.97 or 274 u n its

Place an order for 366 units. When in the course of using the
inventory you are left with only 274 units, place the next order of 366
units.
 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
 ABC Classification System
• Items kept in inventory are not of equal
importance in terms of:
– dollars invested 60
% of
– profit potential $ Value 30 A
– sales or usage volume
0 B
% of 30 C
– stock-out penalties Use 60

So, identify inventory items based on percentage of total dollar value, where
“A” items are roughly top 15 %, “B” items as next 35 %, and the lower 50%
are the “C” items
 ABC Analysis
Percent of Percent of
Item Number of Annual Annual Annual
Stock 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%

Percent of annual dollar usage ABC Analysis
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

Percent of inventory items

 ABC Analysis

 Other criteria than annual dollar

volume may be used
 Anticipated engineering changes
 Delivery problems
 Quality problems
 High unit cost
 ABC Analysis

 Policies employed may include

 More emphasis on supplier
development for A items
 Tighter physical inventory control for
A items
 More care in forecasting A items
 Real Inventory Systems: ABC ideas
• This was the true basis of Pareto’s Economic Analysis!
• In a typical Inventory System most companies find that
their inventory items can be generally classified as:
– A Items (the 10 - 20% of SKU’s) that represent up to
80% of the inventory value
– B Items (the 20 – 30%) of the inventory items that
represent nearly all the remaining worth
– C Items the remaining 50 – 70% of the inventory
items SKU’s) stored in small quantities and/or worth
very little
 Real Inventory Systems: ABC ideas and Control

• A Items must be well studied and controlled to

minimize expense
• C Items tend to be overstocked to ensure no
runouts but require only occasional review
 Record Accuracy
 Accurate records are a critical
ingredient in production and inventory
systems
 Allows organization to focus on what
is needed
 Necessary to make precise decisions
about ordering, scheduling, and
shipping
 Incoming and outgoing record
keeping must be accurate
 Stockrooms should be secure
 Inventory Record Accuracy
• Accurate on-hand balances are needed to:
– avoid shortages
– maintain schedules
– avoid excess inventory
• (of the wrong goods)
– provide good customer service
 Inventory Record Accuracy
• Operate an effective materials management
system
• Maintain customer service
• Operate effectively and efficiently
• Analyse inventory

• The system is only as good as the data used

 Inaccurate Inventories
• Result in:
– Lost sales
– Disrupted schedules
– Excess inventory of the wrong things
– Low porductivity
– Poor delivery performance
– Excess expediting
 Causes of Inventory Errors
• Unauthorized withdrawal of material
• Unsecure stockroom
• Poorly trained personnel
• Inaccurate transaction recording
• Poor transaction recording system
– system should reduce the likelihood of human
error
• Lack of audit capability
 Measuring Inventory Record Accuracy
• Ideal is 100%
– banks
– ‘A’ items
• A tolerance may be allowed for some items
 Auditing Inventory Records
• Checking the accuracy of inventory records
• Periodic Inventory
– usually an annual count
• Cycle Counting
– daily counts of items
 Auditing Inventory Records
• To correct the on-hand balance
– periodic inventory

• To find the reasons for errors and eliminate

them
– cycle counting
 Periodic (Annual) Inventory
• To satisfy financial auditors
• Determine the value of the inventory
• Financial auditors are concerned with the total
value
• Planners are concerned with the item detail
 Taking the Physical Inventory
Taking a physical inventory is like painting; the results
depend on good preparation
– George Plossl
•Housekeeping
– sort items, precount and seal
•Identification
– identify and tag items
– use personnel familiar with the items
•Training in procedures
 Physical Inventory - Process
1. Count the items and record the count on tickets left
with the item
2. Verify the count, sampling may be used
3. Collect the tickets and list all items
4. Reconcile the inventory
update financial records
correct inventory balances
Investigate reasons for descrepancies
 Physical Inventory - Problems
• Production may be shut down
• Labor and paperwork effort
• Pressure to get the inventory completed
• People doing the inventory may not be
familiar with the items
• Errors may be introduced
Inventory Accuracy and Cycle Counting Defined

• Inventory accuracy refers to how well the

inventory records agree with physical count
• Cycle Counting is a physical inventory-taking
technique in which inventory is counted on a
frequent basis rather than once or twice a
year
 Cycle Counting
• Count inventory continually throughout the
year
• Predetermined schedule
– some items counted frequently
• depending on value
• past history of problems

• Count some items every day

 Cycle Counting
 Items are counted and records updated
on a periodic basis
 Often used with ABC analysis
to determine cycle
 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- Advantages
• Timely correction of errors
• Reduction of lost production
• Use of trained personnel
– familiar with the items
– fewer errors
– able to identify problems
 Count Frequency
• The number of times each item is counted per
year
• Increases by:
– the value or critical nature of the item
– the number of transactions per year
• chances of error
– a past history of problems with the item
 Count Frequency - Methods
• ABC method
– management establishes a rule for how many
times an item should be counted per year
• e.g. ‘A’ items once per month, ‘B’ items quartery, ‘C’
items twice per year
– a mix of all items is counted every day
• computerized systems can identify daily lists of items to
count
 Scheduling Cycle Counts

Count Number of
Number Number
Classification Frequency Counts
of Items of Counts
per Year per Day

A 1000 12 12,000 48*

B 1500 4 6000 24
C 2500 1 2500 10

Total Count 20,500

Workdays per Year 250
Counts per Day 82

* Counts per day = 82 * 12,000 / 20,500

 Scheduling Cycle Counts - Example
Problem

Count Number of
Number Number
Classification Frequency Counts
of Items of Counts
per Year per Day

A 2000 12
24,000 96
B 3000 4
12,000 48
C 5000 2
10,000 40

Total Count
Workdays per Year
46,000
250
Counts per Day 184
 Count Frequency Methods - Continued

• Zone Method
– used with:
– fixed location system
– work-in-process counts
– in-transit inventory counts
• Location Audit
– verifies location of goods
 Cycle Counting - When to Count
• Counts items when errors are likely to have occurred
– when an order is placed
• detects errors when stock is low
– when an order is received
• stock is at its lowest
– when inventory reaches zero
– when an error occurs
• inventory shows negative or there is no stock when
there should be
 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)

Item Number of Items

Class Quantity Cycle Counting 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 on incoming shipments
3. Effective control on all goods leaving
facility
 Transaction System
1. Identfy the item
– quantity, location, part number
2. Verify quantity
– standard size containers if possible
3. Record the transaction
– manual or computerized
4. Physically execute the transaction
– move the goods
 Physical Control and Security

• Limited access
– locked
– to ensure transactions are completed
• A well trained workforce
– to ensure transactions are completed
– familiar with handling the goods
 Technology Applications
• Bar Codes
– paper labels which show a product code
• RF Tags
– Radio Frequency
– do not need to ‘see’ the item
• Reduce recording errors
• Improve transaction speed
Thank You
 Session 5

Materials Requirements
Planning
 Topics to be Discussed
• Material Requirements Planning (MRP)
• MRP Logic and Product Structure Trees- Develop a
product structure
• Time Fences- MRP Example- Build a gross
requirements plan and a net requirements plan
• Lot Sizing- Determine lot sizes for lot-for-lot, EOQ,
and POQ
• MRP II (Next Class)
• Describe closed-loop MRP(Next Class)
• Describe ERP(Next Class)
 Material Requirements Planning

• Materials requirements planning (MRP) is a

means for determining the number of parts,
components, and materials needed to produce a
product.
• MRP provides time scheduling information
specifying when each of the materials, parts, and
components should be ordered or produced
• Dependent demand drives MRP
• MRP is now-a-days a software system
 An Overview of MRP

MRP uses the concept of backward scheduling to

determine how much and when to order and replenish
• The CPR module checks to make sure the scheduled
work load profile is feasible
• The MPS module contains the authorized schedule
• The BOM module contains the product structure for
each unique product
• MRP output includes schedules for all internal activities
and parts as well as orders for all supply chain items.
 MRP
► Four Key Tasks
► Material plan must meet both the requirements of
the master schedule and the capabilities of the
production facility
► Plan must be executed as designed
► Minimize inventory investment
► Maintain excellent record integrity
Schematic of MRP System
 Material Requirements Planning (MRP)

• Computer-based information system that

schedules and orders dependent-demand
inventory components;
• Uses the master production schedule, bills of
materials, and inventory records as inputs;
• Outputs recommendations:
– When to release new orders
– When to reschedule open orders.
Input/Output - MRP Process
 MRP Structure
Data Files Output Reports

MRP by
BOM Master period report
production schedule
MRP by
date report

Lead times
(Item master file) Planned order
report

Inventory data
Purchase advice
Material
requirement
planning
programs
(computer and Exception reports
Purchasing data software)
Order early or late
or not needed

Order quantity too

small or too large
 321

Aggregate Forecasts
Firm orders
product of demand
from known
plan from random
customers
customers

Engineering Master production

Schedule (MPS) Inventory
design
transactions
changes
Material
planning
Bill of (MRP Inventory
material computer record file
file program)

Primary reports Secondary reports

Exception reports
Planned order schedule for Planning reports
inventory and production control Reports for performance control
 Material Requirements Planning System

• Based on a master production schedule, a material

requirements planning system:
– Creates schedules identifying the specific parts
and materials required to produce end items
– Determines exact unit numbers needed
– Determines the dates when orders for those
materials should be released, based on lead
times
 Objectives of MRP

• Determines the quantity and timing of

material requirements
– Determines what to order (checks BOM), how
much to order (lot size rules), when to place the
order (need date minus lead time), and when to
schedule delivery (on date needed)
• Maintain priorities
– In a changing environment, MRP reorganizes
priorities to keep plans current and viable
 Types of Demand

There are two types of demand.

• Independent Demand
– Is the demand for finished products
– Does not depend on the demand of other products
– Needs to be forecasted
• Dependent Demand
– Is the demand derived from finished products
– Is the demand for component parts based on the number of
end items being produced and is managed by the MRP
system
 Benefits of MRP

1. Better response to customer orders

2. Faster response to market changes
3. Improved utilization of facilities and
labor
4. Reduced inventory levels
 Dependent Inventory Model
Requirements
Effective use of dependent demand
inventory models requires the following
1. Master production schedule
2. Specifications or bill of material
3. Inventory availability
4. Purchase orders outstanding
5. Lead times
Master Production Schedule (MPS)
▶ Specifies what is to be made and when
▶ Must be in accordance with the aggregate
production plan
▶ Inputs from financial plans, customer demand,
engineering, supplier performance
▶ As the process moves from planning to
execution, each step must be tested for
feasibility
▶ The MPS is the result of the production planning
process
Master Production Schedule (MPS)
▶ MPS is established in terms of specific products
▶ Schedule must be followed for a reasonable
length of time
▶ The MPS is quite often fixed or frozen in the
near term part of the plan
▶ The MPS is a rolling schedule
▶ The MPS is a statement of what is to be
produced, not a forecast of demand
 Master Production Schedule (MPS)

• Time-phased plan specifying how many and

when the firm plans to build each end item

Aggregate Plan
(Product Groups)

MPS
(Specific End Items)
 Bill of Materials (BOM) File
A Complete Product Description
• Materials
• Parts
• Components
• Production sequence
• Modular BOM
– Subassemblies
• Super BOM
– Fractional options
Bills of Material (Product Structure Tree)

▶ List of components, ingredients, and

materials needed to make product
▶ Provides product structure
▶ Items above given level are called parents
▶ Items below given level are called
components or children
 BOM Example

Level Product structure for “Awesome” (A)

0 A

1 B(2) C(3)

2 E(2) E(2) F(2)

3 D(2) G(1) D(2)

 BOM Example
For an order of 50 Awesome speaker kits

Level Product structure for “Awesome” (A)

0 B:
Part 2 x number of As = A (2)(50) = 100
Part C: 3 x number of As = (3)(50) = 150
Part
1 D: B2(2)x number of Bs C(3)
+ 2 x number of Fs = (2)(100) + (2)(300) = 800
Part E: 2 x number of Bs
2 +2E x number of Cs = (2)(100)E+ (2)(150) = F500
(2) (2) (2)
Part F: 2 x number of Cs = (2)(150) = 300
Part G: 1 x number of Fs = (1)(300) = 300
3 D(2) G(1) D(2)
Let’s look at another example of BOM...

Question:
How many D’s we need in order
to produce 50 A’s?

B(2) C(1)

D(3) E(3) D(1)

 Bills of Material
▶ Modular BOMs
▶ Modules are not final products but components
that can be assembled into multiple end items
▶ Can significantly simplify planning and scheduling
 Bills of Material
▶ Planning BOMs
▶ Also called “pseudo” or super bills
▶ Created to assign an artificial parent to the
BOM
▶ Used to group subassemblies to reduce the
number of items planned and scheduled
▶ Used to create standard “kits” for production
 Bills of Material

• Phantom BOMs
– Describe subassemblies that exist only temporarily
– Are part of another assembly and never go into
inventory
• Low-Level Coding
– Item is coded at the lowest level at which it occurs
– BOMs are processed one level at a time
 Time Fences
• Frozen
– No schedule changes allowed within this window
• Moderately Firm
– Specific changes allowed within product groups as
long as parts are available
• Flexible
– Significant variation allowed as long as overall
capacity requirements remain at the same levels
 Safety Stock
▶ BOMs, inventory records, purchase and
production quantities may not be perfect
▶ Consideration of safety stock may be prudent
▶ Should be minimized and ultimately
eliminated
▶ Typically built into projected on-hand
inventory
 MRP Management
▶ MRP dynamics
▶ Facilitates re-planning when changes occur
▶ System nervousness can result from too
many changes
▶ Time fences put limits on re-planning
▶ Pegging links each item to its parent allowing
effective analysis of changes
 MRP Management
▶ MRP limitations
▶ MRP does not do detailed scheduling–it plans
▶ Works best in product-focused, repetitive
environments
▶ Requires fixed lead time and infinite size time
buckets
 MRP Outputs
There are two outputs and a variety of messages/reports:
• Output 1 is the "Recommended Production Schedule"
which lays out a detailed schedule of the required
minimum start and completion dates, with quantities, for
each step of the Routing and Bill Of Material required to
satisfy the demand from the Master Production Schedule
(MPS).
• Output 2 is the "Recommended Purchasing Schedule".
This lays out both the dates that the purchased items
should be received into the facility AND the dates that the
Purchase Orders, or Blanket Order Release should occur to
match the production schedules.
 Primary MRP Reports

• Planned orders to be released at a future time

• Order release notices to execute the planned
orders
• Changes in due dates of open orders due to
rescheduling
• Cancellations or suspensions of open orders due
to cancellation or suspension of orders on the
master production schedule
• Inventory status data
 Secondary MRP Reports

• Planning reports, for example, forecasting

inventory requirements over a period of time
• Performance reports used to determine
agreement between actual and programmed
usage and costs
• Exception reports used to point out serious
discrepancies, such as late or overdue orders
 MRP Action Notices

• Action Notices:
– Indicate items that need a production planner’s
attention
– Are created when a planned order needs to be
released, due dates need to be adjusted, or when
there is insufficient lead time for normal
replenishment
– Often require planners to rush or expedite orders
 MRP Action Notices

• Action Bucket:
– Is the current period where we take actions such as
releasing, rescheduling, or canceling orders
– A positive quantity in current period’s planned order
row means that an order must be released
 Benefits of MRP
The MRP is a framework for providing useful information
for decision makers. The key to realizing the benefits from
any MRP system is the ability of the inventory planner to
use the information well. The specific benefits of MRP
include the following:
• Increased customer service and satisfaction
• Improved utilization of facilities and personnel
• Better inventory planning and scheduling
• Faster response to market changes and shifts
• Reduced inventory levels without reduced customer
service
 Benefits of MRP
The MRP is also a very powerful tool since it takes
into consideration changes in certain
assumptions especially under uncertain
conditions, especially when the inputs to the
MRP system change because of the following
realities in the production area:
• Delays in scheduled receipts
• Changes in planned order sizes because of
capacity constraints
• Changes in gross requirements which dictate
changes in lot sizes at sub-component levels
 Benefits of MRP

• Unavailability of raw materials for one sub-component

which negates the need for a fellow subcomponent as
both must be ready for the parent production
• Utilization of same parts at different levels indicating
the need to restructure the bill of materials and
• Presence of price discounts or some other features
which makes it advisable to purchase more than the
anticipated need
 Problems with MRP systems
• The major problem with MRP systems is the integrity of the data. If
there are any errors in the inventory data, the bill of materials
(commonly referred to as 'BOM') data, or the master production
schedule, then the outputted data will also be incorrect
(colloquially, "GIGO": Garbage In, Garbage Out).
• Data integrity is also effected by inaccurate cycle count
adjustments, mistakes in receiving input and shipping output, scrap
not reported, waste, damage, box count errors, supplier container
count errors, production reporting errors, and system issues. Many
of these types of errors can be minimized by implementing pull
systems and using bar code scanning. Most vendors of this type of
system recommend at least 99% data integrity for the system to
give useful results.
 Problems with MRP systems

Another major problem with MRP systems is the

requirement that the user specify how long it will take
a factory to make a product from its component parts
(assuming they are all available). Additionally, the
system design also assumes that this "lead time" in
manufacturing will be the same each time the item is
made, without regard to quantity being made, or other
items being made.
 Accurate Inventory Records
▶ Accurate inventory records are
absolutely required for MRP (or any
dependent demand system) to operate
correctly
▶ Generally MRP systems require more
than 99% accuracy
Purchase Orders Outstanding
▶ A by-product of well-managed
purchasing and inventory control
department
▶ Outstanding purchase orders must
accurately reflect quantities and
scheduled receipts
 How does MRP work?
The goal of the MRP or Material Requirements Planning
document is to supply information that will enable
the company
• to have enough inventory on hand to fulfill demand, (and
no more)
• available only when needed, (and no sooner)
• at a quality level that meets specification, (but does not
have to exceed it) and
• at the lowest price.

A good MRP or Material Requirements Planning program can

provide the basic needs of keeping inventory levels low and
fulfilling customer expectations for on time delivery.
 How does MRP work?
There are two important questions to ask here. How
much of an item is needed? When is an item needed to
complete a specified number of units, in a specified
period of time? The MRP process involves the
following steps:
• Determine the gross requirements for a particular item
• Determine the net requirements and when orders will
be released for fabrication or subassembly
• Net Requirements = Total Requirements – Available
Inventory
• Net Requirements = (Gross Requirements +
Allocations) – (On Hand) + Scheduled Receipts
 How does MRP work?
Develop a master production schedule for the end
item (this is the output of the aggregate / production
planning). The MPS is adjusted accordingly, as follows:
• Create schedules identifying the specific parts and
materials required to produce the end items. The bill of
materials will be useful here
• Determines the exact numbers needed
• Determines the dates when orders for those materials
should be released, based on lead times
 Additional MRP Scheduling Terminology

• Gross Requirements

• Scheduled receipts

• Projected available balance

• Net requirements

• Planned order receipt

• Planned order release

 MPR Processing
• Gross requirements
– Total expected demand
• Scheduled receipts
– Open orders scheduled to arrive
• Planned on hand
– Expected inventory on hand at the beginning of each time period
• Net requirements
– Actual amount needed in each time period
• Planned-order receipts
– Quantity expected to received at the beginning of the period
– Offset by lead time
• Planned-order releases
– Planned amount to order in each time period
Example of MRP Logic and Product Structure Tree
Given the product structure tree for “A” and the lead time and
demand information below, provide a materials requirements
plan that defines the number of units of each component and
when they will be needed
Product Structure Tree for Assembly A Lead Times
A 1 day
A B 2 days
C 1 day
D 3 days
E 4 days
B(4) C(2) F 1 day
Total Unit Demand
Day 10 50 A
D(2) E(1) D(3) F(2) Day 8 20 B (Spares)
Day 6 15 D (Spares)
 First, the number of units of “A” are scheduled
backwards to allow for their lead time. So, in the
materials requirement plan below, we have to place
an order for 50 units of “A” on the 9th day to receive
them on day 10.

Day: 1 2 3 4 5 6 7 8 9 10
A Required 50
Order Placement 50

LT = 1 day
 Next, we need to start scheduling the components that make up
“A”. In the case of component “B” we need 4 B’s for each A.
Since we need 50 A’s, that means 200 B’s. And again, we back
the schedule up for the necessary 2 days of lead time.
Day: 1 2 3 4 5 6 7 8 9 10
A R e q u ire d 50
O rd e r P la c e m e n t 50
B R e q u ire d 20 200
O rd e r P la c e m e n t 20 200

LT = 2
Spares
A
4x50=200

B(4) C(2)

D(2) E(1) D(3) F(2)

 363
Finally, repeating the process for all components, we have the
final materials requirements plan:
Day: 1 2 3 4 5 6 7 8 9 10
A Required 50
LT=1 Order Placement 50
B Required 20 200
LT=2 Order Placement 20 200
C Required 100
LT=1 Order Placement 100
D Required 55 400 300
LT=3 Order Placement 55 400 300
E Required 20 200
LT=4 Order Placement 20 200
F Required 200
LT=1 Order Placement 200

Part D: Day 6
B(4) C(2) 40 + 15 spares

D(2) E(1) D(3) F(2)

 Determining Gross
Requirements
▶ Starts with a production schedule for the end
item – 50 units of Item A in week 8
▶ Using the lead time for the item, determine the
week in which the order should be released –
a 1 week lead time means the order for 50
units should be released in week 7
▶ This step is often called “lead time offset” or
“time phasing”
 Determining Gross
Requirements
▶ From the BOM, every Item A requires 2 Item
Bs – 100 Item Bs are required in week 7 to
satisfy the order release for Item A
▶ The lead time for the Item B is 2 weeks –
release an order for 100 units of Item B in
week 5
▶ The timing and quantity for component
requirements are determined by the order
release of the parent(s)
 Determining Gross
Requirements
▶ The process continues through the entire
BOM one level at a time – often called
“explosion”
▶ By processing the BOM by level, items with
multiple parents are only processed once,
saving time and resources and reducing
confusion
▶ Low-level coding ensures that each item
appears at only one level in the BOM
 BOM Example

Level Product structure for “Awesome” (A)

0 A

1 B(2) C(3)

2 E(2) E(2) F(2)

3 D(2) G(1) D(2)

 Gross Requirements Plan
Gross Material Requirements Plan for 50 Awesome Speaker Kits (As)
TABLE
with Order Release Dates Also Shown
WEEK
1 2 3 4 5 6 7 8 LEAD TIME
A. Required date 50
Order release date 50 1 week
B. Required date 100
Order release date 100 2 weeks
C. Required date 150
Order release date 150 1 week
E. Required date 200 300
Order release date 200 300 2 weeks
F. Required date 300
Order release date 300 3 weeks
D. Required date 600 200
Order release date 600 200 1 week
G. Required date 300
Order release date 300 2 weeks
Let’s look at an example BOM...

B(2) C(1)

D(3) E(3) D(1)

How do we manage order release?

We need information on delivery times!

Parts-Product Process Lead Time

A 10
B 15
C 10
D 15
E 10
Let’s look at an example BOM...
(10)
A

Question:
When do we start
producing/ordering each part?

B(2) (15) C(1) (10)

(15)

(10) (15)
D(3) E(3) D(1)
Let’s assume that we need 50 units of A…

Delivery
date for
final
5 days product

Parts-Products
A
B
C
D
E
Let’s assume that we need 50 units of A…

Start
assembly
for 50 units
of A

Parts-Products
A
B
C
D
E
Let’s assume that we need 50 units of A…

Start
assembly
for 100
units of B

Parts-Products
A
B
C
D
E
Let’s assume that we need 50 units of A…

Start
assembly
for 50 units
of C

Parts-Products
A
B
C
D
E
Let’s assume that we need 50 units of A…

Order 300
units of D
for B’s
process

Parts-Products
A
B
C
D
E
Let’s assume that we need 50 units of A…

Order 50
units of D
for C’s
assembly

Parts-Products
A
B
C
D
E
Let’s assume that we need 50 units of A…

Order 50
units of E
for C’s
assembly

Parts-Products
A
B
C
D
E
 Session 6

Capacity Planning
Sales & Operations Planning
Key concept of JIT/ ERP

381
 MRP Evolution
MRP Schedule Materials

Closed Loop Schedule Materials

MRP Incorporate Feedback

Schedule & Purchase

MRP II Materials
Coordinate with Mfg
Resources

ERP
TOPICS TO BE DISCUSSED

▶ Closed-Loop MRP
▶ DRP
▶ MRP II
▶ ERP
▶ Sales and Operations Planning
▶ Capacity Planning, Break Even Analysis,
NPV
▶ JIT, KANBAN
 Closed-Loop MRP System

Aggregate Plan

OK?
NO Priority Management Capacity Management

Develop Master Production Evaluate Resource Availability

Schedule (Rough Cut)
OK?
NO OK? YES Planning
Prepare Materials Determine Capacity Availability
Requirements Pan
OK? YES
Execution
Detailed Production Implement Input/Output Control (in repetitive
Activity Control systems JIT
(Shop Scheduling/Dispatching) techniques
are used)

384
 Closed Loop MRP
Production Planning
Master Production Scheduling
Material Requirements Planning
Capacity Requirements Planning

No
Realistic? Feedback
Feedback
Yes
Execute:
Capacity Plans
Material Plans

385
Distribution Resource Planning (DRP)
Using dependent demand techniques
through the supply chain
► Expected demand or sales forecasts become
gross requirements
► All other levels are computed
► DRP pulls inventory through the system
► Small and frequent replenishments

386
 MRP II
▶ Requirement data can be
enriched by other resources
▶ Generally called MRP II or
Manufacturing Resource Planning
▶ Outputs can include scrap,
packaging waste, effluent,
carbon emissions
▶ Data used by purchasing, production
scheduling, capacity planning, inventory,
warehouse management
387
Manufacturing Resource Planning (MRP II)
• Goal: Plan and monitor all resources of a
manufacturing firm (closed loop):
– manufacturing
– marketing
– finance
– engineering
• Simulate the manufacturing system

388
Enterprise Resource Planning (ERP)
▶ An extension of the MRP system to tie in
customers and suppliers
1. Allows automation and integration of many
business processes
2. Shares common data bases and business
practices
3. Produces information in real time
▶ Coordinates business from supplier
evaluation to customer invoicing

389
Enterprise Resource Planning (ERP)
▶ ERP modules include
▶ Basic MRP
▶ Finance
▶ Human resources
▶ Supply chain management (SCM)
▶ Customer relationship management (CRM)
▶ Sustainability

390
 Enterprise Resource Planning

• ERP is software designed for organizing and

managing business processes
– Modules share information across all business
functions
– Can share customer sales data with the supply
chain to help with global replenishment
– All modules are fully integrated and use a
common database – some PC based

391
Integration of ERP

392
Typical ERP System

393
 ERP Modules-4 Categories

• Finance and accounting

– Investment, cost, asset, capital, and debt management
– Budgets, profitability analysis, and performance
reports
• Sales and marketing
– Handles pricing, availability, orders, shipments, &
billing
• Production and materials management
– Process planning, BOM, product costing, ECN’s, MRP,
allocates resources, schedules, PO’s, & inventory
• Human resources
– Workforce planning, payroll & benefits, & org. charts
394
 Evolution of ERP

• First generation ERP

– Managed all routine internal business activities
• From order entry to after-sales customer service
– Lacked supply chain support modules (added in
second generation)

395
 Evolution of ERP

• Second Generation ERP

– Late 1990’s software integrated supply chains
– Systems focused on decision-making
– SCM modules include linear programming (LP) and
simulation support
– SCI capability allows collection of intelligence
along the entire supply chain
– ASP suppliers set-up and run systems for others

396
 Integrating ERP and E-Commerce

• Many companies with ERP use e-commerce

• E-commerce needs to interface with ERP
• Cybex International is a good example:
– Needed to integrate B2C and B2B transactions
– Cybex installed a Peoplesoft, Inc. ERP system
– Reduced BOM’s from 15,200 to 200, suppliers
from 1000 to 550, paperwork by 2/3
– Reduced supplier material shortages and customer
order-to-ship time from 4 to 2 weeks
397
 Benefits of ERP

• ERP presents a holistic view of the business functions from a

single information and IT architecture
• Increases organizational information flow
• Increases ability to incorporate better management control,
speedier decision making, and cost reductions
• Allows replacement of disparate systems
e.g. ExxonMobile used ERP to replace 300 different systems
• A study of ERP implementations reports that benefits typically
start 8 months after implementation with median annual
savings of $1.6 million

398
 The Cost of ERP Systems

• Major suppliers are SAP AG, Peoplesoft,

Oracle, and Baan. Also smaller PC based
suppliers.
• Costs for larger ERP systems range from
hundreds of thousands to several million
dollars.
• Outside consultants are usually involved in
selection, configuration, & implementation.
399
 The Cost of ERP Systems

• Consultant costs can run up to 3 times the

cost of the system itself.
• Added costs also include additional people,
new computer hardware, and the cost to
develop a new, integrated database
• Successful implementation requires
leadership and top management commitment
to a vision for the business
400
 Major ERP Providers
Firm HQ Acquisitions
SAP Germany

Oracle US People Soft

JD Edwards
Sage Group UK

Microsoft US

Infor US SSA
Baan

401
ERP and MRP

402
 ERP and MRP
Customer Relationship Management

Sales Order Shipping

(order entry, Distributors,
Invoicing product configuration, retailers,
sales management) and end users

403
 ERP and MRP
Master
Production
Schedule

Inventory Bills of
Management Material
MRP

Work
Orders

Purchasing Routings
and and
Lead Times Lead Times
Table 13.6

404
 ERP and MRP

Supply-Chain Management
Vendor Communication
(schedules, EDI, advanced shipping notice,
e-commerce, etc.)

405
 Finance/
ERP and MRP
Accounting

Accounts
Receivable

General
Ledger

Accounts
Payable

Payroll

Table 13.6

406
Enterprise Resource Planning (ERP)

▶ ERP systems have the potential to

▶ Reduce transaction costs
▶ Increase the speed and accuracy of
information
▶ Facilitates a strategic emphasis on JIT
systems and supply chain integration
▶ Can be expensive and time-consuming
to install
407
 ERP in the Service Sector
▶ ERP systems have been developed for
health care, government, retail stores,
hotels, and financial services
▶ Also called efficient consumer response
(ECR) systems
▶ Objective is to tie sales to buying,
inventory, logistics, and production

409
 Reasons to Implement ERP

• Desire to standardize and improve processes

• To improve the level of systems integration
• To improve information quality

410
 ERP Drawbacks
• Cost
– $250M+ for a Fortune 100 company
• Transition pain
– Implementation resources
– Training
– Resistance to change

411
 Resource Planning Across the
Organization

• Since MRP determine the quantity and

timing of materials needed, it affects several
functional areas
– Accounting future material commitments based
on MRP output
– Marketing is primarily concerned with MPS as
the MRP reveals potential material shortages
– Information systems maintains the MRP and the
MPS

414
 Sales and Operations Planning

• Determines the resource capacity needed to meet demand

over an intermediate time horizon
– Aggregate refers to sales and operations planning for product lines or
families
– Sales and Operations planning (S&OP) matches supply and demand
• Objectives
– Establish a company wide game plan for allocating resources
– Develop an economic strategy for meeting demand

415
Traditional conflicts between sales and operations
groups must be resolved to reach consensus

Figure Planning Process Conflicts

416
Sales and Operations Planning Process

417
The Planning Process
Long-range plans (over one year)
Capacity decisions critical to long range plans
Issues:
Research and Development
New product plans
Capital investments
Facility location/expansion
Top
executives Intermediate-range plans (3 to 18 months)
Issues:
Sales and operations planning
Production planning and budgeting
Operations Setting employment, inventory,
managers with subcontracting levels
sales and Analyzing operating plans
operations Short-range plans (up to 3 months)
planning team Scheduling techniques
Issues:
Job assignments
Operations Ordering
managers, Job scheduling
supervisors, Dispatching
foremen Overtime
Part-time help
Responsibility Planning tasks and time horizons

418
 Sales and Operations Planning
▶ Coordination of demand forecasts with
functional areas and the supply chain
▶ Typically done by cross-functional teams
▶ Determine which plans are feasible
▶ Limitations must be reflected
▶ Provides warning when resources do not
match expectations
▶ Output is an aggregate plan
419
 Sales and Operations Planning
▶ Decisions must be tied to strategic
planning and integrated with all areas of
the firm over all planning horizons
▶ S&OP is aimed at
1. The coordination and integration of the
internal and external resources necessary
for a successful aggregate plan
2. Communication of the plan to those charged
with its execution
420
 Sales and Operations Planning
▶ Requires
▶ A logical overall unit for measuring sales and
output
▶ A forecast of demand for an intermediate
planning period in these aggregate terms
▶ A method for determining relevant costs
▶ A model that combines forecasts and costs so
that scheduling decisions can be made for the
planning period

421
 Aggregate Planning

The objective of aggregate

planning is usually to meet
forecast demand while minimizing
cost over the planning period

422
 Demand planning
• Demand management system is the information technology
component of the sales and operations planning (S&OP)
process
• Demand management develops the forecasts used by other
supply chain processes to anticipate sales levels
– Demand management processes must integrate
• Historical forecasts
• Promotional plans
• Pricing changes
• New product introductions
• Forecasts are then used to determine production and
inventory requirements
• Must maintain forecast data consistency across multiple
products and warehouse facilities

423
 Production planning
• Production planning uses requirements from demand
management to develop a realistic manufacturing plan
– Must integrate with manufacturing resources and constraints

• Requirements plan defines what items are needed and when

• Production planning systems match the requirements plan

with the production constraints
– Limitations include facility, equipment and labor availability

• Effective planning creates a time-sequenced plan to

manufacture the correct items in a timely manner while
operating within constraints

424
 Logistics planning
• Logistics planning integrates overall movement
demand, vehicle availability, and relevant movement
cost into a decision support system that seeks to
minimize overall freight expense
– Analysis suggests ways freight can be shifted among
carriers or consolidated to lower expenses
• Overcomes these problems resulting from individual
perspectives
– Limited economies of scale
– Limited information sharing
– Excessive transportation expense

425
 Making S&OP work in an organization
requires senior leadership involvement

• Functional leadership from all key operating

areas must be committed to the S&OP
process and be responsible for achieving
success
– Tie manager’s compensation to successful S&OP
performance
– Include regular involvement and accountability
at the general management level

426
 427

8 keys to successful S&OP implementation

• Executing the process every month
• Process ownership and clarity of roles and
responsibilities
• Organizational commitment to achieving high
forecast accuracy
• Focus should be on the next 3 to 12 months
• One integrated plan that integrates the actions of
the entire organization
• Senior management decision making
• Measuring end-to-end supply chain performance
• S&OP forecast versus operating plan or budget
 CAPACITY PLANNING
• CAPACITY
– Defining Capacity
– Capacity and Strategy
– Capacity Considerations
– Managing Demand

• CAPACITY PLANNING

• BREAKEVEN ANALYSIS
– Single-Product Case
– Multiproduct Case
428
 Capacity strategy

Configuring Capacity Capacity Dynamics

Timing of change

Magnitude of change

Capacity Dynamics
Overall Type of Location
level of capacity of
capacity capacity

429
 Capacity Planning Process
Develop Quantitative
Forecast
Alternative Factors
Demand
Plans (e.g., Cost)

Compute Evaluate Qualitative

Rated Capacity Factors
Capacity Plans (e.g., Skills)

Compute Select Best

Implement
Needed Capacity
Best Plan
Capacity Plan

430
 Definition and Measures of Capacity
Capacity: The “throughput,” or number of units a facility can
hold, receive, store, or produce in a period of time.
Effective Capacity a firm can expect to receive given its product
capacity: mix, methods of scheduling, maintenance, and
standards of quality.
Utilization: Actual output as a percent of design capacity. Measure
of planned or actual capacity usage of a facility, work
center, or machine
Actual output as a percent of effective capacity. Measure of
Efficiency:
how well a facility or machine is performing when used.

Actual (or Expected) Output =

(Effective Capacity) * (Efficiency)

431
Implications of Capacity Changes

Changes in:
• Sales
• Cash flow
• Quality
• Supply chain
• Human resources
• Maintenance

432
 Special Requirements for Making Good
Capacity Decisions
• Forecast demand accurately
• Understanding the technology and capacity
increments
• Finding the optimal operating level (volume)
• Build for change

433
Strategies for Matching Capacity to Demand
1. Making staffing changes (increasing or decreasing
the number of employees)
2. Adjusting equipment and processes – which might
include purchasing additional machinery or selling
or leasing out existing equipment
3. Improving methods to increase throughput;
and/or
4. Redesigning the product to facilitate more
throughput

434
 Capacity Bottlenecks

To
Inputs 1 2 3
customers
200/hr 50/hr 200/hr

(a) Operation 2 a bottleneck

Figure 8.2
 Capacity Bottlenecks

To
Inputs 1 2 3
customers
200/hr 200/hr 200/hr

(b) All operations bottlenecks

Figure 8.2
 Theory of Constraints

1. Identify the system

bottleneck(s)
2. Exploit the bottleneck(s)
3. Subordinate all other decisions
to step 2
4. Elevate the bottleneck(s)
5. Do not let inertia
set in
 Economies and
Diseconomies of Scale
250-
bed
Average unit cost

hospital
(dollars per
patient)

Output rate (patients per week)

 Economies and
Diseconomies of Scale
250-
bed 500-bed
Average unit cost

hospital hospital
(dollars per
patient)

Output rate (patients per week)

 Economies and
Diseconomies of Scale
250-
bed 500-bed
Average unit cost

hospital hospital
(dollars per
patient)

Economies
of scale

Output rate (patients per week)

 Economies and
Diseconomies of Scale
250- 750-
bed 500-bed bed
Average unit cost

hospital hospital hospita

(dollars per

l
patient)

Economies
of scale

Output rate (patients per week)

 Economies and
Diseconomies of Scale
250- 750-
bed 500-bed bed
Average unit cost

hospital hospital hospita

(dollars per

l
patient)

Economies Diseconomie
of scale s of scale

Output rate (patients per week)

 Breakeven Analysis

Technique for evaluating process & equipment

alternatives
Objective: Find the point ($ or units) at which total
cost equals total revenue
Assumptions
– Revenue & costs are related linearly to volume
– All information is known with certainty
– No time value of money

443
 Break-Even Analysis

• Fixed costs: costs that continue even if no units are produced:

depreciation, taxes, debt, mortgage payments
• Variable costs: costs that vary with the volume of units
produced: labor, materials, portion of utilities

• BEP ($) = ____Total Fixed Cost_________

1 - ( Variable Cost / Selling Price)

• BEP (units) = ____Total Fixed Cost____

Price – Variable Cost

444
 Breakeven Chart

Total revenue line

Breakeven point Profit
Total cost = Total revenue
Total cost line
Cost in Dollars

Variable cost

Loss Fixed cost

Volume (units/period)

445
 Net Present Value
F = future value
P = present value
r = interest rate
N = number of years

F
P
(i  1) N

446
 NPV in a More Convenient Form
Present value of $1.00
Year 5% 6% 7% 8%
F
1 0.952 0.943 0.935 0.857 P
(r  1)
N
2 0.907 0.890 0.873 0.857

3 0.864 0.840 0.816 0.794

4 0.823 0.792 0.763 0.735

5 0.784 0.747 0.713 0.681

P  FX
1
where X 
6 0.746 0.705 0.666 0.630

7 0.711 0.665 0.623 0.583 (r  1 ) N

8 0.677 0.627 0.582 0.540

9 0.645 0.592 0.544 0.500

447
 Managing Existing Capacity

Demand Management Capacity Management

 Vary prices • Vary staffing
 Vary promotion • Change equipment
& processes
 Change lead times
(e.g., backorders) • Change methods
• Redesign the product for
 Offer complementary
faster processing
products

448
 Just-in-time

• Producing only what is needed and when it is

needed
• A philosophy
• An integrated management system

449
 Just-in-time

• Theme: eliminate all waste including the ones caused by:

– inventory management
– supplier selection
– defective parts
– scheduling of production and delivery
– information system

450
 Examples Of Waste

• Watching a machine run

• Waiting for parts
• Counting parts
• Overproduction
• Moving parts over long
distances
• Storing inventory
• Looking for tools
• Machine breakdown
• Rework

451
 Some Elements Of JIT

1. Focused factory (small specialized plants) networks

2. Grouped Technology: Cellular layouts
3. Quality at the source
4. Flexible resources
5. Pull production system
6. Kanban production control
7. Small-lot production and purchase
8. Quick setups
9. Supplier networks

452
 Kaizen

• Continuous improvement
• Requires total employment involvement
• The essence of JIT is the willingness of workers to
• spot quality problems,
• halt production when necessary,
• generate ideas for improvement,
• analyze problems, and
• perform different functions

454
 Pull Production System

• In a push system, a schedule is prepared in advance

and as soon as one process completes its work, its
products are sent to the next process.
• In a pull system, workers take the parts or materials
from the preceding stations as needed. Workers at
the preceding stations may produce the next unit only
after their outputs are taken by the workers in the
subsequent processes.
• Although the concept of pull production seems
simple, it can be difficult to implement. Kanbans are
introduced to implement the pull system.

455
 A Single-Card Kanban System

Consider the fabrication cell that feeds two assembly lines.

1. As an assembly line needs more parts, the kanban card
for those parts is taken to the receiving post and a full
container of parts is removed from the storage area.
2. The receiving post accumulates cards for both assembly
lines and sequences the production of replenishment
parts.

456
 A Two-Card System
1. When the number of tickets on the withdrawal kanban
reaches a predetermined level, a worker takes these
tickets to the store location.

2. The workers compares the part number on the

production ordering kanban at the store with the part
number on the withdrawal kanban.

3. The worker removes the production ordering kanban

from the containers, places them on the production
ordering kanban post, and places the withdrawal
kanbans in the containers.

457
 A Two-Card System (Cont.)
4. When a specified number of production ordering
kanbans have accumulated, work center 1 proceeds
with production.

5. The worker transports parts picked up at the store to

work center 2 and places them in a holding area until
they are required for production.

6. When the parts enter production at work center 2, the

worker removes the withdrawal kanbans and places
them on the withdrawal kanban post.

458
 Types Of Kanbans

• Kanban Square
– marked area designed to hold items
• Signal Kanban
– triangular kanban used to signal production at
the previous workstation
• Material Kanban
– used to order material in advance of a process
• Supplier Kanban
– rotates between the factory and supplier

459
 Small-Lot Production

• Requires less space & capital investment

• Moves processes closer together

• Makes quality problems easier to detect

• Makes processes more dependent on each other

460
 Benefits Of JIT

1. Reduced inventory 7. Greater flexibility

2. Improved quality 8. Better relations with
3. Lower costs suppliers
4. Reduced space 9. Simplified scheduling
requirements and control activities
5. Shorter lead time 10. Increased capacity
6. Increased productivity 11. Better use of human
resources
12. More product variety
 Industrial and Operational
Management
Course Content
1. Theory of Constraints “TOC” – Lean Manufacturing
2. Throughput Accounting
3. Lean Six Sigma
4. Leadership
5. Sustainability
 Theory of Constraints

• The Big Idea – Every process has a constraint

(bottleneck) and focusing improvement efforts
on that constraint is the fastest and most
effective path to improved profitability.
 WHAT IS THE THEORY OF CONSTRAINTS?
The Theory of Constraints is a methodology for identifying the most
important limiting factor (i.e. constraint) that stands in the way of achieving a
goal and then systematically improving that constraint until it is no longer the
limiting factor. In manufacturing, the constraint is often referred to as a
bottleneck.
The Theory of Constraints takes a scientific approach to improvement. It
hypothesizes that every complex system, including manufacturing processes,
consists of multiple linked activities, one of which acts as a constraint upon
the entire system (i.e. the constraint activity is the “weakest link in the
chain”).
So what is the ultimate goal of most manufacturing companies? To make a
profit – both in the short term and in the long term. The Theory of
Constraints provides a powerful set of tools for helping to achieve that goal,
including:

 The Five Focusing Steps (a methodology for identifying and eliminating

constraints)
 The Thinking Processes (tools for analyzing and resolving problems)
 Throughput Accounting (a method for measuring performance and
guiding management decisions)
 WHAT IS THE THEORY OF CONSTRAINTS?
Dr. Eliyahu Goldratt conceived the Theory of Constraints (TOC), and introduced it to a
wide audience through his bestselling 1984 novel, “The Goal”. Since then, TOC has
continued to evolve and develop, and today it is a significant factor within the world of
management best practices.

One of the appealing characteristics of the Theory of Constraints is that it inherently

prioritizes improvement activities. The top priority is always the current constraint. In
environments where there is an urgent need to improve, TOC offers a highly focused
methodology for creating rapid improvement.

A successful Theory of Constraints implementation will have the following benefits:

• Increased profit (the primary goal of TOC for most companies)

• Fast improvement (a result of focusing all attention on one critical area – the
system constraint)
• Improved capacity (optimizing the constraint enables more product to be
manufactured)
• Reduced lead times (optimizing the constraint results in smoother and faster
product flow)
• Reduced inventory (eliminating bottlenecks means there will be less work-in-
process)
 BASICS OF TOC
Core Concept
The core concept of the Theory of Constraints is that every
process has a single constraint and that total process throughput
can only be improved when the constraint is improved. A very
important corollary to this is that spending time optimizing non-
constraints will not provide significant benefits; only
improvements to the constraint will further the goal (achieving
more profit).

Thus, TOC seeks to provide precise and sustained focus on

improving the current constraint until it no longer limits
throughput, at which point the focus moves to the next
constraint. The underlying power of TOC flows from its ability to
generate a tremendously strong focus towards a single goal
(profit) and to removing the principal impediment (the
constraint) to achieving more of that goal. In fact, Goldratt
considers focus to be the essence of TOC.
 The Five Focusing Steps
The Theory of Constraints provides a specific methodology for identifying and eliminating constraints,
referred to as the Five Focusing Steps. As shown in the following diagram, it is a cyclical process.
 The Five Focusing Steps are further described in the following table:

Step Objective
Identify Identify the current constraint (the single part of the process that
limits the rate at which the goal is achieved).
Exploit Make quick improvements to the throughput of the constraint using
existing resources (i.e. make the most of what you have).

Subordina Review all other activities in the process to ensure that they are
te aligned with and truly support the needs of the constraint.
Elevate If the constraint still exists (i.e. it has not moved), consider what
further actions can be taken to eliminate it from being the
constraint. Normally, actions are continued at this step until the
constraint has been “broken” (until it has moved somewhere else).
In some cases, capital investment may be required.
Repeat The Five Focusing Steps are a continuous improvement cycle.
Therefore, once a constraint is resolved the next constraint should
immediately be addressed. This step is a reminder to never become
complacent – aggressively improve the current constraint…and then
immediately move on to the next constraint.
 The Thinking Processes
The Theory of Constraints includes a sophisticated problem
solving methodology called the Thinking Processes. The Thinking
Processes are optimized for complex systems with many
interdependencies (e.g. manufacturing lines). They are designed
as scientific “cause and effect” tools, which strive to first identify
the root causes of undesirable effects (referred to as UDEs), and
then remove the UDEs without creating new ones.

The Thinking Processes are used to answer the following three

questions, which are essential to TOC:

• What needs to be changed?

• What should it be changed to?
• What actions will cause the change?
 Examples of tools that have been formalized as part of the Thinking
Processes include:
Tool Role Description
Current Documents the Diagram that shows the current state, which is unsatisfactory
Reality Tree current state. and needs improvement. When creating the diagram, UDEs
(symptoms of the problem) are identified and traced back to
their root cause (the underlying problem).

Evaporating Evaluates Diagram that helps to identify specific changes (called

Cloud Tree potential injections) that eliminate UDEs. It is particularly useful for
improvements. resolving conflicts between different approaches to solving a
problem. It is used as part of the process for progressing from
the Current Reality Tree to the Future Reality Tree.

Future Documents the Diagram that shows the future state, which reflects the results
Reality Tree future state. of injecting changes into the system that are designed to
eliminate UDEs.

Strategy and Provides an Diagram that shows an implementation plan for achieving the
Tactics Tree action plan for future state. Creates a logical structure that organizes
improvement. knowledge and derives tactics from strategy. Note: this tool is
intended to replace the formerly used Prerequisite Tree in the
Thinking Processes.
 Throughput Accounting
• Throughput Accounting is an alternative accounting methodology that
attempts to eliminate harmful distortions introduced from traditional
accounting practices – distortions that promote behaviors contrary to the
goal of increasing profit in the long term.

• In traditional accounting, inventory is an asset (in theory, it can be

converted to cash by selling it). This often drives undesirable behavior at
companies – manufacturing items that are not truly needed. Accumulating
inventory inflates assets and generates a “paper profit” based on

• Inventory that may or may not ever be sold (e.g. due to obsolescence) and
that incurs cost as it sits in storage. The Theory of Constraints, on the
other hand, considers inventory to be a liability – inventory ties up cash
that could be used more productively elsewhere.

• In traditional accounting, there is also a very strong emphasis on cutting

expenses. The Theory of Constraints, on the other hand, considers cutting
expenses to be of much less importance than increasing throughput.
Cutting expenses is limited by reaching zero expenses, whereas increasing
throughput has no such limitations.
 Throughput Accounting
These and other conflicts result in the Theory of Constraints emphasizing Throughput
Accounting, which uses as its core measures: Throughput, Investment, and Operating
Expense.

Core Measures Definition

Throughput The rate at which customer sales are generated less truly
variable costs (typically raw materials, sales commissions,
and freight). Labor is not considered a truly variable cost
unless pay is 100% tied to pieces produced.

Investment Money that is tied up in physical things: product

inventory, machinery and equipment, real estate, etc.
Formerly referred to in TOC as Inventory.

Operating Money spent to create throughput, other than truly

Expense variable costs (e.g. payroll, utilities, taxes, etc.). The cost
of maintaining a given level of capacity.
 Throughput Accounting
In addition, Throughput Accounting has four key derived measures: Net Profit, Return
on Investment, Productivity, and Investment Turns.
• Net Profit = Throughput − Operating Expenses
• Return on Investment = Net Profit / Investment
• Productivity = Throughput / Operating Expenses
• Investment Turns = Throughput / Investment

In general, management decisions are guided by their effect on achieving the

following improvements (in order of priority):

• Will Throughput be increased?

• Will Investment be reduced?
• Will Operating Expenses be reduced?

The strongest emphasis (by far) is on increasing Throughput. In essence, TOC is saying
to focus less on cutting expenses (Investment and Operating Expenses) and focus
more on building sales (Throughput).
 Drum-Buffer-Rope
Drum-Buffer-Rope – A method from the Theory of Constraints for synchronizing production to
the constraint while minimizing inventory and work-in-process. The “Drum” is the constraint. The
“Buffer” is the inventory needed to maintain production. The “Rope” is a signal from the
constraint when a specific amount of inventory has been consumed.
(DBR) is a method of synchronizing production to the constraint while minimizing inventory and
work-in-process.
The “Drum” is the constraint. The speed at which the constraint runs sets the “beat” for the
process and determines total throughput.
The “Buffer” is the level of inventory needed to maintain consistent production. It ensures that
brief interruptions and fluctuations in non-constraints do not affect the constraint. Buffers
represent time; the amount of time (usually measured in hours) that work-in-process should
arrive in advance of being used to ensure steady operation of the protected resource. The more
variation there is in the process the larger the buffers need to be. An alternative to large buffer
inventories is sprint capacity (intentional overcapacity) at non-constraints. Typically, there are two
buffers:

• Constraint Buffer (immediately before the constraint; protects the constraint)

• Customer Buffer (at the very end of the process; protects the shipping schedule)

The “Rope” is a signal generated by the constraint indicating that some amount of inventory has
been consumed. This in turn triggers an identically sized release of inventory into the process.
The role of the rope is to maintain throughput without creating an accumulation of excess
inventory.
 Drum-Buffer-Rope
• Metaphoric example to understand the flow of a supply chain. A concept of increasing throughput
by adjusting buffers by a rope and controlling speed by a drum.
• Like members of a mountaineering team who climb a mountain on the rope, a drum and rope are
used for an analogy of management tools when soldiers march or boy scouts hike.
• This troop analogy was first applied to a production line by Ford Motor Co., Ltd. who connected
production processes of an automobile assembly line by conveyer belts. Then, Mr. Taiichi Ohno of
Toyota Motor Corporation introduced a rope called "KANBAN". Both of the concepts brought an
innovation in company management and had a great impact on economic growth.
• As in an example of boy scouts hiking, those who are bottlenecks are positioned at the beginning
and a rope is used for subordinating (synchronizing) the speed of followers with that of the
bottleneck persons. This enables preventing the march (work-in-process inventory) from
expanding. In other words, to eliminate work-in-process inventory is to reduce costs. Also, in
preventing the front ones of the bottleneck group who determine the marching speed of the entire
team from slowing down, a rope plays an important role as a buffer to absorb the changes in the
marching speed of the front ones of the bottleneck group. A drum plays a role of conveying the
information about the speed of the slowest bottleneck persons to everyone in the group and
cheering up the bottleneck persons to raise their speed up.
• When the rope is stretched out to the limit, it is necessary to impose a constraint on those who tied
to the rope so that they will not be able to raise the speed any further. In some cases, work needs
to suspend when the buffer reaches the limit. Similarly, the team may sometimes need to stop. If
the drum is beaten at the speed of the first person of the team, an interval with the following
persons will get wider and wider. In that case, the inventory level will increase and throughput will
decrease. If the drum is beaten at the speed of the last person of the team, i.e. the team marches
at the speed of the inventory, the inventory level will decrease and throughput will increase as the
speed of demand increases. The pull-type system means to beat a drum at the speed of the last
person, which corresponds to as demand-driven pull type supply chain management.
Drum-Buffer-Rope
Drum-Buffer-Rope
 THE NATURE OF CONSTRAINTS
What are Constraints?
Constraints are anything that prevents the organization from making progress towards its goal. In
manufacturing processes, constraints are often referred to as bottlenecks. Interestingly,
constraints can take many forms other than equipment. There are differing opinions on how to
best categorize constraints; a common approach is shown in the following table.

Constraint Description
Physical Typically equipment, but can also be other tangible items, such as material
shortages, lack of people, or lack of space.
Policy Required or recommended ways of working. May be informal (e.g.
described to new employees as “how things are done here”). Examples
include company procedures (e.g. how lot sizes are calculated, bonus plans,
overtime policy), union contracts (e.g. a contract that prohibits cross-
training), or government regulations (e.g. mandated breaks).
Paradigm Deeply engrained beliefs or habits. For example, the belief that “we must
always keep our equipment running to lower the manufacturing cost per
piece”. A close relative of the policy constraint.
Market Occurs when production capacity exceeds sales (the external marketplace is
constraining throughput). If there is an effective ongoing application of the
Theory of Constraints, eventually the constraint is likely to move to the
marketplace.
 THE NATURE OF CONSTRAINTS
• There are also differing opinions on whether a system can have
more than one constraint. The conventional wisdom is that most
systems have one constraint, and occasionally a system may have
two or three constraints.
• In manufacturing plants where a mix of products is produced, it is
possible for each product to take a unique manufacturing path and
the constraint may “move” depending on the path taken. This
environment can be modeled as multiple systems – one for each
unique manufacturing path.
SIMPLIFIED ROADMAP
An excellent way to deepen your understanding of the Theory of
Constraints is to walk through a simple implementation example.
In this example, the Five Focusing Steps are used to identify and
eliminate an equipment constraint (i.e. bottleneck) in the
manufacturing process.
 Step One – Identify the Constraint
In this step, the manufacturing process is reviewed to identify the constraint.
A simple but often effective technique is to literally walk through the
manufacturing process looking for indications of the constraint.
Item Description
WIP Look for large accumulations of work-in-process on the plant floor.
Inventory often accumulates immediately before the constraint.
Expedite Look for areas where process expeditors are frequently involved. Special
attention and handholding are often needed at the constraint to ensure that
critical orders are completed on time.
Cycle Review equipment performance data to determine which equipment has the
Time longest average cycle time. Adjust out time where the equipment is not
operating due to external factors, such as being starved by an upstream
process or blocked by a downstream process. Although such time affects
throughput, the time loss is usually not caused or controlled by the
starved/blocked equipment.
Demand Ask operators where they think equipment is not keeping up with demand.
Pay close attention to these areas, but also look for other supporting
indicators.

The deliverable for this step is the identification of the single piece
of equipment that is constraining process throughput.
 Step Two – Exploit the Constraint
In this step, the objective is to make the most of what you have – maximize throughput of the constraint using
currently available resources. The line between exploiting the constraint (this step) and elevating the constraint
(the fourth step) is not always clear. This step focuses on quick wins and rapid relief; leaving more complex and
substantive changes for later.
Item Description
Buffer Create a suitably sized inventory buffer immediately in front of the constraint
to ensure that it can keep operating even if an upstream process stops.
Quality Check quality immediately before the constraint so only known good parts
are processed by the constraint.
Continuou Ensure that the constraint is continuously scheduled for operation (e.g.
s operate the constraint during breaks, approve overtime, schedule fewer
Operation changeovers, cross-train employees to ensure there are always skilled
employees available for operating the constraint).
Maintenan Move routine maintenance activities outside of constraint production time
ce (e.g. during changeovers).
Offload Offload some constraint work to other machines. Even if they are less
(Internal) efficient, the improved system throughput is likely to improve overall
profitability.
Offload Offload some work to other companies. This should be a last resort if other
(External) techniques are not sufficient to relieve the constraint.
The deliverable for this step is improved utilization of the constraint, which in turn will
result in improved throughput for the process. If the actions taken in this step “break” the
constraint (i.e. the constraint moves) jump ahead to Step Five. Otherwise, continue to
Step Three.
 Step Three – Subordinate and Synchronize to the Constraint
In this step, the focus is on non-constraint equipment. The primary objective is to support the needs of the
constraint (i.e. subordinate to the constraint). Efficiency of non-constraint equipment is a secondary
concern as long as constraint operation is not adversely impacted.
By definition, all non-constraint equipment has some degree of excess capacity. This excess capacity is a
virtue, as it enables smoother operation of the constraint. The manufacturing process is purposely
unbalanced:

Item Description

Upstream Upstream equipment has excess capacity that ensures that the constraint buffer is
continuously filled (but not overfilled) so that the constraint is never “starved” by the
upstream process.

Downstream Downstream equipment has excess capacity that ensures that material from the
constraint is continually processed so the constraint is never “blocked” by the
downstream process.
 Step Three – Subordinate and Synchronize to the Constraint

Some useful techniques for this step include:

tem Description
DBR Implement DBR (Drum-Buffer-Rope) on the constraint as a way of
synchronizing the manufacturing process to the needs of the constraint.
Priority Subordinate maintenance to the constraint by ensuring that the constraint
is always the highest priority for maintenance calls.
Sprint Add sprint capacity to non-constraint equipment to ensure that
interruptions to their operation (e.g. breakdowns or material changes) can
quickly be offset by faster operation and additional output.

Steady Operate non-constraint equipment at a steady pace to minimize stops.

Operation Frequent inertial changes (i.e. stops and speed changes) can increase wear
and result in breakdowns.

The deliverable for this step is fewer instances of constraint operation being stopped by
upstream or downstream equipment, which in turn results in improved throughput for
the process. If the actions taken in this step “break” the constraint (i.e. the constraint
moves) jump ahead to Step Five. Otherwise, continue to Step Four.
 Step Four – Elevate Performance of the Constraint
In this step, more substantive changes are implemented to “break” the constraint. These changes
may necessitate a significant investment of time and/or money (e.g. adding equipment or hiring
more staff). The key is to ensure that all such investments are evaluated for effectiveness
(preferably using Throughput
Item Accounting metrics).
Description
Performance Data Use performance data (e.g. Overall Equipment Effectiveness metrics
plus downtime analytics) to identify the largest sources of lost
productive time at the constraint.
Top Losses Target the largest sources of lost productive time, one-by-one, with
cross-functional teams.
Reviews Implement ongoing plant floor reviews within shifts (a technique
called Short Interval Control) to identify tactical actions that will
improve constraint performance.
Setup Reduction Implement a setup reduction program to reduce the amount of
productive time lost to changeovers.
Updates/Upgrades Evaluate the constraint for potential design updates and/or
component upgrades.
Equipment Purchase additional equipment to supplement the constraint (a last
resort).

The deliverable for this step is a significant enough performance improvement to

break the constraint (i.e. move the constraint elsewhere).
 Step Five – Repeat the Process
In this step, the objective is to ensure that the Five Focusing Steps are not
implemented as a one-off improvement project. Instead, they should be implemented
as a continuous improvement process.

Item Description
Constraint Broken If the constraint has been broken (the normal case),
recognize that there is a new constraint. Finding and
eliminating the new constraint is the new priority
(restart at Step One).
Constraint Not Broken If the constraint has not been broken, recognize that
more work is required, and a fresh look needs to be
taken, including verifying that the constraint has been
correctly identified (restart at Step One).

This step also includes a caution…beware of inertia. Remain vigilant and ensure
that improvement is ongoing and continuous. The Five Focusing Steps are kind of
like “Whac-A-Mole”…pound one constraint down and then move right on to the
next!
 INTEGRATING WITH LEAN
Contrasting Theory of Constraints and Lean Manufacturing
The Theory of Constraints and Lean Manufacturing are both systematic
methods for improving manufacturing effectiveness. However, they have
very different approaches:
• The Theory of Constraints focuses on identifying and removing
constraints that limit throughput. Therefore, successful application
tends to increase manufacturing capacity.
• Lean Manufacturing focuses on eliminating waste from the
manufacturing process. Therefore, successful application tends to
reduce manufacturing costs.
Both methodologies have a strong customer focus and are capable of
transforming companies to be faster, stronger, and more agile.
Nonetheless, there are significant differences, as highlighted in the
following table.
 INTEGRATING WITH LEAN
Both methodologies have a strong customer focus and are capable of
transforming companies to be faster, stronger, and more agile. Nonetheless,
there are significant differences, as highlighted in the following table.
What? Theory of Constraints Lean Manufacturing
Objective Increase throughput. Eliminate waste.
Focus Singular focus on the constraint (until it is no Broad focus on the elimination of
longer the constraint). waste from the manufacturing
process.
Result Increased manufacturing capacity. Reduced manufacturing cost.
Inventory Maintain sufficient inventory to maximize Eliminate virtually all inventory.
throughput at the constraint.
Line Create imbalance to maximize throughput at Create balance to eliminate waste
Balancing the constraint. (excess capacity).
Pacing Constraint sets the pace (Drum-Buffer-Rope). Customer sets the pace (Takt
Time).
From the perspective of the Theory of Constraints, it is more practical and less expensive to
maintain a degree of excess capacity for non-constraints (i.e. an intentionally unbalanced line)
than to try to eliminate all sources of variation (which is necessary to efficiently operate a
balanced line). Eliminating variation is still desirable in TOC; it is simply given less attention
than improving throughput.
 Combining Theory of Constraints and Lean Manufacturing
One of the most powerful aspects of the Theory of Constraints is its laser-like
focus on improving the constraint. While Lean Manufacturing can be focused,
more typically it is implemented as a broad-spectrum tool.

In the real world, there is always a need to compromise, since all companies
have finite resources. Not every aspect of every process is truly worth
optimizing, and not all waste is truly worth eliminating. In this light, the
Theory of Constraints can serve as a highly effective mechanism for
prioritizing improvement projects, while Lean Manufacturing can provide a
rich toolbox of improvement techniques. The result – manufacturing
effectiveness is significantly increased by eliminating waste from the parts of
the system that are the largest constraints on opportunity and profitability.

While Lean Manufacturing tools and techniques are primarily applied to the
constraint, they can also be applied to equipment that is subordinated to the
constraint (e.g. to equipment that starves or blocks the constraint; to post-
constraint equipment that causes quality losses).

The remainder of this section describes how to apply a range of Lean

Manufacturing tools and techniques to the Five Focusing Steps.
 Combining Theory of Constraints and Lean Manufacturing
The remainder of this section describes how to apply a range of Lean
Manufacturing tools and techniques to the Five Focusing Steps.
 Applying Lean Tools to “Identify the Constraint”
Lean Manufacturing provides an excellent tool for visually mapping the flow of
production (Value Stream Mapping) as well as a philosophy that promotes spending
time on the plant floor (Gemba).

Lean Tool Description

Value Stream •Value Stream MappingProvides a foundation from which to work
Mapping when identifying the constraint. For example, the cycle time of each
stage can be marked on the map.
•Engages teams and useful for problem solving exercises.
•Helpful for documenting complex processes.
(VSM) visually maps the flow of production (current and future
states) using a defined set of symbols and techniques.

Gemba •GembaWalking the plant floor, observing production, and

interacting with employees can be a very effective way to gather
information that helps identify the constraint.
encourages leaving the office to spend time on the plant floor. This
promotes a deep and thorough understanding of real-world
manufacturing issues – by first-hand observation and by talking
with plant floor employees.
 Applying Lean Tools to “Exploit the Constraint”
Lean Manufacturing strongly supports the idea of making the most of what you have,
which is also the underlying theme for exploiting the constraint. For example, lean
teaches to organize the work area (5S), to motivate and empower employees (Visual
Factory/Andon), to capture best practices (Standardized Work), and to brainstorm
incremental ideas for improvement (Kaizen).
Lean
Tool Description
5S 5SCreates a foundation for better performance at the constraint.
•Enables faster identification of emerging issues at the constraint.
•Results in increased motivation and pride (from the improved work environment).
is a program for eliminating the waste that results from a poorly organized work area. It consists of
five elements: Sort (eliminate that which is not needed), Set In Order (organize the remaining items),
Shine (clean and inspect the area), Standardize (create standards for 5S), and Sustain (consistently
apply the standards).

Visual Visual FactoryDisplays constraint production metrics in real time – a powerful motivator.
Factory •Reduces reaction time to stoppages by instantly alerting operators to intervene.
/ Andon •Empowers operators to call immediate attention to problems at the constraint.
•Increases focus by using visuals to reinforce the importance of the constraint.
is a strategy for conveying information through easily seen plant floor visuals. Andons are visual
displays that indicate production status and enable operators to bring immediate attention to
problems – so they can be instantly addressed.
 Applying Lean Tools to “Exploit the Constraint”

Lean Tool Description

Standardized •Standardized WorkImproves throughput by consistently applying best
Work practices at the constraint.
•Reduces variation by applying standardized procedures at the constraint.
•Ensures that all operators setup and run the constraint in a repeatable way.
captures best practices in work area documents that are consistently applied by
all operators and that are kept up-to-date with the current best practices.

Kaizen •KaizenProvides a proven mechanism for generating ideas on how to exploit the
constraint.
•Identifies “quick win” opportunities for improving throughput of the
constraint.
•Engages operators to work as a team and to think critically about their work.
provides a framework for employees to work in small groups that suggest and
implement incremental improvements for the manufacturing process. It
combines the collective talents of a company to create an engine for continuous
improvement.
 Applying Lean Tools to “Subordinate to the Constraint”
Lean Manufacturing techniques for regulating flow (Kanban) and synchronizing automated lines
(Line Control) can be applied towards subordinating and synchronizing to the constraint.

Lean
Tool Description
Kanban Kanban
• Offers simple visual techniques for controlling the flow of materials.
• Synchronizes material usage at the constraint with material usage in the
upstream process by controlling when new materials are released into the
process.
is a method for regulating the flow of materials, which provides for automatic
replenishment through signal cards that indicate when more materials are
needed.
Line Line Control
Control • Provides an effective alternative to traditional Drum-Buffer-Rope for
FMCG lines.
• Optimizes constraint and non-constraint running speeds to maximize
throughput and reduce the frequency of minor stops.
• Reduces startup delays on the constraint by synchronizing equipment
startup.
is a sophisticated technique used with synchronous automated lines, such as
FMCG (Fast Moving Consumer Goods) lines, which slaves non-constraint
equipment to the constraint in such a way as to increase overall system
throughput.
 Applying Lean Tools to “Elevate the Constraint”
Lean Manufacturing techniques for proactively maintaining equipment (TPM), dramatically reducing
changeover times (SMED), building defect detection and prevention into production processes (Poka-
Yoke), and partially automating equipment (Jidoka) all have direct application when elevating the
constraint. TPM and SMED can also be viewed as exploitation techniques (maximizing throughput using
currently available resources); however, they are fairly complex and are likely to benefit from working
with outside experts.

Lean
Tool Description
TPM TPM (Total Productive Maintenance)Reduces the frequency of constraint breakdowns and
minor stops.
• Provides operators with a stronger feeling of “ownership” for their equipment.
• Enables most maintenance to be planned and scheduled for non-production time.
• Targets quality issues by finding and removing the root causes of defects.
offers a holistic approach to maintenance that focuses on proactive and preventative
maintenance to maximize the operational time of the constraint (increasing up time,
reducing cycle times, and eliminating defects).
SME SMED (Single-Minute Exchange of Dies)
D • Increases usable production time at the constraint.
• Enables smaller lot sizes, resulting in improved responsiveness to customer demand.
• Enables smoother startups, since a simplified and standardized changeover process
improves quality and consistency.
is a method for dramatically reducing changeover time at the constraint. As many steps as
possible are converted to external (performed while the process is running) and remaining
steps are streamlined (e.g. bolts and manual adjustments are eliminated).
 Applying Lean Tools to “Elevate the Constraint”

Lean Tool Description

Poka-Yoke •Poka-YokeReduces the number of defects (which is also very
important post-constraint).
•Enables the operator to spend more time on Autonomous
Maintenance.
(also referred to as “mistake proofing”) designs defect detection
and prevention into equipment with the goal of achieving zero
defects.
Jidoka •JidokaIn some cases, the constraint cannot be broken without
significant capital investment. Jidoka can provide valuable
guidance on equipment design and upgrades.
means “intelligent automation” or “automation with a human
touch”. It recognizes that partial automation is significantly less
expensive than full automation. Jidoka also emphasizes automatic
stoppage of equipment when defects are detected.
Lean
Six sigma
Lean Six Sigma
Leadership
Sustainability