1. 1
Conestoga College Institute of Technology and Advanced Learning
Kitchener, Ontario
Course No: OPER 3000
Section # 1
Course Name: Operations Management
Professor: Ravi Sharma
Case Study Assignment – Zhou Bicycle Company
Due Date: November 11th, 2016 Time: 2:00pm
Submission Date: November 11th, 2016 Time: 2:00pm
Group #
Personal Work Statement
I/ We, the undersigned:
Warrant that the work submitted herein is our work and not the work of others
Acknowledge that we have read and understood the College Policy on Academic
Dishonesty
Acknowledge that it is a breach of College Regulations to give or receive unauthorized
and/or unacknowledged assistance on a graded piece of work
Acknowledge that I am / (we are jointly and equally) responsible for the work submitted
herein
Name (Print/Type) Student # Signature
Juliana Brudiu -
Partner’s name has been
removed for privacy
reasons
-
2. 2
Table of Contents
Executive Summary ..................................................................................................................... 3
Zhou Bicycle Company’s Key Facts ......................................................................................... 4
Primary Issue................................................................................................................................. 4
Qualitative Evaluation of Appropriate Models ................................................................... 4
Production Order Quantity Model (POQ................................................................................... 4
Economic Order Quantity Model ............................................................................................... 5
Single Period Inventory Model ................................................................................................... 5
Fixed Period Systems ................................................................................................................... 5
Quality Discounts.......................................................................................................................... 6
Probabilistic Model + Safety Stock ............................................................................................. 6
ABC Model ..................................................................................................................................... 6
Qualitative Approach ................................................................................................................... 6
Assumptions.................................................................................................................................. 7
Quantitative Approach ............................................................................................................. 9
Implementation Plan ...............................................................................................................10
Recommendations .....................................................................................................................11
Reverences .................................................................................................................................11
3. 3
Executive Summary
Zhou Bicycle Company (WILL BE REFERED TO AS ZHOU OR THE COMPANY) was
founded by Young – Ping Zhou in 1981 and to this day is located in Vancouver, British
Columbia. Zhou is a wholesale distributor of bicycles and individual parts while having their
retailors located within a 650-km radius of the firm’s distribution centre. Zhou has found that the
most popular bike they’ve encountered is the AirWing Model and thus for the purpose of this
report will be focused on the model’s projected figures for the year 2017 because currently the
case in BOOK on page 475 illustrates these components. Next up, the primary issue Zhou is
facing will be addressed.
The primary issue Zhou has established is that they are lacking a back-order system and
as a result the company is experiencing inventory shortage which has led to a loss in sales and
revenue. This fault is considered a poor operations management handle on the company and it
is recommended Zhou reviews their logistics. Due to lacking a back-order system which
essentially provides the company with the inventory they require to meet demand, they also do
not carry an access amount of inventory in case of excess demand or faulty models. The
following section will overview the different possible solutions Zhou can incorporate to his
company.
A vital step in understanding how to figure out the most efficient and smart solution for
Zhou’s company is to assess and understand all possible solutions. The following six methods
are possible solutions for the firm’s inventory problem that Zhou should consider in order to
bounce back from their fall and rise to the top: Production Order Quantity (POQ), Economic
Order Quantity (EOQ), Single – Period, Fixed – Period, Quantity Discounts, Probabilistic +
Safety Stock, and lastly the ABC model. In the section of Appropriate Models to consider on
page 447 in the report is described in depth with detail the different aspects, requirements, and
criteria associated per model. The next paragraph will shortly explain what model Zhou should
use as their solution.
To be able to revive the company and bring back its stance Zhou needs to consider
implementing the probabilistic + safety stock model to this company. This model essentially
incorporates the EOQ model in order to completely remove inventory shortage and in contract
create a surplus. The company’s main problem is that they are not able to meet required
demand and therefore are losing out on sales and revenue. At the same time the company is
ruining their cliental in public relations by creating a negative reputation of not being able to
meet demand. The next section focuses on the recommendations that Zhou should consider
alongside the solution model.
In order to achieve success and greatness the firm should look into implementing a few
success features that will overview the company’s performance on an on-going basis. The
following are the recommendations that are thoroughly explained in the implementation plan of
the upcoming report. The company should consider having a documentation + historical data
plan, an increase to their service level currently at 95% to 99%, a computerized automated
system, and proper forecasting methods. If Zhou implements all solutions and
recommendations it is guaranteed that not only will the company be able to meet demands, they
will also be prepared for unexpected occurrences. The following report breaks down in detail to
explain Zhou’s background, their primary issue, possible solutions, recommendations, as well
as an implantation plan to bring success to the company.
4. 4
Zhou Bicycle Company’s Key Facts
Zhou Bicycle Company is a whole sale distributor of bikes as well as bicycle parts and is
located in Vancouver which was founded by Young Ping Zhou in 1981. Zhou’s most
popular model that consumers seem to want is their AirWing model. All of Zhou’s
retailers are within a 650-km radius of his distribution centre. Due to this, it is important
for Zhou to have enough inventory to supply because if not his retailers are eager to
turn elsewhere to fulfil their inventory. The case on page 475 and reference book also
mentions that when Zhou is out in inventory they do not have any sort of back order
system to re-stock inventory. This is where issues arise from retailers to Zhou. It is
mentioned in the case that Zhou is responsible to place a re-order of inventory not vice
versa from suppliers having to chase after Zhou. The shipment per order is at a cost of
$65 and is required a four-week delivery lead time in order for the bicycles to arrive at
the same time. The company has a 1% carrying cost per month and is charged 60%
purchase price off of retail which results to $102: based on the retail price per model
AirWing with a cost of $170. For the upcoming year, 2017 Zhou wishes to maintain a
95% service level. Zhou does not seem to understand the consequences of lacking
safety stock but yet understands that he needs to implement fast action to take care of
the inventory shortage.
Primary Issue
As mentioned in the previous section, the case states that Zhou’s retailers do not mind
going elsewhere as long as they have the product to fill orders. When and if Zhou does
not have the inventory to supply the company then they are losing sales and customers.
Furthermore, it has been established that the biggest problem Zhou faces is the fact
that they lack a back-order system. As a result, the company is experiencing inventory
shortage, which led to a loss in sales and revenue. A secondary issue is that due to
their inventory shortage, revenue loss, and cliental loss, Zhou is also destroying their
public relations with potentials investors and associations.
Qualitative Evaluation of Appropriate Models
In order to assess and help Zhou discover the most appropriate way to handle his
situation he needs to be aware of all possible solutions and their meaning. The following
will list the appropriate models to consider and briefly explain each of the models. Later
in the report will be discussed which model has been selected to specifically solve
Zhou’s safety stock problem and accompanied with a full in-depth detailed explanation
of why that model was selected.
Production Order Quantity Model (POQ)
1) Economic order quantity technique applied to production orders. Most useful in
the situation of when inventory constantly builds over time. i.e.: Excessive
Inventory
5. 5
POQ is a model that focuses and answers how much to produce and when. In this
model, the materials produced are used immediately and hence lowering the holding
cost than the economic order quantity. This model is applicable only under two
situations; when inventory continuously builds up over a period of time or after an order
has been placed or when unit are produced and sold together. Due to this, the daily
production rate and the daily demand rate should be taken in to account. This model is
useful when inventory continuously builds up over time.
Economic Order Quantity Model (EOQ)
2) EOQ is one of the most commonly used models and it assumes that the
materials or goods are shipped in bulk at a time. It is easy to use but it is based
on some assumptions.
1. Expected demand has been forecasted and demand is independent
2. The production rate per day is known
3. The only variable costs of production and storage are the setup cost and holding cost
4. It is possible to avoid stock outs if the production begins at the right time.
Single-Period Inventory Model.
3) Ordering items that at the end of a given time frame have little to no residual
value.
This model describes a situation in which one order is placed for a product and at the
end of the sales period; any remaining product has no value. For example seasonal
goods and bakery goods. Items that are ordered daily or weekly cannot be held over
and used as the inventory in the next sales period. This is because the exact demand
for these products are never known therefore the probability distribution related to
demand has be considered. Assume that the bicycle company stocked and sold an
average mean of 200 bicycle during the summer season, then there is a 50% chance
that the company will stock out and a 50% chance that bicycles would be left over
because of the changes in seasons. Therefore, in order to determine the optimal
stocking policy before the season begins, the Zhou Company will need to know the
standard deviation and consider 2 marginal cost (cost of shortage and cost of overage).
Fixed Period Systems
4) An ordering system that has the same order amount each and every time. Can
also be referred to as a consecutive order: a simple re-stock call and same order
is provided with repeated figures.
For this model, the same fixed amount is added to inventory every time an order for an
item is placed. When inventory decreases to the reorder point, a new order for Q unit is
placed. In order for this model to be effective, inventory must be continuously monitored
which requires a perpetual inventory system. This model also has several assumptions
Lead times are known and constant
Items are independent of one another
Ordering and holding cost are the only relevant cost.
6. 6
Quantity Discounts
5) A reduced value for items purchased in large quantities or in bulk. This model
uses the assumption that price goes down per larger order.
To increase sales and encourage customers, many companies always like to offer
quantity discounts. A quantity discount is when a price is reduced based on the large
quantity good a customer purchase. As quantity discounts goes up, the production cost
reduces, due to this, holding cost increase because orders are larger.
Probabilistic Model + Safety Stock
6) A model has two components that create a whole.
The first component is that the model is constructed of an unknown variable. This
variable can be solved by strategic probability value distribution. The second aspect to
this model is the safety stock component. Essentially this looks at how much inventory
does a company have, how fast they remove their inventory, during stock removal: how
much inventory can hold the company until it runs dry. The model mixes these factors
up and determines how much to establish as safety stock to have as extra inventory
kept on hand in case of shortage or needed surplus stock.
ABC
7) ABC model is not able to be used in under any circumstance within Zhou’s case
because the case itself did not provide enough information.
Qualitative Approach – Explanation of the selected model
EOQ is one of the most commonly used models and it assumes that the materials or
goods are shipped in bulk at a time. It is easy to use but it is based on some
assumptions.
1. Expected demand has been forecasted and demand is independent
2. The production rate per day is known
3. The only variable costs of production and storage are the setup cost and holding cost
4. It is possible to avoid stock outs if the production begins at the right time.
To determine the quantity to be ordered, EOQ uses the annul demand, cost per order
and carrying cost. The total of ordering and carrying cost is minimized when optimum
quantity or economic quantity “Q” is ordered. The EOQ gives an answer to the quantity
that can be ordered.
7. 7
Q represents the amount of inventory ordered and an industry level can increase from
point 0 to Q units when an inventory arrives. The slope lines on the graph indicate that
inventory drops systematically. Each time the inventory level reaches 0, a new order is
placed and received and inventory level again jumps to Q units.
Therefore, EOQ can be an effective tool in inventory management to find optimum
quantity to be ordered. But, it cannot be adopted as one stop solution for total inventory
management. Therefore, other techniques and methods need to be considered and
adopted along with EOQ which could help minimize storage and holding cost.
Assumptions
A model that will be briefly touched upon, yet has been explained previously in the
section of Qualitative Evaluation of appropriate models is the EOQ model. This model
incorporates and is in partnership with the probabilistic + safety stock model which Zhou
Bicycle company is using to undergo a reformation in order to address and solve their
current inventory shortage. The basic EOQ model is one of the three independent
demand models. Thus, due to its certain criteria and based off the readings in BOOK on
page 447 it remains evident that the EOQ model in association with the probabilistic +
safety stock model is partnered with six presumed assumptions. The following are the
six assumptions with respect to the EOQ model on the probabilistic + safety stock
model.
1) Demand for an item is known, reasonably consistent, and independent of
decisions for other items
2) Lead time is known + consistent
3) Instantaneous inventory receipts. I.e.: Order arrives in one batch all at once!
4) Quantity discounts are not possible
5) Only variable costs are ordering (set up) + carrying (holding)
6) Stock outs/shortages can be completely avoided if planned accordingly
8. 8
Quantitative Approach – Application of Model
The main goal Zhou wishes to accomplish is to reduce shortage and to have a surplus
instead while minimizing total order and holding cost. Below is the demand for Awing
Model.
Month 2015 2016 Forecast for 2017
January 6 7 8
February 12 14 15
March 24 27 31
April 46 53 59
May 75 86 97
June 47 54 60
July 30 34 39
August 18 21 24
September 13 15 16
October 12 13 15
November 22 25 28
December 38 42 47
Totals 343 391 439
1. Zhou is responsible to place re-order of inventory
2. Shipment takes 4 weeks from time order is placed
3. Ordering cost is $65
4. Purchase price paid by Zhou is 60% of retail
5. Retail /AirWing is $170
6. Carrying cost is 1% per month (12% per year)
7. Wish to maintain a 95% service level
Cost per bike= 170*0.60= $102
Holding cost= ($102)*1%*12% per year per bicycle
=$12.24 per year/bicycle
Service level= 95%
Z- Value= 1.65
Total demand per year= 439 units
Average demand per month= 439/12= 36.58 or 37bikes
EOQ= (Q*) Economic Order Quantity
=
√2𝐷𝑆
𝐻
=
√(2)(439)(65)
$12.24
9. 9
=68.28 𝑜𝑟 69 Units
Within each order, Zhou should only order 68 Awings from their manufacturer.
ROP =𝑑. ℓ + 𝑧𝜎𝑑ℓ𝑡
= (36.58) + (1.65) (25.67)
=36.58 + 42.35
=78.93 𝑜𝑟 79 Bicycles
SS = 𝑧𝜎𝑑ℓ𝑡
= (1.65) (25.67)
=42.35 𝑜𝑟 43 Bicycles
Total cost= ½ Q* (holding cost) + SS (holding cost) + Total demand/Q* (ordering cost)
68/2*12.24 42*12.24 439/68*65
= $416.16
=$514.08 =$419.63
Total Cost= 416.16+514.08+419.63
=$1349.87
Demand for AirWing Model
8
15
31
59
97
60
39
24
16 15
28
47
36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58
0
20
40
60
80
100
120
January
February
M
arch
April
M
ay
June
July
AugustSeptem
ber
O
ctoberN
ovem
berD
ecem
ber
Forecasted 2008
Average
10. 10
From the above graph, the blue line represents the average forecast demand for 2017
and the pink line represents the average demand. This indicates that demand for their
product peaks in the spring due to seasonal factors and safety stock prevents against
higher than expected demand. Order periods are flexible in preparation for lower than
expected demand. Therefore the model must be adjusted throughout the year as
demand changes.
Implementation Plan
In essence Zhou was losing sales, revenue, public relations, and most importantly
experiencing inventory shortage. The following are strategic recommendations
suggested specifically for Zhou Bicycle Company to implement within 2017 as well as
future logistics and operations.
1) Documentation + Historical Data
Having and maintaining a historical database is important to consider in case the
company. This is useful in case anyone wishes to question or review an action that was
executed. Documentation can help prevent fraud, losses, inaccurate information, and
reduce liability. Documentation can also show future projections, trends, and provide
reference.
2) 95% service level or higher
A main concern when evaluating Zhou Bicycle Company is the fact that they wish to
peruse a 95% service level with its customers. The questionable factor is questioning
why Zhou does not wish to peruse a 99% service level or as high as possible. The
company should aim to pursue and have the highest quality product and this can only
be done by a 99% service level expectation. Zhou should consider switching their
service level expectation.
3) Computerized pre-set system
Currently the human error Zhou is currently experiencing is due to having to manually
count the units which resulted in uncertainty of the reorder point. A note pad system is
frowned upon because it is favorable to human error. In contract, to move around the
previous errors this system will be there to help automatically because it will be pre-set
to specifics of Zhou Bicycle company to determine ROP, EOQ, and price. An electronic
computerized system designated to journal keeping is recommended for Zhou
Company because it implements six sigma to achieve four parts per million error.
Systems such as excel are multi-useful and friendly in this situation.
4) Forecasting Methods
By having and maintaining a proper forecasting method to predict future business
orders Zhou will be able to know the future rather than be surprised by its actions. The
following methods should be considered when assessing and projecting future figures.
11. 11
Recommendations
Zhou can accomplish this by analyzing their yearly data, having a correct yet accurate
forecasting plan, and implementing this strategically. Not only is Zhou saving money by
implementing safety stock but it also cost the company less money to hold the
additional 43 bicycles up until the new 69 units of bikes arrive. As previously mentioned,
Zhou is saving money by investing in a cheaper and lower risk situation of holding
safety stock. They are also not going to be running low or out as their issue was
previously, which will re-build and secure cliental and public relations.
The company saves money by implementing the probabilistic model + safety stock
because it has also been calculated and found that Zhou now only needs to order 7
times a year. The member in charge of safety stock requires proper training but yet is
simple enough to be done by a co-op post-secondary student. With this computerized
system, it is recommended that twice a year the system needs to be reviewed to ensure
minimum cost of plan implementation.
In conclusion
The main issue that Zhou Bicycle Company was facing in their previous model was that
they were not holding any safety stock, they did not have a back-order policy instituted,
and they were fully draining their funds and revenue for all orders they could not fill.
They could not fill orders because they were not properly planning and forecasting and
thus their back orders went to other suppliers. By implementing safety stock as part of
their inventory management, Zhou will be able to reduce the amount of stock outs that
they have and more accurately fill, complete, and exceed expectations of their 95%
service level projected for the upcoming 2017 year. If Zhou takes into considerations all
recommendations and strategically implements the success factors, they will be able to
redeem themselves, meet demand, and build core competencies and become a core
competitor in the field.
