- The document discusses the concepts of lean operations and lean manufacturing. It focuses on Toyota Motor Corporation as a case study for implementing lean techniques like just-in-time production and the Toyota Production System. - Key lean principles discussed include eliminating waste, reducing variability, improving throughput, implementing kanban pull systems, reducing setup times and inventory levels, and establishing supplier partnerships. - The goal of lean is to supply customers with precisely what they want, when they want it, without any waste, through continuous improvement.

1. (Mt) – QM Discussion Board
Operations Management: Sustainability and Supply Chain Management Thirteenth Edition
Chapter 16 Lean Operations Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Outline • Global Company Profile: Toyota Motor Corporation • Lean
Operations • Lean and Just-in-Time • Lean and the Toyota Production System • Lean
Organizations • Lean in Services Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Toyota Motor Corporation (1 of 2) • One of the largest vehicle
manufacturers in the world with annual sales of over 10 million vehicles • Success due to
two techniques, JIT and TPS • Continual problem solving is central to JIT • Eliminating
excess inventory makes problems immediately evident Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Toyota Motor Corporation (2 of 2) • Central to
TPS is employee learning and a continuing effort to produce products under ideal
conditions • Respect for people is fundamental • Small building but high levels of
production • Subassemblies are transferred to the assembly line on a JIT basis • High
quality and low assembly time per vehicle Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved TPS Elements Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Learning Objectives (1 of 2) When you complete this
chapter you should be able to: 16.1 Define Lean operations 16.2 Define the seven wastes
and the 5Ss 16.3 Identify the concerns of suppliers when moving to supplier partnerships
16.4 Determine optimal setup time Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Learning Objectives (2 of 2) When you complete this chapter you
should be able to: 16.5 Define kanban 16.6 Compute the required number of kanbans 16.7
Identify six attributes of Lean organizations 16.8 Explain how Lean applies to services
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lean Operations
(1 of 3) • Lean operations supply the customer with exactly what the customer wants when
the customer wants it, without waste, through continuous improvement • Driven by
“pulling” customer orders Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Lean Operations (2 of 3) • Just-in-time (JIT) focuses on continuous forced problem
solving • Toyota Production System (TPS) emphasizes continuous improvement, respect for
people, and standard work practices in an assembly-line environment Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Lean Operations (3 of 3) •
Encompasses both JIT and TPS • Sustains competitive advantage and increases return to
stakeholders • Three fundamental issues – Eliminate waste – Remove variability – Improve
throughput Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved

2. Eliminate Waste (1 of 2) • Waste is anything that does not add value from the customer
point of view • Storage, inspection, delay, waiting in queues, and defective products do not
add value and are 100% waste Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Ohno’s Seven Wastes • Overproduction • Queues • Transportation •
Inventory • Motion • Overprocessing • Defective products Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Eliminate Waste (2 of 2) • Other resources such
as energy, water, and air are often wasted • Efficient, sustainable production minimizes
inputs, reduces waste • Traditional “housekeeping” has been expanded to the 5Ss Copyright
© 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved The 5Ss (1 of 2) •
Sort/segregate – when in doubt, throw it out • Simplify/straighten – methods analysis tools
• Shine/sweep – clean daily • Standardize – remove variations from processes •
Sustain/self-discipline – review work and recognize progress Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved The 5Ss (2 of 2) • Sort/segregate – when
in doubt, throw it out • Simplify/straighten – methods analysis tools • Shine/sweep – clean
daily • Standardize – remove variations from processes • Sustain/self-discipline – review
work and recognize progress Two additional Ss • Safety – built-in good practices •
Support/maintenance – reduce variability and unplanned downtime Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Remove Variability • Variability is
any deviation from the optimum process • Lean systems require managers to reduce
variability caused by both internal and external factors • Inventory hides variability • Less
variability results in less waste Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Sources of Variability (1 of 2) • Poor processes resulting in improper
quantities, late, or non-conforming units • Inadequate maintenance • Unknown and
changing customer demands • Incomplete or inaccurate drawings, specifications, or bills of
material Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Sources
of Variability (2 of 2) • Poor processes resulting in improper quantities, late, or
nonconforming units • Inadequate maintenance • Unknown and changing customer
demands • Incomplete or inaccurate drawings, specifications, or bills of material Copyright
© 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Improve Throughput (1 of
2) • The rate at which units move through a process • Each wasted minute products are in
the process, costs accumulate and competitive advantage is lost • A pull system increases
throughput Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Improve Throughput (2 of 2) • By pulling material in small lots, inventory cushions are
removed, exposing problems and emphasizing continual improvement • Manufacturing
cycle time is reduced • Push systems dump orders on the downstream stations regardless of
the need Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lean
and Just-In-Time • Powerful strategy for improving operations • Materials arrive where
they are needed only when they are needed • Identifying problems and driving out waste
reduces costs and variability and improves throughput • Requires a meaningful buyer-
supplier relationship Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved JIT and Competitive Advantage (1 of 2) Figure 16.1 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved JIT and Competitive Advantage (2 of 2) Figure
16.1 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Supplier

3. Partnerships • Supplier partnerships exist when a supplier and purchaser work together to
remove waste and drive down costs • Four goals of supplier partnerships are: – Removal of
unnecessary activities – Removal of in-plant inventory – Removal of in-transit inventory –
Improved quality and reliability Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved JIT Partnerships Figure 16.2 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Concerns of Suppliers • Diversification – ties to only one
customer increases risk • Scheduling – don’t believe customers can create a smooth
schedule • Lead time – short lead times mean engineering or specification changes can
create problems • Quality – limited by capital budgets, processes, or technology • Lot sizes –
small lot sizes may transfer costs to suppliers Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Lean Layout • Reduce waste due to movement Table
16.1 Lean Layout Tactics Build work cells for families of products Include a large number of
operations in a small area Minimize distance Design little space for inventory Improve
employee communication Use poka-yoke devices Build flexible or movable equipment
Cross-train workers to add flexibility Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Distance Reduction • Large lots and long production lines with single-
purpose machinery are being replaced by smaller flexible cells • Often U-shaped for shorter
paths and improved communication • Often using group technology concepts Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Increased Flexibility • Cells
designed to be rearranged as volume or designs change • Applicable in office environments
as well as production settings • Facilitates both product and process improvement
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Impact on
Employees • Employees may be cross-trained for flexibility and efficiency • Improved
communications facilitate the passing on of important information about the process (poka-
yoke functions can help) • With little or no inventory buffer, getting it right the first time is
critical Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Reduced
Space and Inventory • With reduced space, inventory must be in very small lots • Units are
always moving because there is no storage Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Lean Inventory • Inventory is at the minimum level
necessary to keep operations running Table 16.2 Lean Inventory Tactics Use a pull system
to move inventory Reduce lot sizes Develop just-in-time delivery systems with suppliers
Deliver directly to point of use Perform to schedule Reduce setup time Use group
technology Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Reduce Variability (1 of 3) Figure 16.3 Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Reduce Variability (2 of 3) Figure 16.3 Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Reduce Variability (3 of 3) Figure 16.3
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Reduce
Inventory • Reducing inventory uncovers the “rocks” • Problems are exposed • Ultimately
there will be virtually no inventory and no problems • Shingo says “Inventory is evil”
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Reduce Lot Sizes
(1 of 2) Figure 16.4 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Reduce Lot Sizes (2 of 2) • Ideal situation is to have lot sizes of one pulled from
one process to the next • Often not feasible • Can use EOQ analysis to calculate desired

4. setup time • Two key changes necessary – Improve material handling – Reduce setup time
Q*p = 2 DS H [1 − (d / p )] Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Setup Time Example D = Annual demand = 400,000 units d = Daily demand =
400,000/250 = 1,600 per day p = Daily production rate = 4,000 units Qp = EOQ desired =
400 H = Holding cost = $20 per unit S = Setup cost (to be determined) Q*p = S= 2 DS H [1 −
(d / p )] (Qp2 )( H )(1 − d / p ) 2D Q 2p = 2 DS H [1 − (d / p )] (400) 2 (20)(1 − 1,600 /
4,000) = = $2.40 2(400,000) Setup time = $2.40/($30/hour) = 0.08 hr = 4.8 minutes
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Reduce Setup
Costs (1 of 2) • High setup costs encourage large lot sizes • Reducing setup costs reduces lot
size and reduces average inventory • Setup time can be reduced through preparation prior
to shutdown and changeover Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Lower Setup Costs Figure 16.5 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Reduce Setup Costs (2 of 2) Figure 16.6 Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lean Scheduling (1 of 2) •
Schedules must be communicated inside and outside the organization • Level schedules –
Process frequent small batches – Freezing the schedule helps stability • Kanban – Signals
used in a pull system Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Lean Scheduling (2 of 2) • Better scheduling improves performance Table 16.3
Lean Scheduling Tactics Make level schedules Use kanbans Communicate schedules to
suppliers Freeze part of the schedule Perform to schedule Seek one-piece-make and one-
piece-move Eliminate waste Produce in small lots Make each operation produce a perfect
part Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Level
Schedules • Process frequent small batches rather than a few large batches • Make and
move small lots so the level schedule is economical • Freezing the schedule closest to the
due dates can improve performance Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Scheduling Small Lots Figure 16.7 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Kanban (1 of 6) • Kanban is the Japanese word
for card • The card is an authorization for the next container of material to be produced • A
sequence of kanbans pulls material through the process • Many different sorts of signals are
used, but the system is still called a kanban Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Kanban (2 of 6) Figure 16.8 Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Kanban (3 of 6) • When there is visual
contact – The user removes a standard-size container of parts from a small storage area, as
shown in Figure 16.8. – The signal at the storage area is seen by the producing department
as authorization to replenish the using department or storage area. Because there is an
optimum lot size, the producing department may make several containers at a time.
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Kanban (4 of 6)
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Kanban (5 of 6) •
When the producer and user are not in visual contact, a card can be used; otherwise, a light
or flag or empty spot on the floor may be adequate • Usually each card controls a specific
quantity of parts although multiple card systems may be used if there are several
components or if the lot size is different from the move size Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Kanban (6 of 6) • Kanban cards provide a direct

5. control and limit on the amount of work-in-process between cells • A complicating factor in
a manufacturing firm is the time needed for actual manufacturing (production) to take place
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved The Number of
Kanban Cards or Containers • Need to know the lead time needed to produce a container of
parts • Need to know the amount of safety stock needed Demand during + Safety lead time
stock Number of kanbans ( containers ) = Size of container Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Number of Kanbans Example Daily demand
Production lead time (Wait time + Material handling time + Processing time) Safety stock
Container size = 500 cakes = 2 days = 1/2 day = 250 cakes Demand during lead time = 2
days × 500 cakes = 1,000 Safety stock = ½ × Daily demand = 250 1,000 + 250 Number of
kanbans = =5 250 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Advantages of Kanban • Small containers require tight schedules, smooth
operations, little variability • Shortages create an immediate impact • Places emphasis on
meeting schedules, reducing lead time and setups, and economic material handling •
Standardized containers reduce weight, disposal costs, wasted space, and labor Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lean Quality • Strong
relationship – Lean cuts the cost of obtaining good quality because Lean exposes poor
quality – Because lead times are shorter, quality problems are exposed sooner – Better
quality means fewer buffers and allows simpler Lean systems to be used Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Lean Quality Tactics Table 16.4
Lean Quality Tactics Use statistical process control Empower employees Build fail-safe
methods (poka-yoke, checklists, etc.) Expose poor quality with small lots Provide immediate
feedback Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Toyota
Production System (1 of 3) • Continuous improvement – Build an organizational culture and
value system that stresses improvement of all processes, kaizen – Part of everyone’s job •
Respect for people – People are treated as knowledge workers – Engage mental and
physical capabilities – Empower employees Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Toyota Production System (2 of 3) • Processes and
standard work practice – Work shall be completely specified as to content, sequence,
timing, and outcome – Internal and external customer-supplier connections are direct –
Material and service flows must be simple and directly linked to the people or machinery
involved – Process improvement must be made in accordance with the scientific method at
the lowest possible level of the organization Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Toyota Production System (3 of 3) • Processes and
standard work practice – Stopping production because of a defect is called jidoka – Dual
focus Education and training of employees Responsiveness of the system to problems –
Result is continuous improvement Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Lean Organizations • Understanding the customer and the customer’s
expectations • Functional areas communicate and collaborate to make sure customer
expectations are met • Implement the tools of Lean throughout the organization Copyright
© 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Building a Lean
Organization (1 of 2) • Transitioning to a Lean system can be difficult • Build a culture of
continual improvement • Open communication • Demonstrated respect for people • Gemba

6. walks to see work being performed Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Building a Lean Organization (2 of 2) • Lean systems tend to have the
following attributes – Respect and develop employees – Empower employees – Develop
worker flexibility – Develop collaborative partnerships with suppliers – Eliminate waste by
performing only value-added activities Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Lean Sustainability • Two sides of the same coin • Maximize
resource use and economic efficiency • Focus on issues outside the immediate firm •
Driving out waste is the common ground Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Lean in Services • The Lean techniques used in manufacturing are
used in services – Suppliers – Layouts – Inventory – Scheduling Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Copyright This work is protected by
United States copyright laws and is provided solely for the use of instructors in teaching
their courses and assessing student learning. Dissemination or sale of any part of this work
(including on the World Wide Web) will destroy the integrity of the work and is not
permitted. The work and materials from it should never be made available to students
except by instructors using the accompanying text in their classes. All recipients of this
work are expected to abide by these restrictions and to honor the intended pedagogical
purposes and the needs of other instructors who rely on these materials. Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Operations Management:
Sustainability and Supply Chain Management Thirteenth Edition Chapter 14 Material
Requirements Planning (MRP) and ERP Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Outline (1 of 2) • Global Company Profile: Wheeled Coach •
Dependent Demand • Dependent Inventory Model Requirements • MRP Structure • MRP
Management Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Outline (2 of 2) • Lot-Sizing Techniques • Extensions of MRP • MRP In Services • Enterprise
Resource Planning (ERP) Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved MRP for Wheeled Coach (1 of 2) • Largest manufacturer of ambulances in the
world • International competitor • 12 major ambulance designs – 18,000 different
inventory items – 6,000 manufactured parts – 12,000 purchased parts Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved MRP for Wheeled Coach (2 of 2) •
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 Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Learning Objectives (1 of 2) When
you complete this chapter you should be able to: 14.1 Develop a product structure 14.2
Build a gross requirements plan 14.3 Build a net requirements plan 14.4 Determine lot sizes
for lot-for-lot, EOQ, and POQ Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Learning Objectives (2 of 2) When you complete this chapter you should be
able to: 14.5 Describe MRP II 14.6 Describe closed-loop MRP 14.7 Describe ERP Copyright
© 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Dependent Demand (1 of
3) For any well-defined product for which a schedule can be established, dependent
demand techniques should be used Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Dependent Demand (2 of 3) • Benefits of MRP 1. Better response to

7. customer orders 2. Faster response to market changes 3. Improved utilization of facilities
and labor 4. Reduced inventory levels Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Dependent Demand (3 of 3) • The demand for one item is related to
the demand for another item • Given a quantity for the end item, the demand for all parts
and components can be calculated • In general, used whenever a schedule can be
established for an item • MRP is the common technique Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved 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 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Master Production Schedule (MPS) (1 of 2) • Specifies what is to be made
and when • Must be in accordance with the aggregate production plan • Inputs from
financial plans, customer demand, engineering, labor availability, inventory fluctuations,
supplier performance • As the process moves from planning to execution, each step must be
tested for feasibility Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Master Production Schedule (MPS) (2 of 2) • MPS is established in terms of
specific products, it disaggregates the aggregate plan • 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 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved The Planning Process (1 of 3) Figure 14.1 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved The Planning Process (2 of 3) Figure 14.1 Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved The Planning Process (3 of 3)
Figure 14.1 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Aggregate Production Plan Figure 14.2 Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Master Production Schedule (MPS) Can be expressed in any of the
following terms: 1. A customer order in a job shop (make-to-order) company 2. Modules in
a repetitive (assemble-to-order or forecast) company 3. An end item in a continuous (stock-
to-forecast) company Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved MPS Example Table 14.1 Master Production Schedule for Chef John’s Buffalo
Chicken Mac & Cheese Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Bills of Material (1 of 4) • 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 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved BOM Example (1 of 2) Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved BOM Example (2 of 2) For an order of 50
Awesome speaker kits Part B: Part C: Part D: Part E: Part F: Part G: 2 × number of As = 3 ×
number of As = 2 × number of Bs + 2 × number of Fs = 2 x number of Bs + 2 × number of Cs
= 2 × number of Cs = 1 × number of Fs = (2)(50) = (3)(50) = 100 150 (2)(100) + (2)(300) =
800 (2)(100) + (2)(150) = (2)(150) = (1)(300) = 500 300 300 Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Bills of Material (2 of 4) • Modular Bills –
Modules are not final products but components that can be assembled into multiple end
items – Can significantly simplify planning and scheduling Copyright © 2020, 2017, 2014

8. Pearson Education, Inc. All Rights Reserved Bills of Material (3 of 4) • Planning Bills – Also
called “pseudo” or super bills – Created to assign an artificial parent to the BOM 1. Used to
group subassemblies to reduce the number of items planned and scheduled 2. Used to
create standard “kits” for production Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Bills of Material (4 of 4) • Phantom Bills – 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 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Accurate Inventory Records • Accurate inventory records are absolutely required for MRP
(or any dependent demand system) to operate correctly • MRP systems require more than
99% accuracy Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Purchase Orders Outstanding • A by-product of well-managed purchasing and inventory
control department • Outstanding purchase orders must accurately reflect quantities and
scheduled receipts Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Lead Times for Components Table 14.2 Lead Times for • The time required to
Awesome Speaker Kits (As) purchase, produce, or assemble an item COMPONENT LEAD
TIME – For production – the A 1 week sum of the move, setup, B 2 weeks and assembly or
run C 1 week times D 1 week E 2 weeks – For purchased items – F 3 weeks the time
between the G 2 weeks recognition of a need and when it’s available for production
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Time-Phased
Product Structure Figure 14.3 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved MRP Structure Figure 14.4 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Determining Gross Requirements (1 of 3) • 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” Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Determining Gross Requirements (2 of 3) • 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) Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Determining Gross Requirements (3 of 3) • 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 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Gross
Requirements Plan Table 14.3 Gross Material Requirements Plan for 50 Awesome Speaker
Kits (As) with Order Release Dates Also Shown Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Net Requirements Plan (1 of 3) ITEM ON HAND ITEM
ON HAND A 10 E 10 B 15 F 5 C 20 G 0 D 10 blank blank Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Net Requirements Plan (2 of 3) Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Determining Net

9. Requirements (1 of 3) • Starts with a production schedule for the end item − 50 units of
Item A in week 8 • Because there are 10 Item As on hand, only 40 are actually required −
(net requirement) = (gross requirement − on-hand inventory) • The planned order receipt
for Item A in week 8 is 40 units − 40 = 50 − 10 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Determining Net Requirements (2 of 3) • Following the
lead time offset procedure, the planned order release for Item A is now 40 units in week 7 •
The gross requirement for Item B is now 80 units in week 7 • There are 15 units of Item B
on hand, so the net requirement is 65 units in week 7 • A planned order receipt of 65 units
in week 7 generates a planned order release of 65 units in week 5 Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Determining Net Requirements (3 of 3) •
The on-hand inventory record for Item B is updated to reflect the use of the 15 items in
inventory and shows no on-hand inventory in week 8 • This is referred to as the Gross-to-
Net calculation and is the third basic function of the MRP process Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Gross Requirements Schedule Figure 14.5
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Net
Requirements Plan (3 of 3) The logic of net requirements Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved MRP Management (1 of 3) • MRP dynamics –
Demand-driven MRP strategically alters lead times and precisely places safety stock within
the BOM structure to improve MRP performance – Can reduce stockouts and improve
stability Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Demand-Driven MRP (1 of 2) • Five primary components 1. Determine where within the
BOM structure to position the safety stock 2. Determine initial safety-stock levels 3. Monitor
conditions and adjust levels 4. Identify, track, and prioritize forecasted demand 5. Use
DDMRP information for increased communication and collaboration Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Demand-Driven MRP (2 of 2) Figure
14.6 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved MRP
Management (2 of 3) • MRP dynamics – Facilitates replanning when changes occur – System
nervousness can result from too many changes – Time fences put limits on replanning –
Pegging links each item to its parent, allowing effective analysis of changes Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved MRP Management (3 of 3) •
MRP limitations – MRP does not do detailed scheduling–it plans – Works best in product-
focused, repetitive environments – Requires fixed lead times and time buckets with
unlimited capacity Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Lot-Sizing Techniques (1 of 3) • Lot-for-lot technique orders just what is required
for production based on net requirements – May not always be feasible – If setup costs are
high, lot-for-lot can be expensive • Economic order quantity (EOQ) – EOQ expects a known
constant demand and MRP systems often deal with unknown and variable demand
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lot-Sizing
Techniques (2 of 3) • Periodic order quantity (POQ) orders quantity needed for a
predetermined time period – Interval = EOQ / average demand per period – Order quantity
set to cover the interval – Order quantity recalculated at the time of the order release – No
extra inventory Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Lot-Sizing Techniques (3 of 3) • Dynamic lot sizing techniques – Balance lot size and setup

10. costs – Part period balancing (least total cost) – Least unit cost – Least period cost (Silver-
Meal) • Dynamic programming approach – Wagner-Whitin Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Lot-for-Lot Example (1 of 2) Holding cost =
$1/week; Setup cost = $100; Lead time = 1 week Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Lot-for-Lot Example (2 of 2) Holding cost = $1/week;
Setup cost = $100; Lead time = 1 week No on-hand inventory is carried through the system
Total holding cost = $0 There are seven setups for this item in this plan Total ordering cost
= 7 × $100 = $700 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved EOQ Lot Size Example (1 of 2) Holding cost = $1/week; Setup cost = $100; Lead
time = 1 week Average weekly gross requirements = 27; EOQ = 73 units Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved EOQ Lot Size Example (2 of 2)
Holding cost = $1/week; Setup cost = $100; Lead time = 1 week Average weekly gross
requirements = 27; EOQ = 73 units Annual demand D = 1,404 Holding cost = 375 units × $1
(including 57 units on hand at end of week 10) Ordering cost = 4 × $100 = $400 Total cost =
$375 + $400 = $775 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved POQ Lot Size Example (1 of 2) EOQ = 73 units; Average weekly gross
requirements = 27; POQ interval = 73/27 ≅ 3 weeks Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved POQ Lot Size Example (2 of 2) EOQ = 73 units; Average
weekly gross requirements = 27; POQ interval = 73/27 ≅ 3 weeks Setups = 3 × $100 = $300
Holding cost = (40 + 70 + 30 + 55) units × $1 = $195 Total cost = $300 + $195 = $495
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lot-Sizing
Summary For these three examples Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved Lot-Sizing Summary (1 of 2) • In theory, lot sizes should be recomputed
whenever there is a lot size or order quantity change • In practice, this results in system
nervousness and instability • Lot-for-lot should be used when low-cost setups can be
achieved Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Lot-
Sizing Summary (2 of 2) • Lot sizes can be modified to allow for scrap, process constraints,
and purchase lots • Use lot-sizing with care as it can cause considerable distortion of
requirements at lower levels of the BOM • When setup costs are significant and demand is
reasonably smooth, POQ or EOQ should give reasonable results Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Extensions of MRP • MRP II • Closed-Loop
MRP • Capacity Planning Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Material Requirements Planning II • Requirement data can be enriched by other
resources • Generally called MRP II or Material Resource Planning • Outputs can include
scrap, packaging waste, effluent, carbon emissions • Data used by purchasing, production
scheduling, capacity planning, inventory, warehouse management Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Material Resource Planning (1 of 2) Table
14.4 Material Resource Planning (MRP II) Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Material Resource Planning (2 of 2) Table 14.4 Material
Resource Planning (MRP II) Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Closed-Loop MRP System Figure 14.7 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Capacity Planning • Feedback from the MRP
system • Load reports show resource requirements for work centers • Work can be moved

11. between time periods or work centers to smooth the load or bring it within capacity
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Smoothing
Tactics 1. Overlapping – Sends part of the work to following operations before the entire lot
is complete – Reduces lead time 2. Operations splitting – Sends the lot to two different
machines for the same operation – Shorter throughput time but increased setup costs 3.
Order or lot splitting – Breaking up the order into smaller lots and running part earlier (or
later) in the schedule Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Order Splitting (1 of 2) • Develop a capacity plan for a work cell at Wiz Products •
There are 12 hours available each day • Each order requires 1 hour Day Orders 1 10 2 14 3
13 4 10 5 14 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Order Splitting (2 of 2) DAY UNITS ORDERED CAPACITY REQUIRED (HOURS) CAPACITY
AVAILABLE (HOURS) UTILIZATION: OVER/ (UNDER) (HOURS) 1 10 10 12 (2) 2 14 14 12 3
13 13 4 10 5 blank PRODUCTION NEW PLANNER’S PRODUCTION ACTION SCHEDULE blank
12 2 Split order: move 2 units to day 1 12 12 1 Split order: move one unit to day 6 or
request overtime 13 10 12 (2) 14 14 12 2 61 blank blank blank 12 Split order: move 2 units
to day 4 blank 12 blank Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Order Splitting Figure 14.8 Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved MRP in Services (1 of 3) • Some services or service items are directly
linked to demand for other services • These can be treated as dependent demand services
or items – Restaurants – Hospitals – Hotels Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved MRP in Services (2 of 3) Figure 14.9 Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved MRP in Services (3 of 3) Figure 14.9
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Distribution
Resource Planning (DRP) Using dependent demand techniques throughout 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
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Enterprise
Resource Planning (ERP) (1 of 2) • An extension of the MRP system to tie in customers and
suppliers 1. Allows automation and integration of many business processes 2. Shares
common databases and business practices 3. Produces information in real time •
Coordinates business from supplier evaluation to customer invoicing Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Enterprise Resource Planning (ERP)
(2 of 2) • ERP modules include – Basic MRP – Finance – Human resources – Supply-chain
management (SCM) – Blockchain – Customer relationship management (CRM) –
Sustainability Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
ERP and MRP (1 of 5) Figure 14.10 Copyright © 2020, 2017, 2014 Pearson Education, Inc.
All Rights Reserved ERP and MRP (2 of 5) Figure 14.10 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved ERP and MRP (3 of 5) Figure 14.10 Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved ERP and MRP (4 of 5) Figure
14.10 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved ERP and
MRP (5 of 5) Figure 14.10 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Enterprise Resource Planning (ERP) • ERP systems have the potential to – Reduce
transaction costs – Increase the speed and accuracy of information • Facilitates a strategic

12. emphasis on JIT systems and supply chain integration • Can be expensive and time-
consuming to install Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved SAP’s ERP Modules Figure 14.11 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved 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 in the grocery industry • Objective is to
tie sales to buying, inventory, logistics, and production Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Copyright This work is protected by United
States copyright laws and is provided solely for the use of instructors in teaching their
courses and assessing student learning. Dissemination or sale of any part of this work
(including on the World Wide Web) will destroy the integrity of the work and is not
permitted. The work and materials from it should never be made available to students
except by instructors using the accompanying text in their classes. All recipients of this
work are expected to abide by these restrictions and to honor the intended pedagogical
purposes and the needs of other instructors who rely on these materials. Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Operations Management:
Sustainability and Supply Chain Management Thirteenth Edition Chapter 12 Inventory
Management Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Outline (1 of 2) • Global Company Profile: Amazon.com • The Importance of Inventory •
Managing Inventory • Inventory Models • Inventory Models for Independent Demand
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Outline (2 of 2) •
Probabilistic Models and Safety Stock • Single-Period Model • Fixed-Period (P) Systems
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Inventory
Management at Amazon.com (1 of 3) • Amazon.com started as a “virtual” retailer – no
inventory, no warehouses, no overhead – just computers taking orders to be filled by others
• Growth has forced Amazon.com to become a world leader in warehousing and inventory
management Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Inventory Management at Amazon.com (2 of 3) 1. Each order is assigned by computer to
one of the distribution centers 2. A “flow meister” at each distribution center assigns work
crews 3. Robots and technology help workers move merchandise and pick the correct items
4. Items are placed into crates on a conveyor, bar code scanners scan each item 15 times to
virtually eliminate errors Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Inventory Management at Amazon.com (3 of 3) 5. Crates arrive at central point
where items are boxed and labeled with new bar code 6. Order arrives at customer within 1
– 2 days Amazon expects the customer experience to yield the lowest price, fastest delivery,
and error-free order fulfillment Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Learning Objectives (1 of 2) When you complete this chapter you should be
able to: 12.1 Conduct an ABC analysis 12.2 Explain and use cycle counting 12.3 Explain and
use the EOQ model for independent inventory demand 12.4 Compute a reorder point and
explain safety stock Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Learning Objectives (2 of 2) When you complete this chapter you should be able
to: 12.5 Apply the production order quantity model 12.6 Explain and use the quantity
discount model 12.7 Understand service levels and probabilistic inventory models

13. Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Inventory
Management The objective of inventory management is to strike a balance between
inventory investment and customer service Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Importance of Inventory • One of the most expensive
assets of many companies representing as much as 50% of total invested capital • Less
inventory lowers costs but increases chances of shortages, which might stop processes or
result in dissatisfied customers • More inventory raises costs but improves the likelihood of
meeting process and customer demands Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Functions of Inventory 1. To provide a selection of goods for
anticipated demand and to separate the firm from fluctuations in demand 2. To decouple or
separate various parts of the production process 3. To take advantage of quantity discounts
4. To hedge against inflation Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Types of Inventory • Raw material – Purchased but not processed • Work-
in-process (WIP) – Undergone some change but not completed – A function of flow time for
a product • Maintenance/repair/operating (MRO) – Necessary to keep machinery and
processes productive • Finished goods – Completed product awaiting shipment Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved The Material Flow Cycle
Figure 12.1 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Managing Inventory 1. How inventory items can be classified (ABC analysis) 2. How
accurate inventory records can be maintained Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved ABC Analysis (1 of 5) • 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 Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved ABC Analysis (2 of 5) Figure 12.2
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved ABC Analysis (3
of 5) ABC Calculation Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved ABC Analysis (4 of 5) • Other criteria than annual dollar volume may be used –
High shortage or holding cost – Anticipated engineering changes – Delivery problems –
Quality problems Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved ABC Analysis (5 of 5) • Policies employed may include 1. More emphasis on
supplier development for A items 2. Tighter physical inventory control for A items 3. More
care in forecasting A items Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Record Accuracy (1 of 2) • Accurate records are a critical ingredient in production
and inventory systems – Periodic systems require regular checks of inventory Two-bin
system – Perpetual inventory tracks receipts and subtractions on a continuing basis May be
semi-automated Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Record Accuracy (2 of 2) • Incoming and outgoing record keeping must be accurate •
Stockrooms should be secure • Necessary to make precise decisions about ordering,
scheduling, and shipping Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Cycle Counting • Items are counted and records updated on a periodic basis •
Often used with ABC analysis • Has several advantages 1. Eliminates shutdowns and
interruptions 2. Eliminates annual inventory adjustment 3. Trained personnel audit

14. inventory accuracy 4. Allows causes of errors to be identified and corrected 5. Maintains
accurate inventory records Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Cycle Counting Example 5,000 items in inventory, 500 A items, 1,750 B
items, 2,750 C items Policy is to count A items every month (20 working days), B items
every quarter (60 days), and C items every six months (120 days) CYCLE COUNTING
POLICY NUMBER OF ITEMS COUNTED PER DAY ITEM CLASS QUANTITY A 500 Each month
B 1,750 Each quarter 1,750/60 = 29/day C 2,750 Every 6 months 2,750/120 = 23/day blank
blank blank 500/20 = 25/day 77/day Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Control of Service Inventories • Can be a critical component of
profitability • Losses may come from shrinkage or pilferage • Applicable techniques include
1. Good personnel selection, training, and discipline 2. Tight control of incoming shipments
3. Effective control of all goods leaving facility Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Inventory Models (1 of 2) • Independent demand – the
demand for item is independent of the demand for any other item in inventory • Dependent
demand – the demand for item is dependent upon the demand for some other item in the
inventory Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Inventory Models (2 of 2) • Holding costs – the costs of holding or “carrying” inventory over
time • Ordering cost – the costs of placing an order and receiving goods • Setup cost – cost
to prepare a machine or process for manufacturing an order – May be highly correlated
with setup time Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Holding Costs (1 of 2) Table 12.1 Determining Inventory Holding Costs COST (AND RANGE)
AS A PERCENTAGE OF INVENTORY VALUE CATEGORY Housing costs (building rent or
depreciation, operating costs, taxes, insurance) Material handling costs (equipment lease or
depreciation, power, operating cost) Labor cost (receiving, warehousing, security) 6% (3 –
10%) Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage,
space, and obsolescence (much higher in industries undergoing rapid change like tablets
and smart phones) 11% (6 – 24%) Overall carrying cost 26% 3% (1 – 3.5%) 3% (3 – 5%)
3% (2 – 5%) Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Holding Costs (2 of 2) Table 12.1 Determining Inventory Holding Costs COST (AND RANGE)
AS A PERCENTAGE OF INVENTORY VALUE CATEGORY Housing costs (building rent or
depreciation, operating costs, taxes, insurance) Material handling costs (equipment lease or
depreciation, power, operating cost) Labor cost (receiving, warehousing, security) 6% (3 –
10%) Investment costs (borrowing costs, taxes, and insurance on inventory) Pilferage,
space, and obsolescence (much higher in industries undergoing rapid change like tablets
and smart phones) 11% (6 – 24%) Overall carrying cost 26% 3% (1 – 3.5%) 3% (3 – 5%)
3% (2 – 5%) Holding costs vary considerably depending on the business, location, and
interest rates. Generally greater than 15%, some high tech and fashion items have holding
costs greater than 40%. Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Inventory Models for Independent Demand Need to determine when and how
much to order 1. Basic economic order quantity (EOQ) model 2. Production order quantity
model 3. Quantity discount model Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Basic EOQ Model Important assumptions 1. Demand is known, constant,
and independent 2. Lead time is known and constant 3. Receipt of inventory is

15. instantaneous and complete 4. Quantity discounts are not possible 5. Only variable costs are
setup (or ordering) and holding 6. Stockouts can be completely avoided Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Inventory Usage Over Time Figure
12.3 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Minimizing
Costs (1 of 7) Objective is to minimize total costs Figure 12.4c Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Minimizing Costs (2 of 7) • By minimizing
the sum of setup (or ordering) and holding costs, total costs are minimized • Optimal order
size Q* will minimize total cost • A reduction in either cost reduces the total cost • Optimal
order quantity occurs when holding cost and setup cost are equal Copyright © 2020, 2017,
2014 Pearson Education, Inc. All Rights Reserved Minimizing Costs (3 of 7) The necessary
steps are: 1. Develop an expression for setup or ordering cost 2. Develop an expression for
holding cost 3. Set setup (order) cost equal to holding cost 4. Solve the equation for the
optimal order quantity. Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Minimizing Costs (4 of 7) Q = Number of units per order Q* = Optimal number of
units per order (EOQ) D = Annual demand in units for the inventory item S = Setup or
ordering cost for each order H = Holding or carrying cost per unit per year Annual setup
cost = ( Number of order
Minimizing Costs (5 of 7) 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 or
D Annual setup cost = S Q Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Minimizing Costs (6 of 7) 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
holding cost = D S Q Q H 2 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Minimizing Costs (7 of 7) Q = Number of pieces per order Q* = Optimal number of
pieces per order (EOQ) Annual setup cost = D = Annual demand in units for the inventory
item Annual holding cost = S = Setup or ordering cost for each order D S Q Q H 2 H = Holding
or carrying cost per unit per year Optimal order quantity is found when annual setup cost
DS Q2 = H 2 DS Q* = H Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved An EOQ Example (1 of 6) Determine optimal number of needles to order D = 1,000
units S = $10 per order H = $.50 per unit per year Q = 2 DS H Q = 2(1,000)(10) = 40,000 =
200 units 0.50 * * Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved An EOQ Example (2 of 6) Determine expected number of orders Q* = 200 units D
= 1,000 units S = $10 per order H = $.50 per unit per year Demand D Expected number of
orders = N = = Order quantity Q * 1,000 N= = 5 orders per year 200 Copyright © 2020,

16. 2017, 2014 Pearson Education, Inc. All Rights Reserved An EOQ Example (3 of 6) Determine
optimal time between orders D = 1,000 units Q* = 200 units S = $10 per order N = 5
orders/year H = $.50 per unit per year Number of working days per year Expected number
of orders 250 T= = 50 days between orders 5 Expected time between orders = T = Copyright
© 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved An EOQ Example (4 of 6)
Determine the total annual cost D = 1,000 units Q* = 200 units S = $10 per order N = 5
orders/year H = $.50 per unit per year T = 50 days Total annual cost = Setup cost + Holding
cost D Q S+ H Q 2 1,000 200 = ($10) + ($.50) 200 2 = (5)($10) + (100)($.50) = $50 + $50 =
$100 TC = Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved The
EOQ Model When including actual cost of material P Total annual cost = Setup cost +
Holding cost + Product cost D Q TC = S + H + PD Q 2 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved 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 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
An EOQ Example (5 of 6) Ordering old Q* Ordering new Q* D Q TC = S + H Q 2 1,500 200 =
($10) + ($.50) 200 2 = $75 + $50 = $125 1,500 244.9 = ($10) + ($.50) 244.9 2 = 6.125($10) +
122.45($.50) = $61.25 + $61.22 = $122.47 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved An EOQ Example (6 of 6) Only 2% less than the total cost
of $125 when the order quantity was 200 Ordering old Q* D Q TC = S + H Q 2 1,500 200 =
($10) + ($.50) 200 2 = $75 + $50 = $125 Ordering new Q* 1,500 244.9 = ($10) + ($.50) 244.9
2 = 6.125($10) + 122.45($.50) = $61.25 + $61.22 = $122.47 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Reorder Points • EOQ answers the “how much”
question • The reorder point (ROP) tells “when” to order • Lead time (L) is the time
between placing and receiving an order ROP = (Demand per day)(Lead time for a new order
Pearson Education, Inc. All Rights Reserved Reorder Point Curve Figure 12.5 Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Reorder Point Example
Demand = 8,000 iPhones per year 250 working day year Lead time for orders is 3 working
days, may take 4 D Number of working days in
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Production Order Quantity
Model (1 of 5) 1. Used when inventory builds up over a period of time after an order is
placed 2. Used when units are produced and sold simultaneously Figure 12.6 Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Production Order Quantity
Model (2 of 5) Q = Number of units per order p = Daily production rate H = Holding cost per
unit per year
– – dt Copyright © 2020,
2017, 2014 Pearson Education, Inc. All Rights Reserved Production Order Quantity Model (3
of 5) Q = Number of units per order p = Daily production rate H = Holding cost per unit per
year d = Daily demand (usage) rate t = Length of the production run in days (Maximum

17. inventory level) = (Total produced during the production run) – (Total used during the
inventory
2014 Pearson Education, Inc. All Rights Reserved Production Order Quantity Model (4 of 5)
Q = Number of units per order p = Daily production rate H = Holding cost per unit per year d
= Daily demand (usage) rate t = Length of the production run in days Setup cost = ( D/Q) S
017, 2014 Pearson Education, Inc. All
Rights Reserved Production Order Quantity Example D = 1,000 units p = 8 units per day S =
= 80,000 0.50(1 / 2) = 282.8 hubcaps, or 283
hubcaps Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Production Order Quantity Model (5 of 5) Note: d =4= D 1,000 = Number of days the plant is
in operation 250 When annual data are
Education, Inc. All Rights Reserved Quantity Discount Models (1 of 5) • Reduced prices are
often available when larger quantities are purchased • Trade-off is between reduced
product cost and increased holding cost Table 12.2 A Quantity Discount Schedule PRICE
RANGE QUANTITY ORDERED PRICE PER UNIT P Initial price 0 to 119 $100 Discount price 1
120 to 1,499 $98 Discount price 2 1,500 and over $96 Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Quantity Discount Models (2 of 5) Total annual
cost = Setup cost + Holding cost + Product cost TC = D Q S + IP + PD Q 2 where Q = Quantity
ordered P = Price per unit D = Annual demand in units I = Holding cost per unit per year S =
Ordering or setup cost per order expressed as a percent of price P 2 DS Q = IP * Because unit
price varies, holding cost is expressed as a percentage (I) of unit price (P) Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Quantity Discount Models (3
of 5) Steps in analyzing a quantity discount 1. Starting with the lowest possible purchase
price, calculate Q* until the first feasible EOQ is found. This is a possible best order quantity,
along with all price-break quantities for all lower prices. 2. Calculate the total annual cost
for each possible order quantity determined in Step 1. Select the quantity that gives the
lowest total cost. Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Quantity Discount Models (4 of 5) Figure 12.7 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Quantity Discount Models (5 of 5) Calculate Q* for every
discount starting with the lowest price 2DS Q = IP * 2 ( 5, 200 )( $200 ) Q$96* = = 278
drones / order (.28)( $96 ) Infeasible – calculate Q* for next-higher price 2 ( 5, 200 )( $200 )
Q$98* = = 275 drones / order (.28)( $98) Feasible Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Quantity Discount Example Table 12.3 Total Cost
Computations for Chris Beehner Electronics Choose the price and quantity that gives the
lowest total cost Buy 275 drones at $98 per unit Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Quantity Discount Variations • All-units discount is the
most popular form • Incremental quantity discounts apply only to those units purchased
beyond the price break quantity • Fixed fees may encourage larger purchases • Aggregation

18. over items or time • Truckload discounts, buy-one-get-one-free offers, onetime-only sales
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Probabilistic
Models and Safety Stock • Used when demand is not constant or certain • Use safety stock to
achieve a desired service level and avoid stockouts ROP = d + L + ss Annual stockout costs =
The sum of the units short for each demand level × The probability of that demand level ×
The stockout cost/unit × The number of orders per year Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Safety Stock Example (1 of 2) ROP = 50 units
Stockout cost = $40 per frame Orders per year = 6 Carrying cost = $5 per frame per year
NUMBER OF UNITS ROP → PROBABILITY 30 .2 40 .2 50 .3 60 .2 70 .1 blank 1.0 Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Safety Stock Example (2 of 2)
ROP = 50 units Stockout cost = $40 per frame Orders per year = 6 Carrying cost = $5 per
frame per year A safety stock of 20 frames gives the lowest total cost ROP = 50 + 20 = 70
frames Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Probabilistic Demand (1 of 3) Figure 12.8 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Probabilistic Demand (2 of 3) Use prescribed service
levels to set safety stock when the cost of stockouts cannot be determined ROP = demand
deviation of demand during lead time Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved Probabilistic Demand (3 of 3) Copyright © 2020, 2017, 2014
Pearson Education, Inc. All Rights Reserved Probabilistic Example (1 of 3) μ = Average
demand = 350 kits σdLT = Standard deviation of demand during lead time = 10 kits
Stockout policy = 5% (service level = 95%) Using Appendix I, for an area under the curve of
95%, the Z = 1.645 Safety stock = ZσdLT = 1.645(10) = 16.5 kits Reorder point = Expected
demand during lead time + Safety stock = 350 kits + 16.5 kits of safety stock = 366.5 or 367
kits Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Other
Probabilistic Models (1 of 4) • When data on demand during lead time are not available,
there are other models available 1. When demand is variable and lead time is constant 2.
When lead time is variable and demand is constant 3. When both demand and lead time are
variable Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Other
Probabilistic Models (2 of 4) Demand is variable and lead time is constant ROP = (Average
deviation of demand per day Copyright © 2020, 2017, 2014 Pearson Education, Inc. All
Rights Reserved Probabilistic Example (2 of 3) Average daily demand (normally
distributed) = 15 Lead time in days (constant) = 2 Standard deviation of daily demand = 5
From Appendix I ( 2) = 30
© 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Other Probabilistic Models
(3 of 4) Lead time is variable and demand is constant ROP = (Daily demand × Average lead
time in days)
days Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Probabilistic Example (3 of 3) Daily demand (constant) = 10 Average lead time = 6 days
Standard deviation of lead time = σLT = 1 Service level = 98%, so Z (from Appendix I) =
2.055 ROP = (10 units × 6 days) + 2.055 (10 units )(1) = 60 + 20.55 = 80.55 Reorder point is

19. about 81 cameras Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Other Probabilistic Models (4 of 4) Both demand and lead time are variable ROP =
Education, Inc. All Rights Reserved Probabilistic Example Average daily demand (normally
distributed) = 150 Standard deviation = σd = 16 Average lead time 5 days (normally
distributed) Standard deviation = σLT = 1 day Service level = 95%, so Z = 1.645 (from
Inc. All Rights Reserved 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
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Single-Period
Example (1 of 2) Average demand = μ = 120 papers/day Standard deviation = σ = 15 papers
Cs = cost of shortage = $1.25 − $.70 = $.55 Co = cost of overage = $.70 − $.30 = $.40 Cs
Service level = Cs + Co .55 = .55 + .40 .55 = = .579 .95 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Single-Period Example (2 of 2) From Appendix I, for the
area .579, Z ≅ .199 The optimal stocking level = 120 copies + (.199)(σ) = 120 + (.199)(15) =
120 + 3 = 123 papers The stockout risk = 1 − Service level = 1 − .579 = .421 = 42.1%
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Fixed-Period (P)
Systems (1 of 3) • Fixed-quantity models require continuous monitoring using perpetual
inventory systems • In fixed-period systems orders placed at the end of a fixed period •
Periodic review, P system Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights
Reserved Fixed-Period (P) Systems (2 of 3) • Inventory counted only at end of period •
Order brings inventory up to target level – Only relevant costs are ordering and holding –
Lead times are known and constant – Items are independent of one another Copyright ©
2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved Fixed-Period (P) Systems (3
of 3) Figure 12.9 Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
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 Copyright © 2020, 2017, 2014 Pearson
Education, Inc. All Rights Reserved Copyright This work is protected by United States
copyright laws and is provided solely for the use of instructors in teaching their courses and
assessing student learning. Dissemination or sale of any part of this work (including on the
World Wide Web) will destroy the integrity of the work and is not permitted. The work and
materials from it should never be made available to students except by instructors using the
accompanying text in their classes. All recipients of this work are expected to abide by these
restrictions and to honor the intended pedagogical purposes and the needs of other
instructors who rely on these materials. Copyright © 2020, 2017, 2014 Pearson Education,
Inc. All Rights Reserved