Instructor: Aydin Aysan

Spring 2016

Engineering Management & Ethics Aydin

Aysan

PRODUCTION &
OPERATIONS
MANAGEMENT

PRODUCTION & OPERATIONS

MANAGEMENT
Engineering Management & Ethics Aydin Aysan

Production: Theprocessesandmethodsused to
transformtangibleinputs (raw materials,semifinished goods, subassemblies) and intangible inputs
(ideas,information,knowledge) into goods or
services.
Operations: Jobsortasksconsisting of one or more
elementsor subtasks, performed typically in one
location.
We will study Production and Operations
Management in 3 aspects:
1) Inventory Management
2) Layout Management
3) Quality Management

INVENTORY MANAGEMENT
Engineering Management & Ethics Aydin Aysan

Activitiesemployedin maintaining the optimum

number oramountof eachinventoryitem.
Theobjectiveof inventory management is to
provide uninterruptedproduction,sales, and/or
customer-servicelevels at the minimumcost.
Since for manycompaniesinventory is the
largest item in thecurrent assetscategory,
inventory problems can and docontributeto
losses or even business failures.
We use calculations to find the optimum quantity
that needs to be produced/ordered to keep our
benefit at maximum, and we call this quantity
EOQ (Economic Order Quantity).

INVENTORY MANAGEMENT

An import sales company buys an item for

$100/unit and sells it for $120/unit. Annual sales of the item
are around 1,000 units, with average stock of 150 units. Each
unit held in stock costs approximately 25% of cost a year.
What are the benefits if average stocks of the item are
reduced to 100 units without affecting customer service?
Solution:
Annual Stock Holding Cost (with 150 units of average stock):
Annual Stock Holding Cost (with 100 units of average stock):
We would make $1,250 more profit per year if we decrease
our average stocks quantity from 150 unit to 100 units.
Instead of making $20,000 profit per year we would make
$21,250. This means a 6% increase in yearly profit.

Engineering Management & Ethics Aydin Aysan

Question:

APPROACHES TO INVENTORY CONTROL

Engineering Management & Ethics Aydin Aysan

1. What items should we keep in stock? Holding any stock is expensive, so

organizations have to make sure that their stocks remain at the lowest level
that allows acceptable service. This means:
keeping stock of existing items at reasonable levels;
not adding unnecessary items to the inventory;
removing all items which are no longer used from the inventory.
2. When should we place an order? There are basically three different
approaches to this question.
The first uses a periodic review to place orders of variable size at regular
intervals of time. The stocks are reviewed at the end of a day and any units sold
are replaced.
The second approach uses a fixed order quantity. Stock levels are continuously
monitored and when they fall to a specified level a fixed amount is ordered.
The third approach relates the supply more directly to the demand and orders
enough stock to meet known demand over a specified period.
3. How much should we order? Every time we place an order, there are
associated costs for administration, delivery, and so on. If we place large,
infrequent orders, the costs of ordering and delivery are kept low, but stock
levels and average inventory value are high. If we place small frequent orders,
costs of ordering and delivery are high, but average stock level is low. We will
look for a compromise between these two extremes that minimizes overall cost.

ECONOMIC ORDER QUANTITY (EOQ)

Per
Unit

(devide
by D)

Minimu
m

(derivativ
e equals to

Engineering Management & Ethics Aydin Aysan

A factory is placing orders for a product to its supplier from

time to time. There are:
1)
A holding cost per unit i.e. storage, perishing, interest
lost
2)
A setup cost associated per order i.e. documentation,
carrying
What would be the optimal order quantity to reduce the
costs?

BANK QUESTION
A bank wants to decide the
replenishment period for an ATM. The money
loading process costs 300 TL. The customers
withdraws daily 2000 TL from this ATM. The
annual interest rate for the bank is 15%. How
frequently should the bank replenish the money in
the ATM and how much should it deposit each time?
Solution:
D (Annual Demand) = 365 * 2000 = 730,000 TL
A (Setup Cost) = 300 TL, h (holding cost) = 0.15 TL

Q* = 54,037 TL,

730,000 / 54,037 = 13.5 times per year.

365 / 13.5 = 27.04 (replenishment in every 27 days)

Engineering Management & Ethics Aydin Aysan

Question:

BANK QUESTION

Total cost per year is:

Engineering Management & Ethics Aydin Aysan

Now
lets examine the answer:
We found that we will replenish the money every 27
days. Which means we will deposit 27 * 2000 =
54,000 TL every time. (we will replenish 13.5
times/year)
The total holding cost in each 27 days is:

BANK QUESTION

try the same thing for 10 days, 50 days and 30 days

too:
* For 10 days:

* For 50 days:

* For 30 days:

These results prove that our calculation was right.

Replenishing every 27 days have the least total cost per
year.

Engineering Management & Ethics Aydin Aysan

Lets

PLASTIC INJECTION FACTORY

QUESTION
Engineering Management & Ethics Aydin Aysan

Question 1: You are producing a plastic component for

a customer. You use plastic moulding machines
(injection process) for this production.
The component is 55 gr, and it is made from ABS
plastic raw material.
The price of ABS is 5 TL/kg
The labor cost is 12 TL/hour, electric consumption of
the machine is 7 TL/hour and the other variable costs
(lubricating oil, maintenance cost etc.) is 1 TL/hour.
The products cycle time in the machine is 40 seconds
and its a 1 cavity mold.
What is the variable cost of this plastic component?

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PLASTIC INJECTION FACTORY

QUESTION
1:
The raw-material cost of the component is:
The injection cost of the component is:

Total variable cost of the component is:

Engineering Management & Ethics Aydin Aysan

Answer

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PLASTIC INJECTION FACTORY

QUESTION
Engineering Management & Ethics Aydin Aysan

Question 2: For the same plastic component the mold

set-up takes 2 hours. 1 foreman and 1 helper works in
the process.
The helper installs the mold to the injection
machine in 75 minutes.
After the mold is installed the foreman comes and
enters the values to the machine and makes
adjustments in 45 minutes.
Foremans hourly cost to the factory is 20 TL/hour
and the helpers cost is 14 TL/hour.
Approximately 2.5 kg of raw-material goes to waste
when trying to adjust the injection values.
What is the set-up cost of this mold?

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PLASTIC INJECTION FACTORY

QUESTION
2:
Helpers labor cost is:
Foremans labor cost is:
Waste material cost is:
Total set-up cost is:

Engineering Management & Ethics Aydin Aysan

Answer

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PLASTIC INJECTION FACTORY

QUESTION

The capital to produce the item is loaned from a

bank with 2% monthly interest rate.
According to the results you found on Questions 1
& 2; how many pieces should you produce each
time you set-up the mold?

Engineering Management & Ethics Aydin Aysan

Question 3: Your customer is using this plastic

component every day (even on holidays), you
dispatch 33 pieces of this item everyday for 365
days a year.

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PLASTIC INJECTION FACTORY

QUESTION

3:

This means we need to make around 3 months of

stock each time we set-up the mold. 2844/(33*30)
We will make production for 32 hours every time
we start production. (2844*40)/3600

Engineering Management & Ethics Aydin Aysan

Answer

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PLASTIC INJECTION FACTORY

QUESTION
examine the results we found by solving the question
manually:
1 months stock worth:
If this stocks wait for 1 month it will cost us:

Considering that the 1st months stock will be dispatched on a

daily basis, the stock cost will be:

The 2nd months stock will cost:

The total stock cost is 5.02 + 15.06 = 20.08 TL, its still lower than
the set-up cost of 45 TL, so we should produce more.

The 3rd months stock will cost:

The total stock cost is 5.02 + 15.06 + 26 = 46.08 TL, its a little more
than the set-up cost, so we shouldnt produce more. 3 months stock
will be fine.

Engineering Management & Ethics Aydin Aysan

Lets

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PLASTIC INJECTION FACTORY

QUESTION

Total cost of this component is:

This 0.52 TL/pcs cost is only reliable if we always make the

planning efficiently, otherwise it will increase.

Why do we dispatch these components 33 pieces/day? Wouldnt

it be better if we dispatch 1 months of component at once?

If we use a lot size slightly different than Q, the increase in the

holding plus setup cost will not be large. (27 days - 30 days,
1800 TL 1850 TL from the first question) The EOQ gives a
good guideline, but if it cannot be used, a close approximation
should give reasonable results.

Engineering Management & Ethics Aydin Aysan

What

else did you notice about this question?

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LEAD TIME
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So far we have been looking at the question of how much to order,

and assumed that as soon as we place an order, the materials
arrive and are ready for use. In practice, this almost never
happens and there can be significant delays. The lead time
occurs because of:
Time for order preparation
Time to get the order to the right place in suppliers
Time at the supplier
Time to get materials delivered from suppliers
Time to process the delivery
This lead time can vary between a few minutes to several years,
and is typically between a few days and a few weeks.
It is in everybodys interests to make it as short as possible.
Customers want their deliveries as fast as possible, and suppliers
want to maintain high customer service and not keep materials
in their own stocks.

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REORDER LEVEL
Engineering Management & Ethics Aydin Aysan

If we assume the lead time is constant, we can add a

useful extension to our previous analysis.
When demand is constant, there is no benefit in
carrying stock from one cycle to the next, so each
order should be timed to arrive just as existing stock
runs out.
The easiest way of arranging this is to define a
reorder level. When stock declines to this reorder
level, it is time to place an order.
The EOQ does not depend on lead time and remains
unchanged.
reorder level = lead time demand = lead time
demand per unit time: ROL = LT D

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REORDER LEVEL

Solution: Substituting values LT = 1 and D = 100.

ROL = LT D = 1 100 = 100 units
As soon as the stock level declines to 100 units, Carl
should place an order for 250 units.
Would the result change if the lead time was 2 weeks?
Yes! We would need to reorder when the stocks decline to
200 units. The lot would still be 250 units.

Engineering Management & Ethics Aydin Aysan

Question: A factory uses a certain component at the

rate of 100 a week, and he has calculated an EOQ of
250 units. What is his best ordering policy if lead time
is one week?

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PRICE DISCOUNTS FROM

SUPPLIERS
Engineering Management & Ethics Aydin Aysan

Question: During a 50-week year a company

notices that demand for one of its products is more
or less constant at 10 units a week.
The cost of placing an order, including delivery, is
around $150.
The company aims for 20 per cent annual return on
assets.
The supplier of the item quotes a basic price of
$250 a unit, with discounts of 10 per cent on orders
of 50 units or more, 15 per cent per cent on orders
of 150 units or more and 20 per cent on orders of
500 units or more.
What is the optimal order size for the item?

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PRICE DISCOUNTS FROM

SUPPLIERS
We can list the variables as:
D = 10 50 = 500 units a year
A = $150 an order
i = 20 per cent of unit cost a year
h = i c = 0.2 c (a unit a year)
1) We should calculate the optimum quantity using
the lowest cost/unit:
The price of $200 () is only valid when the quantity
is more than 500 pieces. So we need to calculate
the total cost at the break point (500 pieces):

Engineering Management & Ethics Aydin Aysan

Solution:

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PRICE DISCOUNTS FROM

SUPPLIERS
should now calculate the cost with the 2nd
lowest rate:
The price of $212.5 () is only valid when the quantity
is more than 150 pieces. So we need to calculate the
total cost at the break point (150 pieces):
3) We should now calculate the cost with the 3rd
lowest rate:

Engineering Management & Ethics Aydin Aysan

2)We

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PRICE DISCOUNTS FROM

SUPPLIERS
price of $225 () is only valid for 58 pieces, so we
dont need to calculate the total cost for the break
point.
When we calculate the total cost for 58 pieces:

Since 58 pieces is valid for 3rd price rate, we dont

need to examine the 4th rate. The total cost will
obviously be higher.
Optimum lot size is 150 units, with the total cost of
109,938 USD/year.

Engineering Management & Ethics Aydin Aysan

The

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OPTIMAL BATCH SIZE

When the production of an item takes long time the optimum batch size
might change since we will use some of the goods we produced as we
continue production.
The optimal quantity will be different than Economic Order Quantity
because we will only have holding cost for the excess production.
Check the graph below where the demand is D and production is P for the
same amount of time:

We use the formula below when there is a situation like this:

Engineering Management & Ethics Aydin Aysan

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OPTIMAL BATCH SIZE

Question:

So the optimal production time is:

Engineering Management & Ethics Aydin Aysan

Demand for an item is constant at 1,800 units a

year. The item can be made at a constant rate of 3,500 units a
year. Unit cost is $50, batch set-up cost is $650, and holding
cost is 30% of value a year. What is the optimal batch size for
the item? If production set-up time is 2 weeks, when should
this be started?
Solution:
D = 1,800 units a year, P = 3,500 units a year, c = $50 a unit, A
= $650 a batch, h = 0.3 50 = $15 a unit a year

So the optimal cycle time will be:

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This means that we will produce for 59 days, than stop for 56
days, and than start production again.

OPTIMAL BATCH SIZE

* Youll get a + for the home assignment

Engineering Management & Ethics Aydin Aysan

Homework (Voluntary): What would the optimal

quantity be if we ignored the consumption while
producing? Calculate both of the total costs and
compare. (Answer)

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UNCERTAIN DEMAND
Engineering Management & Ethics Aydin Aysan

Even when the demand varies, we could still use the

mean value in a deterministic model.
In practice, this usually gives us reasonable results
however if the demands fluctuation is high, we might
get poor results. (if we get orders like this monthly: 10
pcs, 240 pcs, 40 pcs, 130 pcs)
If the demand goes like 50 pcs, 60 pcs, 55 pcs, 70 pcs
we would get better results.
What indicates this fluctuation is Standard Deviation.
These type of questions are often explained by a
Newsboy Problem where the newsboy wants to
maximize his profit while trying to have the minimum
number of newspapers left at the end of the day.

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UNCERTAIN DEMAND
Engineering Management & Ethics Aydin Aysan

Suppose, for example, a newsagent buys a Sunday

magazine from its wholesaler; it wants enough copies to
meet demand on Sunday morning, but it does not want
any stock afterwards.
If we place a very small order for Q units, the probability
of selling the Qth unit is high and the expected profit is
greater than the expected loss. If we place a very large
order, the probability of selling the Q th unit is low and the
expected profit is less than the expected loss.
Based on this observation, we might suggest that the best
order size is the largest quantity that gives a net expected
profit on the Qth unit and, therefore, a net expected loss
on the (Q+1)th and all following units.
Ordering less than this value of Q will lose some potential
profit, while ordering more will incur net costs.

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UNCERTAIN DEMAND

we
buy a number of units, Q;

some of these are sold in the cycle to meet demand, D;

any units left unsold, Q D, at the end are scrapped at a lower value;

Prob(D > Q) = probability demand in the cycle is greater than Q;

SP = selling price of a unit during the cycle;

SV = scrap value of an unsold unit at the end of the cycle.

The profit on each unit sold is (SP UC), so the expected profit on the
Qth unit is: probability of selling the unit profit made from selling it
=Prob(D Q) (SP UC)
And the loss on each unit scrapped is (UC SV), so the expected loss on
the Qth unit is: probability of not selling the unit loss incurred with
not selling it. =Prob(D < Q) (UC SV). (=(1 Prob(D Q))(UC SV)
We will only buy Q units if the expected profit is greater than the
expected loss and: Prob(D Q)(SP UC) (1 Prob(D Q))(UC
SV)
which we can rearrange to give the general rule, that we place an order
for the largest value of Q which still has:

Engineering Management & Ethics Aydin Aysan

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HEATER RETAILER EXAMPLE

Demand

Probability

20%

30%

30%

10%

10%

How many heaters should the company buy?

Engineering Management & Ethics Aydin Aysan

Question: A heater retailer company is about to

place an order for industrial heaters for a forecast
spell of cold weather. They pay $1,000 for each
heater, and during the cold spell sell them for
$2,000 each. Demand for the heaters declines
markedly after a cold spell, and any unsold units
are discounted to $500. Previous experience
suggests the likely demand for heaters is as follows:

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HEATER RETAILER EXAMPLE

Prob(D Q) is the cumulative probability of selling at least Q heaters,

and we want the largest value of Q for which this is less than 0.33.
If Q = 1, Prob(D 1) = 1.0. This is greater than 0.33, so the
inequality is valid and we increase Q.
If Q = 2, Prob(D 2) = 0.8. This is greater than 0.33, so the
inequality is valid and we increase Q.
If Q = 3, Prob(D 3) = 0.5. This is greater than 0.33, so the
inequality is valid and we increase Q.
If Q = 4, Prob(D 4) = 0.2. This is less than 0.33, so the inequality is
no longer valid.

!!! This identifies Q = 3 as the highest value where the

inequality is valid, so the company should buy three heaters.

Engineering Management & Ethics Aydin Aysan

Solution:
UC = $1,000 a unit, SP = $2,000 a unit, SV = $500 a unit

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DISCRETE DEMAND WITH

SHORTAGES
We sometimes face problems where we have a holding cost of
an item which is rarely used but cause a big problem if we dont
have it when we need it.

The characteristics of these problems are:

Known probability of demand

Relatively low demand

A policy of replacing each unit when its used.

When an amount of stock is greater than the demand, the

holding cost is (A D) HC per unit of time.
When demand is greater than the stock, the shortage cost is (D
A) SC per unit of time.
We decide on how many units of stock we want according to the
formula below:

Engineering Management & Ethics Aydin Aysan

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SPARE PART EXAMPLE

The company checked the last 5 years consumptions

per month and the results are as shown below:
Demand of

0.63

Spare Part

average

Months/5 years

40

10

60 total

How many pieces of this spare part should the

company keep in their stocks?

Engineering Management & Ethics Aydin Aysan

Question: A manufacturing firm is using a spare

part when there is a problem with their machine. The
holding cost of the spare part is 30 TL/month. When
there is a shortage of item production is disrupted
and the estimated cost will be 2000 TL. The spare
parts lead time is 1 month.

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SPARE PART EXAMPLE

We know that HC = 30 TL and SC = 2000 TL

The probabilities of each demand is as below:

0 units/month: 40/60 = 66.7%
1 units/month: 10/60 = 16.7%
2 units/month: 5/60 = 8.3%
3 units/month: 3/60 = 5.0%
4 units/month: 1/60 = 1.7%
5 units/month: 1/60 = 1.7%
This means that more than 4 unit of stock, the expected
cost of holding stock will be more than the expected cost
of shortage. So holding 4 units of this spare part would
be the best decision.

Engineering Management & Ethics Aydin Aysan

Solution:

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