Notes310 08

COURSE:
OPERATIONS MANAGEMENT
OPIM 310
Suresh Nair, Ph.D.
Professor
Operations & Information Management
Te
UConn Graduate Business
Studies Program
SCHOOL OF BUSINESS
EXECUTIVE EDUCATION PROGRAMS
1
Prof. Suresh Nair 1 Operations Management OPIM 310
OPIM 310 OPIM 310
OPERATIONS MANAGEMENT OPERATIONS MANAGEMENT
Suresh Nair
Professor
Department of Operations and Information Management
School of Business
University of Connecticut
OPIM 310 Operations Management OPIM 310 Operations Management
What are Operations?
They are all activities associated with the production and
distribution of goods and services.
Manufacturing
Distribution
Services
Along with Finance and Marketing, it is one of the three basic
functions of business organizations. Support functions
include Accounting, Personnel and Engineering.
2
The essence of Operations Management is to add value during
the transformation process.
Sun Microsystems: We put the dot in .com
Operations Management: We put the operating in operating earnings!
However, remember that Process should not replace
Execution.
We will study techniques that help in both design and
operation of OM systems, with emphasis on the latter.
Under design we will study capacity planning, including
waiting lines.
Under operation we will study inventory management, MRP
and JIT systems, project management, and quality control.
History of OM History of OM
1776 Division of labor Adam Smith
1790 Interchangeable parts Eli Whitney
1911 Scientific Management FW Taylor
1913 Moving assembly lines Henry Ford
1935 Statistical Quality Control Shewhart et al.
1940 Operations research
1947 Linear Programming George Dantzig
1980s Japanese Mfg. techniques
1990s Time based competition
3
THE NATURE OF SERVICES
Types of services
Degree of customer interaction and customization
Low High
Lo
Labor
intensity
Hi
Service Factory
Airlines
Hotels
Trucking
Service Shop
Hospitals
Auto repair
Mass Service
Retail, wholesale
Schools
Retail banking
Professional Service
Doctors, lawyers
Architects
The following are distinctive characteristics of services
Customer is a participant in the service process
supermarkets, fast food drink dispensing
education
Simultaneous production and consumption
No inventory to decouple internal operation from customer
Waiting time is the corresponding decoupler
Time perishable capacity
Airlines seats, hotels. Yield Management
High seasonality of demand
Site selection dictated by location of customer
Malls, restaurants, fire stations
Limited scale economies because of geographic focus
Limited managerial (Head Office) control of decentralized facilities
Labor intensive, importance of training.
Intangible output, quality issues. Registration, licensing required.
Difficulty of measuring output.
4
SERVICE DELIVERY SYSTEM
The service delivery system can benefit from
Service blueprinting (process mapping)
separate front office from back office operations (line of visibility)
identify potential fail-points and customer waits
standards should be set for service execution times.
Differentiate between direct (loan officer) and indirect
(ATM/phone) customer contact.
In some applications a production line approach works
Limited discretion with personnel (McDonalds)
Division of labor
Substitution of technology for people
Service standardization
In others a customer participation approach works
substitute consumer labor for firm labor
smooth service demand from consumers (off peak pricing)
customer training (use of ATMs, etc.)
In still other situations, a customer contact approach to service
delivery works best.
separate high contact operations from low contact operations
sales opportunity during customer contact (branch banking)
5
Process and Information Flow Charts Process and Information Flow Charts
They help define the service delivery system
They help critically analyze processes for improvement by
highlighting bottlenecks, needs for standardization of
processes, reduction of steps, where capacity needs to be
added, etc.
PROCESS FLOW CHARTS
The symbols used are
Rectangle: a process step
Triangle: inventory or process waits
Circle: inspection
Diamond: a decision point
Arrows: show how the process fits together
Example Process Flow Chart
A companion to the process flow is the information flow chart.
6
Example Information Flow Chart
Critical Examination of Flow Charts Critical Examination of Flow Charts
Once the process is mapped, you should critically examine
them to identify problems
Long waits, steps with episodic or chronic bottlenecks.
Long execution times
Pass-offs of work or information between workers
Steps where many people are involved
Steps where processing is held up for a decision
Steps that involve lots of movement of people, customers,
materials, or paperwork
Steps that could be automated
Steps that could be eliminated, simplified, combined,
rearranged, or standardized.
7
Ask the Questions (Creative Ask the Questions (Creative
Brainstorming) Brainstorming)
Why
Is it necessary, can it be eliminated, combined, etc.?
Where
Why there? Can it be done somewhere else?
By whom
Can it be done by someone else?
How
Can it be done some other way? Automated? Can be made
easier?
When
Why then? Can it be done before? After?
Capacity Planning in Service Capacity Planning in Service
Waiting Lines (Queueing) Waiting Lines (Queueing)
8
WAITING LINES WAITING LINES
The study of Waiting Lines or Queueing Theory is of utmost
importance in the design of Service Systems, e.g., capacity
study of a computer network, determining the number of
servers, tellers, emergency services, size of a restaurant,
number of elevators in a building, phone lines, etc., to
achieve some level of service.
In each of these situations, there are servers who provide
service (e.g., tellers, phone lines) and customers who
require that service (e.g., bank customers, phone calls).
If the server is busy, the customer has to wait, and forms a
waiting line of queue.
Even if there are enough servers to handle customer traffic on
average, queues will form because of the variability in
customer traffic, and service times.
You can add service capacity to reduce waiting, but the costs will go
up. There is a trade-off between waiting costs and capacity costs.
Usually, a service level is specified by the management, e.g, no more
than 4 customers will have to wait, or an average customer will
not have to wait more than 2 minutes.
9
Studies have shown that there are certain common service
configurations.
Studies have also shown that in many cases
Customer arrivals typically follow a Poisson Distribution
specified by a single parameter, , called the Arrival Rate, e.g.,
on average 8 arrivals/hour
Service time are Exponentially distributed
specified by a single parameter, , called the Service Rate,
e.g, serves on average 10 customers/hour.
Case 1: Poisson Arrivals, Exponential Service Case 1: Poisson Arrivals, Exponential Service
=1
=2
=4
A
10
We evaluate various designs of service systems by analyzing
the waiting lines that would result from the designs under
known traffic and service patterns.
If the source of customers is infinite (Infinite source, the most
common case)
For a SINGLE SERVER MODEL, with first come first served
discipline ( / <1, M=number of servers)
Average number in line
In general (for single and multi-server models)
Average time in line
Average system utilization
) (
2

=
q
L
q
q
L
W =
M
=
Example:
A customer service rep can handle 15 calls/hour on average.
Calls come in at the rate of 10/hr. What would be the
number of calls getting a busy signal, the amount of wait,
and the utilization of the rep?
Solution
= 10, =15. = 10, =15. = 10, =15. = 10, =15.
Lq = (10*10)/15(15-10)=100/75 = 1.33 calls
Wq = 1.33/10 = 0.133 hours = 8 minutes
Utilization, = = = = 10/(1*15)= 0.667 = 66.7%
Service time = 60/15=4 minutes
Total time = 8+4 = 12 minutes
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Exercise
A company is considering leasing one of two photocopying
machines.
Mark I is capable of duplicating 20 jobs/hr at $50 per day.
Mark II is capable of duplicating 24 jobs/hr, at $80/day
The duplicating center is open 10 hours a day, with average
arrivals of 18 jobs/hour.
Duplication is performed by employees from various
departments whose hourly wage is $5/hr.
Should the company lease Mark I or Mark II?
For a SINGLE SERVER, CONSTANT SERVICE TIME MODEL
the queue length will be half, the other formulas remain the same.
For a MULTIPLE SERVER MODEL,
The formulas are complicated.
Use Spreadsheet on Website, first tab.
You may use the spreadsheet even for Single Server models
12
Example:
In a store, 5 checkout counters are open. Arrivals to the
counters are at the rate of 36 per hour, service is at the rate of
10/hr per counter. What will be the average length of queue?
Solution:
/ = / = / = / = 36/10 = 3.6, M=5
From the Spreadsheet,
Lq = 1.055 and P(No one in line) = 0.023 or 2.3%.
Utilization, = / = = / = = / = = / = 36/5*10 = 72%
Wq=1.055/36 = 0.029 hrs = 1.7 minutes
Exercise: What would happen if arrival rate=25/hr
Exercise: If waiting time (with arrival rate=36/hr) should be at
most 1 minute, how many counters should be open?
If the arrivals are not Poisson, and the service is not
Exponential, use the following approach.
The arrivals and service times can be analyzed by studying
the Coefficient of Variation (CV, defined as std
deviation/mean) of time between arrivals and service times
(c
a
and c
s
respectively).
Example: Time between arrivals are 2,6,4,1,7 and 10. Then
the mean of these numbers is 5, and std deviation is 3.35.
Then c
a
is (3.35/5) or 0.67. c
s
can be computed similarly.
Suppose the service times are 1,4,2,6,5,3, then c
s
is
(1.87/3.5) or 0.53.
If customer arrivals follow a Poisson distribution, then c
a
=1
If service time are Exponentially distributed, then c
s
=1
If standard deviation is not given or known, assume
Poisson arrivals and Exponential service.
It is best to use the spreadsheet on website, second tab.
Case 2: General Arrivals and Service Case 2: General Arrivals and Service
13
Waiting Line Metrics Waiting Line Metrics
Please use the spreadsheet Multi_queues.xls on the website.
Suppose the mean time between arrivals is t
a
and the mean service
time is t
s
. Then the utilization of the server is
For single server models
Total time in system
Average time in queue
Average length of queue
a
s
t
t
=
a
q
q
t
W
L =
s
s a
T
t
c c
W
|
|
.
|
\
|
|
|
.
|
\
|
+
=
1
1
2
2 2
s T q
t W W =
Example:
A customer service rep can handle calls in 4 minutes on average,
with a standard deviation of 2. Calls come in with an inter-
arrival time of 6 minutes on average, with a standard deviation
of 8. What would be the number of calls waiting, the amount of
wait, the total time in the system, and the utilization of the rep?
Solution
t
a
=6, c
a
=(8/6)=1.33, t
s
=4, c
s
=(2/4)=0.5
=4/6=0.67 or 67%
W
q
= 12.24-4 = 8.24 minutes
Length of queue, L
q
= 8.24/6 = 1.37 customers
Suppose the arrivals were Poisson and the service time
Exponential, then c
a
=1 and c
s
=1
min 24 . 12 4
67 . 0 1
1
2
5 . 0 33 . 1
2 2
= |
.
|
\
|
|
|
.
|
\
| +
=
T
W
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Exercise Suppose the following data has been collected for one
associate at a claims processing center, all times in hours
What is the average waiting time in queue, the total time in the
system, and the utilization of the associate?
Claim
Time
between
arrivals
Service
Times
1 4 1
2 1 2
3 3 1
4 7 4
5 0 2
Analyzing the Waiting Line Formula Analyzing the Waiting Line Formula
We can rewrite the total time in system formula as
The above formula has three parts, the Variability part, the
Utilization part, and the service Time part. We can call this the
VUT equation
Note that an increase in any of the parts will increase the total
time in the system.
Beyond 85% utilization, the
waiting time increases rapidly
Reducing variability of arrival time
and/or service time can reduce
waiting time.
Reducing processing time also helps.
s
s a
T
t
c c
W
|
|
.
|
\
|
|
|
.
|
\
|
+
=
1
1
2
2 2
0.0
20.0
40.0
60.0
80.0
100.0
0 0.2 0.4 0.6 0.8 1
Utilization
W
a
i
t
i
n
g

T
i
m
e
c_a=1
c_a=2
15
Modeling What Modeling What- -ifs, Valuing Alternatives, ifs, Valuing Alternatives,
Risk and Uncertainty Risk and Uncertainty
Monte Carlo Simulation Monte Carlo Simulation
SIMULATION SIMULATION
A Simulation is an experiment in which we attempt to understand
how some process will behave in reality by imitating its behavior
in an artificial environment that approximates reality as closely as
possible.
Simulation is typically used when
No formulae or good solution methods exist because
assumptions in existing formulae/methods are violated.
Data does not follow standard probability distributions
Most importantly, to evaluate alternatives (e.g..., designs,
systems, methods of providing service, etc.)
Examples include evaluating overbooking policies for airplanes,
inventory policies in stores, deciding on the number and location
of warehouses/emission stations/fire stations, evaluating work
schedules, maintenance policies, emergency room schedules,
financial portfolios, real estate salesperson planning, etc., etc.
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Example
Suppose demand and lead time for procuring a particular item
is
Demand Freq. Lead Time Freq.
20 0.3 1 0.4
18 0.4 3 0.6
16 0.3
Suppose the beginning inventory of the item is 120, and the
reorder point is 36. Let order quantity be 75 for the first
scenario
Suppose it costs $0.30 to carry one unit of the item in
inventory per week, it costs $45 to place orders and get a
new consignment, and the penalty for shortages is
$20/unit.
What is the best order quantity?
It is fairly simple to evaluate different alternative order
quantities quickly using simulation.
Step 1
Compute cumulative frequencies and assign random numbers
Dem Freq. CumF RNs LTime Freq. CumF RNs
20 0.3 0.3 00-29 1 0.4 0.4 00-39
18 0.4 0.7 30-69 3 0.6 1.0 40-99
16 0.3 1.0 70-99
The trick for assigning random numbers is easy. Compute the
cumulative frequency, start from 00 to 1 less than the cum
frequency. For the next row, start from the next random
number to 1 less than the cum freq., etc.
Step 2
For a particular order quantity, say Q=75, simulate the process
Life is random
Give Chance a Chance
iPod Shuffle
17
Wk BI RN Dem EIn Ord RN LT Short Random Numbers
1 120 63 18 102 63 59
2 102 88 16 86 88 09
3 86 55 18 68 55 57
4 68 46 18 50 46 87
5 50 55 18 32 75 59 3 55 07
6 32 69 18 14 69
7 14 13 20 0 6 13
8 0 17 20 0 20 17
9 75 36 18 57 36
10 57 81 16 41 81
11 41 84 16 25 75 09 1 84
12 25 63 18 7 63
13 82 70 16 66 70
14 66 06 20 46 06
15 46 20 20 26 75 57 3 20
Step 3 Calculate costs for this value of Q
Holding cost = Ending Inv*0.3 = 620*0.3 = $186
Ordering cost= Orders*45 = 3*45 = $135
Shortage costs= Shortages*20 = 26*20 = $520
TOTAL $841
Choose another Q and r and repeat steps 2 and 3
Choose the Q and r that minimizes total costs
This procedure of simulation is called Monte Carlo Simulation.
If the probabilities were 0.155 0.381 0.464
How many digit random numbers would you choose?
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Exercise
Jack sells insurance. His records on the number of policies
sold per week over a 50 week period are:
Number sold 0 1 2 3 4
Frequency 8 15 17 7 3
1. Simulate his insurance sales for the next 15 weeks
2. Suppose 30% of the policies are Life and 70% are
Supplemental, simulate the type of policies for the next 15
weeks.
3. Suppose 25% of the Life policies are for $100K, 50% for
$250K, and 25% for $500K, simulate the value of the
policies for the next 15 weeks.
Exercise
You want to start a small car rental firm and would like to lease cars
that you will rent out. You want to decide how many cars to lease.
You do some market research and obtain the following information
Number of customers/day 0 1 2
Probability 0.2 0.3 0.5
Length of car rental 1 2 3 4
Probability 0.2 0.3 0.3 0.2
Lease costs are $10 per day, and net profits (exclusive of lease costs)
is $20/day.
Simulate the process for 15 days if you had chosen to lease 3 cars.
19
Simulating Theoretical Distributions
In Excel, use \Tools\Data Analysis and then select Random Number
Generation. This tool can simulate the following distributions:
1. Normal
2. Uniform
3. Binomial
4. Poisson
5. Discrete
The random numbers generated do not change when F9 is pressed
(that is, once generated, they stay fixed).
Random numbers following certain distributions can be generated to
change with every press of F9. This can be very useful in practice.
Generating Normally distributed random numbers:
Suppose you wanted to generate Normal random numbers with a
mean of 50 and standard deviation of 5.
=NORMINV(RAND(),50,5)
Generating Uniformly distributed random numbers:
Suppose you wanted to generate sales per day that were Uniformly
distributed between 6 and 12 (inclusive).
=RANDBETWEEN(6,12)
Generating Exponentially distributed random numbers:
Suppose you want to simulate the next breakdown of a machine that fails
exponentially with a mean of 5 hours (i.e., =0.2), then use
=- 5*LN(RAND())
20
Exercise: Jazz Festival CD Production
Sally Ward wants to press CDs immediately after the Friday performance of the Festival in
Cambridge, and sell CDs on Saturday and Sunday performances. Costs for manufacture
of CDs and revenues are as follows:
Fixed costs $15,000
Unit manufacturing costs $4.50
Revenue/unit sold $15.00
Sales depend on attendance on Friday, Saturday and Sunday. From past years she obtains
the following equation for attendance
Att(Sat+Sun)= 36,578+ 0.7091 Att(Friday) (1)
Which has a residual error of 5952 (more on this later). She figures 4-12% of people who
attend the Saturday and Sunday performances will make CD purchases.
The attendance of this Friday was 21,500. How many CDs should she press that night for sale
on Saturday and Sunday?
Solution:
Plugging 21,500 into (1) we get an expected attendance on Sat and Sun of 51, 823. Therefore
the attendance is going to follow a Normal distribution with mean of 51,823 and standard
deviation of 5982 (the residual error stated above).
Resource Allocation under Constraints Resource Allocation under Constraints
Optimization Optimization
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LINEAR LINEAR PROGRAMMING PROGRAMMING
Example: (Maximization)
A firm makes 2 kinds of TV sets, A&B. The profit from A is
$300, and the profit from B is $250.
The limitations are
Labor: It takes 2 hours to assemble A, and 1 hour to
assemble B. There are only 40 labor hours in a day.
Machine: It takes 1 hour of machine time for A and 3 hours
for B. There are only 45 machine hours in a day.
Marketing: They cannot sell more than 12 units of A per
day.
How many of A&B should be produced each day?
Mathematical model:
Suppose
X1 = The number of units of A to be produced
X2 = The number of units of B to be produced
Then the mathematical model can be stated as:
Maximize
Profits: 300X1 + 250X2 Objective
Function
Subject to the following constraints
Labor 2X1+1X2 <= 40
Machine 1X1+3X2 <= 45 Constraints
Marketing 1X1 <= 12
NonNegativity X1,X2 >= 0
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Solution Method (Graphical)
Setup problem as Mathematical model
Plot constraints
For each constraint
Replace inequality with equality
Set X1 to 0, calculate value of X2, say A. Mark A on Y-axis.
Set X2 to 0, calculate value of X1, say B. Mark B on X-axis.
Draw straight line A-B
Shade area below line for <= constraint, and above line for >=
constraint.
The intersection of shaded areas is the Feasible Region.
The solution has to fall in this area to satisfy all constraints.
Plot Objective Function Line
Set objective equal to some value divisible by both X1 and X2
coefficients (e.g., LCM, or product of the two numbers)
Plot a line for the Objective Function, just as if it were a
constraint, as we did above.
Move objective line till you find the Optimal Solution
For Maximization problems, move the line away from the origin
until it touches the furthest corner point of the feasible region.
For Minimization problems, move the line towards the origin
until it touches the closest corner point of the feasible region
from the origin.
This point is the Optimal Solution.
Note the value of X1 and X2 for this point, substitute in the
objective function to obtain the value of the maximum
profit (the objective function) in this example
23
Example: (Minimization)
In preparing Sungold paint, it is required that the paint have a
brilliance rating of at least 300 degrees, and a hue level of at
least 250 degrees. These can be produced by two
ingredients, A&B.
Both A&B provide 1 degree of brilliance per ounce.
Only A provides hue of 3 degrees per ounce.
A costs 45 cents and B costs 12 cents/ounce.
How much of A&B should be used in the formulation to
minimize costs?
Mathematical model:
Suppose
X1 = The number of ounces of A used.
X2 = The number of ounces of B used
Then the mathematical model can be stated as:
Minimize
Cost: 45X1 + 12X2 Objective
Function
Subject to the following constraints
Brightness 1X1+1X2 >= 300
Hue 3X1+0X2 >= 250 Constraints
NonNegativity X1,X2 >= 0
24
Binary (0-1) Assignment Example:
The coach of any age group swim team needs to assign
swimmers to a 200 yard medley relay team to send to
Junior Olympics. Since most of his best swimmers are very
fast in more than one stroke, it is not clear which swimmer
should be assigned to each of the four strokes. The five
fastest swimmers and their best times (in seconds) for each
of the strokes for 50 yards are:
The coach wishes to assign four swimmers to the four
different strokes to minimize the total relay time.
Stroke Carl Chris David Tony Ken
Backstroke 37.7 32.9 33.8 37.0 35.4
Breaststroke 43.4 33.1 42.2 34.7 41.8
Butterfly 33.3 28.5 38.9 30.4 33.6
Freestyle 29.2 26.4 29.6 28.5 31.1
Non-Binary Allocation Example:
The Energetic Company needs to make plans for the energy
systems for a new building. The energy needs in the building fall
into 3 categories (1) electricity (2) heating water, and (3) heating
space in the building. The costs, daily requirements are shown
below:
The size of the roof limits the largest possible solar heater to 30
units/day. There is no limitation of electricity and natural gas.
However, electricity needs can only be met by purchasing
electricity. Find the plan that minimizes the cost of meeting
energy needs.
Costs for Sources of energy,
$/unit

Needs Electricity Natural
Gas
Solar
Heater
Requirement
/day, units
Electricity 50 20
Water heating 90 60 30 10
Space heating 80 50 40 30

25
Exercise:
The Post Master of a local post office wishes to hire extra help
during the holiday season. Because of limited office space
and budgetary constraints, the number of temporary
helpers must not exceed 10.
From experience, Package sorters can handle 300 letters and
80 packages per day. Letter sorters can handle 400 letters
and 50 packages per day.
The post master estimates that daily volume of extra mail to be
3400 letters and 680 packages.
A Package sorter costs $25/day and Letter sorter costs $22 a
day.
How many of each type of sorter should be hired?
Exercise:
Ace Advertising often uses Linear Programming to determine an
optimal allocation of advertising budgets. Recently they wanted to
develop a plan that would allocate $12000 among radio, TV and
newspaper advertisements with the stipulation that no more than
40% of the budget be allocated to any one medium. They wanted
to maximize effectiveness of the ads.
After some research, the following data was gathered
Medium Effectiveness/ad Cost/ad
Radio 2.4 $200
TV 3.2 $400
Newspaper 1.6 $300
Determine the number of ads in each medium to maximize
effectiveness.
26
Features of Linear Programs
Each problem is either maximization or minimization
There are decision variables, an objective function and
constraints.
The variables can take continuous values (need not be integers)
The solution will only be at corner points, this speeds up the
search for the solution.
Some problems may be infeasible (there is no way all constraints
can be satisfied), or unbounded (the constraints are loose enough
that the objective can be improved without limit)
You can do What-if analysis (Sensitivity Analysis) on the solution
to see what would happen if
coefficients of objective are changed - Range of Optimality
RHS of constraints is changed - Shadow prices.
Try using the SOLVER in Excel
Features of Linear Programs
Each problem is either maximization or minimization
There are decision variables, an objective function and
constraints.
The variables can take continuous values (need not be integers)
The solution will only be at corner points, this speeds up the
search for the solution.
Some problems may be infeasible (there is no way all constraints
can be satisfied), or unbounded (the constraints are loose enough
that the objective can be improved without limit)
You can do What-if analysis (Sensitivity Analysis) on the solution
to see what would happen if
coefficients of objective are changed - Range of Optimality
RHS of constraints is changed - Shadow prices.
Try using the SOLVER in Excel
Additional LP Problems
1. Coordinating Production and Advertising. The Huntz
Company purchases cucumbers and makes two kinds of
pickles: sweet and dill. Huntz has made it a policy that at least
30%, but no more than 60%, of the pickles it produces be sweet.
Huntz wants to produce up to, but not more than, the demand for
each product. The marketing manager estimates that the
demand for sweet pickles is 5000 jars plus an additional 3 jars
for each $1 spent on advertising, and the demand for dill pickles
is 4000 jars plus an additional 5 jars for every $1 spent on
advertising.
Sweet pickles sell for $1.45 per jar, while dill pickles sell for $1.75
per jar. It costs $0.60 to produce a jar of sweet pickles and
$0.85 to produce a jar of dill pickles.
Huntz has $16,000 to spend on producing and advertising pickles.
It wants to know how many units of each product to produce and
how much to spend on advertising for each product to maximize
profit.
Formulate an appropriate linear program.
27
Additional LP Problems
2. Coordinating Production, Advertising, and Capacity Expansion. The engineering staff of
a corporation has developed a promising new product. Management now must make three
decisions for each of the next two years: how much money to spend on expanding
production capacity, how many units to produce, and how much money to spend on
promoting the product in order to increase demand. Management wants to make these six
decisions in such a way that the total profits over the two years will be maximized.
Since this is a new product, the current annual production capacity is 0. However, every $30
spent at the beginning of the first year will immediately increase the annual production
capacity by one unit. Since it is expected that the cost of the required technology will
decrease with time, every $20 spent at the beginning of the second year will immediately
increase the annual production capacity by one unit. The corporation desires to end the
second year with an annual production capacity of at least 6000 units.
It is estimated that if no money is spent at the beginning of the first year promoting the product,
the annual demand will be 600 units. However, every $15 spent at the beginning of the first
year on promotion will immediately increase the annual demand by one unit. It is also
estimated that, if no money is spent on promotion at the beginning of the second year, the
demand during the second year will be 75% of the demand during the first year. However,
every $10 spent at the beginning of the second year on promotion will immediately increase
the annual demand by one unit.
Profits for the first year will be $100 per unit sold minus the cost of capacity expansion and
promotion, and profits for the second year will be $120 per unit sold minus the cost of
capacity expansion and promotion. Because of annual changes in the industry, units
produced during the first year cannot be sold during the second year.
At the beginning of the first year, the corporation has $80,000 available to finance capacity
expansion and product promotion. Funds available to finance capacity expansion and
product promotion at the beginning of the second year include both unspent funds from the
first year and funds obtained by the sale of units during the first year.
Formulate the corporation's two-year decision problem as a linear program.
Forecasting Forecasting
28
Forecasting Forecasting
A forecast is an estimate of the future level of some
variable.
The variable is most often demand, but also can be others
Demand forecasts
Supply forecasts
Price forecasts
Laws of forecasting
Forecasts are almost always wrong (but still useful)
Near term forecasts more accurate that long term
Aggregate forecasts more accurate that individual forecasts
If calculated values can be used, dont use forecasts
Forecast end products, not components (which can be calculated)
Steps in Forecasting
Determine the purpose of the forecast accuracy, granularity
and timeliness needed.
Establish a time horizon
Select a forecasting technique appropriate for the needs and
the data available.
Obtain, clean and analyze data
Make the forecast
Monitor the forecast
Forecasting Methods
Judgmental forecasts historical data scarce, not available or
irrelevant (e.g.; demand for a new technology)
Causal Models variables other than time (price, capacity,
etc.) on the x-axis
Time Series Models time on the x-axis
29
Judgmental Forecasts Judgmental Forecasts
Consumer Surveys
Based of questionnaires submitted to potential customers
Executive and Sales force Opinions
Build-up forecast
Individuals familiar with a particular segment estimate the
demand for that segment. These individual forecasts are
aggregated.
Panel consensus forecast
Brings a panel of experts together to jointly discuss and
develop a forecast.
Delphi method
Similar to panels, but experts work individually and their
forecasts are shared anonymously with the rest of the panel.
The effect of strong personalities in the panel is removed.
Causal Forecasting using Causal Forecasting using
Simple Linear Regression Simple Linear Regression
The objective of regression is to use data to predict values.
We use values of the independent variable, x, to predict the values
of the dependent variable, y.
For example, we may want to predict recruitment as a function of
advertising for recruitment.
The relationship between x and y may be linear or non-linear. We
will focus of linear relationships.
The regression may be simple (one independent variable, x) or
multiple (many independent variables, x
1
, x
2
, ). Excel can be
used for both simple or multiple regression.
The equation can be represented by
y = a + bx
where
a is the intercept on the y-axis, that is, value of y when x=0,
b is the slope of the line, that is, the change in y for a unit change in x.
30
The regression is done using a method called the Least
Squares method.
The R
2
value is a measure of goodness of fit, called Co-
efficient of determination. The closer it is to 1, the better the
fit. Notice from the chart that the fit is very good.
It means that 90.97% of the variation in sales can be explained
by the variation in size of store.
31
From the output we see that the equation is
Sales = 901.25 + 1.69 SqFt
This equation can be used to predict the sales for any other
size store not in the data set. For example, the expected
sales for a store with an area of 6000 square feet would be
Sales = 901.25 + 1.69(6000) = $11041.25
The standard error of 936.85 in the output implies that the
sales of a stores with an area of 6000 square feet would be
normally distributed with a mean of 11041.25 and a
standard deviation of 936.85. (You guessed right, it would
be the same no matter what the square footage was).
Time Series Forecasting Time Series Forecasting
A time series is a set of data obtained at regular periods
over time.
The objective of time series forecasting is to use the time
series data to forecast future values
The components of a time series are
Trend
Seasonality
Cyclicality (like seasonality, but over more than an year)
Irregular or random
The forecast should incorporate all these components, if
present.
If no trend seems to be present, we need to smooth the
series to obtain an overall long term impression. This is
done using moving averages or exponential smoothing.
If trend is present, we need to estimate the trend using least
squares technique.
32
Moving Average
Used to smooth time series data to discern patterns
The. number of periods chosen is the length of the cycle
The higher the number of periods, the smoother the average
Exponential Smoothing
Similar to moving averages, but needs less storage of data
E
i
= (1-w)E
i-1
+wY
i
where Y
i
is the actual, and E
i
the exponential smoothed value is
period
i
. For the first period, E
1
=Y
1
. w (between 0 and 1) is a
smoothing coefficient. Higher the w, lesser the smoothing.
The forecast for the next period is the exponential smoothed
value for the last period.
33
Technique for Seasonality
A seasonal relative could be used
The seasonal relative can be found using the following
method
1. Figure out the moving average by using the number of periods in
a season for averaging (say 7, if you have weekly seasonality, 4
for quarterly seasonality, or 12 for monthly seasonality).
Alternately, fit a trend line through the data.
2. Divide the Actual by the Moving Average or Trend for each period
in the data to get a seasonality ratio
3. Find the seasonal relative for each of the periods in the season
by taking the average of the seasonality ratios in Step 2 for each
period in the season. You obtain seasonal relatives for each
period in the season.
The seasonal relative can be used to
Seasonalize a forecast extrapolate the time series to the next 7
periods and multiply by the seasonal relatives
Deseasonalize a forecast Take seasonal data and divide by the
seasonal relative to remove the seasonal component
Forecast Accuracy Forecast Accuracy
The following measures of the error in the forecasting model
may be used
Mean Absolute Deviation (MAD)
MAD is the average of the absolute deviations between the
observed and the fitted values.
Use abs(.) in Excel to obtain the absolute value.
Mean Square Error (MSE)
MSE is the average of the squared deviations between the
observed and the fitted values.
34
Inventory and Supply Chain Management Inventory and Supply Chain Management
INVENTORY & SUPPLY CHAIN MANAGEMENT INVENTORY & SUPPLY CHAIN MANAGEMENT
Supply Chain Management refers to optimizing inventory planning and
management across the supply chain (vendor, firm, customer) rather
than focusing on the firm as used to be done in the past.
Inventory is idle goods or materials that are held for future use. The
types of goods in inventory may be
Raw materials and purchased parts
Semifinished goods (work in process), and goods in transit
Finished goods (manufacturing) or merchandise (retail stores)
Spares, tools and supplies
In manufacturing firms, material costs may account for about 60% of
the cost of products. This cost consists of the purchase price of the
material and the cost of carrying it in inventory.
Since inventory adds cost and not value to the product, we would like to
minimize inventories as much as possible.
Inventory has financial reporting implications in ROI and Inventory
turnover ratio computations.
Reducing inventory is the primary aim of such management favorites
35
Just in time (JIT) and Lean manufacturing.
Though everyone agrees to the undesirability of carrying excessive
inventories, to some extent it is a necessary evil. The reasons for
carrying inventory are
to meet anticipated demand (e.g., merchandise, office supplies)
to smooth production requirements (e.g., seasonal items)
to decouple operations (buffer stocks between manufacturing
operations that run at different speeds)
to permit operations (work-in-process inventories)
to protect against stockouts (due to inaccuracies in forecasts)
to take advantage of economies of scale and quantity discounts
(e.g., ordering more than is immediately needed)
to hedge against price increases
There are two broad categories of items based on the type of their
demand
Dependent demand items - items whose demand is dependent on
the demand of some other item (e.g., the demand for tires in an
auto plant is dependent on the number of autos produced)
Independent demand items - items whose demand is not
dependent on the demand for some other item (e.g., merchandise,
supplies, tools, finished goods)
Inventory planning for these items are done differently. For
dependent demand items we can compute requirements (e.g., if
we plan to make 100 cars, we will need 400 tires). For independent
demand items we have to forecast demand (e.g., we have to
forecast how many cars to make).
In this part of the course we will focus on inventory planning for
independent demand items. The next chapter on MRP focuses on
dependent demand items.
36
The objective of inventory management is to provide an acceptable
level of service (item being available when needed) at minimum
cost (so that excessive amounts are not carried).
In order to fulfill this objective, we need
a method of exercising appropriate control on items using a
classification system.
a system to keep track of inventory
a reliable forecast of demand
knowledge of procurement lead times and lead time variability
estimates of costs of inventory
ABC Classification As in many other applications, a Pareto
Rule (80-20) applies for inventory. That is, 80% of the costs
are locked up in 20% of the items. This is fortuitous
because then we need to exercise close control on only
these 20% items. This is done by classifying each of the
items in stock as
A items: if they account for 70-80% of dollar usage value
and only 15-20% of the number of items
C items: if they account for 5-15% of dollar usage value, but
as much as 50-60% of the number of items
B items: items that fall between A and C items.
37
Example:
Item# Annual Unit Annual %Annual Class
Volume Cost $ volume $ volume
10286 1000 90 90000 38.8 A
11526 500 154 77000 33.2 A
12760 1550 17 26350 11.4 B
10867 350 42.86 15001 6.5 B
10500 1000 12.5 12500 5.4 B
12572 600 14 8500 3.7 C
14075 2000 0.60 1200 0.5 C
01036 100 8.5 850 0.4 C
01307 1200 0.42 504 0.2 C
10572 250 0.6 150 0.1 C
Note that 20% of items (2) are A and account for 72% of $volume,
and 50% of items (5) are C and account for 5% of $ volume.
Inventory Control Systems Inventory Control Systems
There are two kinds of inventory control systems:
Periodic review system
Perpetual inventory system
Periodic Review System
Review inventory on hand at fixed intervals of time, e.g., weekly
Order up to level R, the reorder level, if inventory is under level r
38
The advantages of the periodic review system are
it is easy to administer
many items can be ordered together (e.g., all Coke
products)
The disadvantages are
lack of control between review periods
could have shortages between review periods
C items can be placed on periodic review.
Perpetual Inventory System
Place an order whenever the stock level goes below r, the
reorder point
The order should be for Q units, the order quantity.
The advantages of the Perpetual inventory system is close
monitoring of stocks. The disadvantage is the amount of
record keeping, though this is less of a problem with
scanning and automatic updating of stock levels.
One easy method of administering this system without
computers is the Two Bin system.
A items may be placed on a perpetual inventory system.
39
Cost Information
There are three basic costs associated with inventory
Holding or carrying costs
rent, electricity, heat
cost of capital, insurance
spoilage, theft and obsolescence
stated as % of unit price. Could be 20-40%.
Ordering costs
typing the order, stationery, postage, calls to expedite, etc.
inspection costs on arrival
stated as $/order.
Shortage costs
lost sales cost
loss of customer goodwill
penalties
The Economic Order Quantity Model The Economic Order Quantity Model
We consider the simplest of models. Here
the demand rate is constant
the lead time is constant
the order is received in a single delivery
there are no quantity discounts
40
The costs incurred are
Annual carrying cost
= (avg. inventory)(inv carrying cost/unit)
= (Q/2)H
where H is the annual carrying cost/unit/year. e.g., if the price of
the item is $5 and the carrying charge is 20%, then
H=0.2(5)=$1/unit/year.
Annual Ordering Cost
= (number of orders/year)(cost/order)
=(D/Q)S
where D is the annual demand for the item, and S is the cost per
order.
Then the total cost is
TC = (Q/2)H+(D/Q)S
The total cost is minimized at the optimal order quantity, Q
o
At this order quantity,
Annual carrying cost = Annual ordering cost
This Q
o
is called the Economic Order Quantity (EOQ)
H
DS
Q
S
Q
D
H
Q
2
2
0
0
0
=
=
EOQ
41
Example:
The demand for a particular item is 18 units/week. The unit cost is $60,
the ordering cost is $45/order, and the inventory carrying charge is
25% per year. What is the EOQ?
Solution:
D=18*52 = 936/year
S=$45/order
H=60*0.25=$15/unit/year. Then
The total cost, TC = (75/2)15+(936/75)*45
= 562+562 = $1124
The number of orders placed/year = 936/75=13/year
The time between orders, or order cycle = 52 weeks/13 = 4 weeks
If lead time is 2 weeks, then the reorder point =demand during LT
= 2*18=36 units
75 95 . 74
15
45 * 936 * 2
0
= = = Q
Exercise:
Suppose the annual demand for an item is 2000. The ordering
cost is $10/order, the inventory carrying charge is 10%, the
price of the item is $10/unit, and the lead time is 4 weeks.
What is the EOQ, total cost, reorder point and order cycle?
42
EOQ Model Sensitivity to Data
The EOQ model is relatively insensitive to small changes in
parameter values entered. This is because of the square
root in the expression.
Also, if orders are placed of quantities around Q
o
but not
exactly Q
o
, the cost increase will be marginal. Thus you can
take advantage of full container loads, etc., near the EOQ,
without adding to costs substantially. This is because the
total cost curve is relatively flat at the EOQ.
If instead of placing orders for a particular item at the optimal
order interval, they were placed at its closest power of 2
interval (say 1,2,4,8,16,), then the extra Total Cost will be
less than 6% over the optimal total cost.
Example: Suppose the optimal order interval is 10 weeks.
Then using an order interval of 8 weeks will not increase
total costs by more than 6%. This will require us to adjust
the order quantity, Q, so that we still purchase D units
during the year.
The advantage of using this rule is that you can save money
by ordering different items together. For example, if the
order interval for an item is 4,8,12,and another item has
an order interval of 8,16,24,, then every other order of the
first item can be placed with the second. This will save
ordering and shipping costs.
Powers of 2 Rule Powers of 2 Rule
43
In the basic EOQ model we assumed that there were no
quantity discounts. That is, no matter how much you order,
the price would be the same.
In practice, quantity discounts may be available. It is possible
to slightly modify the basic EOQ approach to take care of
this.
Model with Quantity Discounts Model with Quantity Discounts
The approach is as follows:
Find the EOQs for each price.
If the EOQ does not qualify for the price, adjust the EOQ
upwards to the minimum amount that will make it qualify for
the price.
Compute the TC for all prices. However, you should now
add the cost of purchase as a third term.
TC = (Q/2)H+(D/Q)S+PD
where P is the price/unit and D is the annual demand.
Choose the quantity that minimize the total cost.
44
Example: In our original example, suppose we add the
following quantity discounts
Order Quantity Price/unit
0-99 $60
100-499 $58
>500 $56
Would you still place an order for Q=75 units?
Solution:
The EOQs are 75, 76, and 78 respectively. To obtain the
price breaks, adjust these to 75, 100 and 500.
The total costs are:
TC(60)= $57,284
TC(58)=$55,015
TC(56)=$55,916
Therefore, choose to order 100.
We have seen that when the demand rate is constant, and the
lead time is known and constant, the
r = demand during lead-time
or, r = demand/week*LT(in weeks)
In this case, we will never have a stockout because everything
is predictable.
What happens if demand is uncertain or leadtime is uncertain?
In our example, suppose the demand could be 18/week on
certain weeks, 15/week on others, and 20/week at times.
Clearly, if we want to avoid stockouts, we will need to carry
additional stocks, just in case. This is called Safety Stock.
Clearly, the more safety stock you carry, the less the chance
of a stockout. But too much can be expensive. How do we
decide how much is enough?
When to Reorder When to Reorder - - Safety Stocks Safety Stocks
45
We need the concept of Service Level. The service level is the
percentage of time we would like to be able to satisfy demand
from stock, i.e., without facing a stockout.
A 95% service level implies a 5% chance of stockouts, which
may be acceptable in certain situations.
The higher the service level needed, the higher the safety stock
you will need to carry.
Variable Demand Rate, Constant Lead Time
We could assume that the demand follows a Normal Distribution
(any other distribution can also be used, as applicable). This
makes our choice of safety stock level easy.
Example: Suppose the lead time is 3 weeks, and the demand has a mean
of 18 with a standard deviation of 2/week. What would be the ROP?
Solution: The average demand during the 3 weeks of lead time will be 54
units. However, this number has a standard deviation of
We could then decide how much safety stock to carry. We could use the
Normal distribution tables to help us here.
For example, we know that 90% of the time, the demand during lead
time will be less than 54+1.28(3.46)= 58.43, or X = + z
Or, 95% of the time, demand during lead time will be less than
54+1.645(3.46) = 59.71
Or, 99% of the time the demand during lead time will be less than
54+2.33(3.46)=62.06.
In other words,
If we wanted a 90% service level, instead of reordering at 54 we
should order at 58.43 (or 59).
LT
d
= = = + + = 46 . 3 12 2 2 2
2 2 2
46
For 95% service level, we should reorder at 59.71(or 60).
For 99% service level, we should reorder at 62.06(or 62)
The additional quantity over 54 in the above examples is the
safety stock.
In general,
The second term in the expression is the level of safety stock.
Read z from the left side page of the inside back cover of
the text.
iod demand/per of deviation standard
level service for on variate distributi normal = z
periods in time, lead = LT
iod demand/per average
where
*
=
=
+ =
d
d
d
LT z LT d ROP

Constant Demand Rate, Variable Lead Time
Here the approach is similar, except that since demand is
constant, we don't need to calculate average demand. Also,
since LT is now variable, we need the average LT and the
standard deviation of the LT.
Example: Suppose the demand was constant at 18/week, but
lead time was an average of 2 weeks with a standard
deviation of 0.5 weeks.
Solution: For 95% service level,
The ROP = 18(2)+1.65(18)(0.5) = 50.85.
LT of deviation standard
level service for on variate distributi normal = z
periods in time, lead average = LT
iod demand/per
where
*
=
=
+ =
LT
LT
d
zd LT d ROP
47
Setting Service Level Setting Service Level
Single period, Perishable items
Suppose cost of Shortage C
s
=Revenue-Cost per unit
Suppose cost of Excess C
e
=Cost Salvage value per unit
Then
Example:
Sweet cider is delivered weekly to UConn Cider Bar. Demand is uniform between
120 and 200 gallons per week. The Bar pays $1 per gallon and charges $4 per
gallon. Unsold cider has no salvage value. What is the optimal stocking level.
C
s
=4-1=3; C
e
=1-0=1; Then the optimal service level = 3/(3+1)=75%
The stocking level should satisfy demand 75% of the time. Therefore, thee
stocking level should be 120+.75(200-120)=180 gallons.
Service Levels and ABC/Criticality classification
The service levels shown are only indicative of direction of reduction and not of
magnitude. Actual numbers should depend on costs of inventory and criticality,
as with the single period model above.
e s
s
C C
C
el ServiceLev
+
=
Criticality Classification
High Med Low
A 90% 85% 75%
B 95% 90% 85%
C 99% 95% 93%

The lower level locations (retailers, distributors) are
supplied by higher level locations (distributors, plants
respectively)
Need to determine stocking and ordering policies for each
echelon.
Trade-off between saving inventory by moving it up the
echelon, and higher resulting response time
Bullwhip effect:
Demand may be stable at the retail level
Demand variability increases at the distributor level
Demand variability even higher at the plant
Multi Multi- -echelon Supply Chains echelon Supply Chains
48
Causes and fixes for the bullwhip effect
Batching: to take advantage of economies in ordering/handling
costs
Replenish orders in small quantities
Reduce costs of replenishing orders Internet
Consolidate orders to fill trucks
Forecasting errors: Need for safety stock increases with more
variability
Share demand data
IBM, Apple, HP require sell-through data from their resellers
Vendor managed inventory (let one entity do all forecasting)
For Pampers, P&G controls inventory all the way from suppliers (3M) to its
customers (Walmart)
Lead time reduction
Pricing: Price discounts clumps up demand. Customers will
forward-buy to take advantage of promotional pricing.
Everyday low pricing
Activity based costing
Gaming behavior: Suppliers may allocate product in short supply
to customers in proportion of quantities they order. Customers
may inflate orders and then cancel. Customer orders then are very
bad information to forecast demand.
Allocate shortages according to past sales
Use more stringent time fencing time windows in which orders cant
be changed (e.g., next 6 weeks orders are frozen)
Lead time reduction
One sweeping policy to reduce the bullwhip effect is to eliminate
layers of the supply chain, as Dell does.
49
Pricing and Revenue Management Pricing and Revenue Management
in the Supply Chain in the Supply Chain
The Role of Revenue Management The Role of Revenue Management
in the Supply Chain in the Supply Chain
Revenue management is the use of pricing to increase the profit
generated from a limited supply of supply chain assets
Supply chain assets exist in two forms: capacity and inventory
Capacity assets production, transportation and storage
Inventory assets to improve product availability
To match supply and demand, these assets are increased or
decreased
Instead firms should explore using pricing to match supply and
demand
Revenue management may also be defined as the use of
differential pricing based on customer segment, time of use, and
product or capacity availability to increase supply chain profits
Most common example is probably in airline pricing
50
Examples of Revenue Management Examples of Revenue Management
A firm has 10 trucks and uses fixed ton-mile pricing
To increase utilization of trucks, they could advertise
An alternative approach is RM
Lower price for customers willing to commit orders well in advance
Lower price for long term contracts
Higher price during times of high demand
In retail differential pricing based on product availability, customer
demand, time remaining in season
In airlines, American Airlines was first to use RM to counter People
Express, 1984
People Express introduced low fare travel
Large airlines could not match those fares by reducing prices across the board
AA started using RM by lowering prices for leisure travel (more than 21 day
advance purchase), but maintained regular prices for business travelers (last
minute booking)
People Express folded in 1986
4 Conditions Under Which Revenue 4 Conditions Under Which Revenue
Management Has the Greatest Effect Management Has the Greatest Effect
1. The value of the product varies in different market segments
(Example: airline seats)
2. The product is highly perishable or product waste occurs
(Example: fashion and seasonal apparel, hotel rooms)
3. Demand has seasonal and other peaks (Example: products
ordered at Amazon.com. Free shipping to move peak to off peak
period before Christmas. Commuter train prices are higher during
peak times.)
4. The product or capacity is sold both in bulk and piecemeal
(Example: owner of warehouse who can decide whether to lease
the entire warehouse through long-term contracts or save a
portion of the warehouse for use in the spot market. TV spots are
sold in May [upfront sales] and on the scatter market at higher
prices How much to sell during the upfront season is an
important decision)
51
Revenue Management for Revenue Management for
Multiple Customer Segments Multiple Customer Segments
If a supplier serves multiple customer segments with a fixed asset, the
supplier can improve revenues by setting different prices for each
segment
Prices must be set with barriers such that the segment willing to pay more
is not able to pay the lower price (Saturday night stay and 21 day advance
booking for airlines)
The amount of the asset reserved for the higher price segment is such that
the expected marginal revenue from the higher priced segment equals the
price of the lower price segment
0
2000
4000
6000
8000
10000
12000
0 1 2 3 4 5
Price
D
e
m
a
n
d
Total revenue =12,000
0
2000
4000
6000
8000
10000
12000
0 1 2 3 4 5
Price
D
e
m
a
n
d
Total revenue =10500+6000
= 16,500
Revenue Management for Revenue Management for
Multiple Customer Segments Multiple Customer Segments
p
L
= the price charged to the lower price segment
p
H
= the price charged to the higher price segment
D
H
= mean demand for the higher price segment

H
= standard deviation of demand for the higher price segment
C
H
= capacity reserved for the higher price segment
R
H
(C
H
) = expected marginal revenue from reserving one more unit of
capacity for high price segment
= Probability (demand from higher price segment > C
H
) x p
H
At the optimal, this should be equal to the marginal price for low price
segment, or
R
H
(C
H
) = p
L
Probability (demand from higher price segment > C
H
) = p
L
/ p
H
C
H
= F
-1
(1- p
L
/p
H
, D
H
,
H
) = NORMINV(1- p
L
/p
H
, D
H
,
H
)
Or,
Reserved inventory = D
H
+z
(1- pL/pH)

H
using the X= +z formula
52
Example: Example: ToFrom ToFrom Trucking Trucking
Suppose capacity available is 6000 cubic ft
Price segment A (24 hr notice) is willing to pay
p
A
= $3.50 per cubic ft
Price segment B (1 week notice) is willing to pay
p
B
= $2.00 per cubic ft
Mean demand for segment A
D
A
= 3,000 cubic ft
Std dev of segment A demand

A
= 1,000 cubic ft
C
A
= NORMINV(1- p
B
/p
A
, D
A
,
A
)
= NORMINV(1- (2.00/3.50), 3000, 1000) or, 3000+z
(1-2/3.5)
1000
= 2,820 cubic ft (reserve so much capacity for
segment A demand, sell remaining capacity to
segment B customers)
If p
A
increases to $5.00 per cubic foot, then
C
A
= NORMINV(1- p
B
/p
A
, D
A
,
A
) or, 3000+z
(1-2/5)
1000
= NORMINV(1- (2.00/5.00), 3000, 1000)
= 3,253 cubic ft
This is why the limited lowest price Y class seats get sold out soon in airlines,
the rest of the seats are reserved for higher paying customers.
Quality Management Quality Management
53
Quality Management Quality Management
Quality is the ability of a product or service to consistently meet or
exceed customer expectations. Quality is a term used in a variety
of ways. The dimensions of quality for the consumer are
Performance (main characteristics of product/service)
Special features (extra characteristics)
Conformance (to customer expectations)
Reliability (consistency of performance)
Durability (useful life)
Service after sale
These are determined by
Quality of design
Quality of conformance (to design specs)
Ease of use
Service after delivery
The consequences of poor quality are
Loss of business (share)
Liability
Productivity (rework, yield, etc.)
Costs (warranty, scrap, repair, rework, liability)
Since the early eighties, quality has taken center stage as a necessity
for competitive advantage. Much of the credit goes to quality gurus
like
Edward Deming (Control charts, sampling)
Joseph Juran (fitness for use, life cycle approach , cost of quality)
Phil Crosby (zero defects, quality is free)
Kaoru Ishikawa (cause and effect diagrams)
Genichi Taguchi (robust design of products and processes)
Since 1952, the Deming Prize has been awarded in Japan and since 1988
the Malcolm Baldrige Award is given in the US to recognize firms
for their quality efforts and results.
54
Malcolm Baldrige Award Criteria
Leadership 110
Leadership System 80
Company Responsibility and Citizenship 30
Strategic Planning 80
Strategy Development Process 40
Company Strategy 40
Customer and Market Focus 80
Customer and Market Knowledge 40
Customer Satisfaction and Relationship 40
Enhancement
Information and Analysis 80
Selection and Use of Info and Data 25
Selection and Use of Comparative Info/Data 15
Analysis and Review of Company Performance 40
Malcolm Baldrige Award Criteria (contd.)
Human Resource Development and Management 100
Work Systems 40
Education, Training, Development 30
Employee well being and satisfaction 30
Process Management 100
Management of Product and Service Processes 60
Management of Support Processes 20
Management of Supplier and Partnering 20
Processes
Business Results 450
Customer Satisfaction Results 130
Financial and Market Results 130
Human Resource Results 35
Supplier and Partner Results 25
Community Specific Results 130
Total 1000
55
Six Sigma Quality Six Sigma Quality
There are 5 steps in applying Six Sigma to a project.
Identify the "critical to quality characteristics" (CTQ) that will
have the most impact on quality.
Identifying the internal processes that affect CTQ and
measuring the defects that result from them.
Analyzing why defects are generated by identifying the
variables most likely to create process variation.
Confirming the variables, quantifying their effect on CTQ,
identifying the maximum acceptable ranges of the variables
and validating a system for measuring deviations of them.
Finally, there is control, which means tools are put into place
to assure that under the modified process, the variables
remain within the acceptable ranges.
Problem statement
Project Y
Magnitude
Impact
Practical
Problem
Statistical
Problem
Statistical
Solution
Practical
Solution
D M A I C
Characterize the
process
Stability
Shape
Center
Variation
Root cause analysis
Critical Xs
Measure the
influence of the
critical Xs on the
mean and variability
Test
Model
Estimate
Verify critical Xs
and (x)
Change process
Control the gains
Risk analysis
Control plans
Data Integrity
MSA (Measurement
Systems Analysis)
Brainstorm potential
Xs
Sampling plan
Collect data
Capability
Using Statistics to Solve Problems Using Statistics to Solve Problems
DMAIC: Define, Measure, Analyze, Improve, Control
56
Quality Control and Continuous Improvement Quality Control and Continuous Improvement
Quality Assurance deals with prevention, detection, and
correction of product and service defects that would make
the product or service unfit for use. Further, it deals with
continuous improvement of quality over time.
Quality Assurance consists of
Acceptance Sampling: sampling inputs to ensure that the
quality of goods from the the vendor is good, and sampling
outputs to ensure that the product quality is good.
Process Control: Taking corrective action during
production or service delivery to ensure quality
product/service.
Continuous Improvement: Improving quality metrics with
time. Just because it isnt broke doesnt mean it cannot be
improved.
Statistical Process Control (SPC/SQC): Statistical Process Control (SPC/SQC):
Traditionally there have been QC inspectors whose sole job is to
inspect goods after they have been produced (to avoid disrupting
production). This is often too late, and a lot of scrap, rework and
productivity loss may result. SPC lets the workers be their own
QC inspectors. Defects are identified as they occur. JIT has
speeded up the adoption of SPC by many manufacturers and
service providers.
When a process produces an item, all the items will not have the
exact same dimensions. There will be minor variations from item
to item. This would be true even under ideal conditions (because
of temperature variations, minor variations in hardness, minor
voltage fluctuations, etc..). These random fluctuations occur
purely by chance and are acceptable (in the sense that no
corrective action need be taken). They are called common causes.
There are other systematic variations in dimensions or quality that
may occur because of excessive tool wear, excessive machine
vibrations, poor material quality, improper machine setting, etc..
These are called
57
assignable causes, and corrective action needs to be taken for such
cases.
The same is true with services. If the process is processing claims, or
approving mortgages, or providing medical services, or providing
hospitality services, etc.., the quality of the service provided will vary
from transaction to transaction. Some of this variation may be due to
random causes (normal variation in time to get police reports, credit
reports, making medical appointments, waiting lines at registration
desk, etc..) and would not require corrective action.
However, some of the variation is the quality of service provided may be
due to assignable causes (computer breakdowns, errors in credit
reports, fraud, insufficient coverage of need by personnel at certain
times, improper housekeeping, etc..), which may need corrective
action.
The purpose of SPC is to highlight the changes in quality because of
assignable causes in the process so that corrective action can be
taken, e.g., improve tooling, improve vendor quality, strengthen
machine foundation, get better machine, etc..). This is done
using Control Charts.
Control charts were invented by Dr. Shewhart of Bell Labs in the
1920s. They were popularized by Deming and others, and are
credited for the success of Japanese quality efforts.
The operator takes a sample of the production from time to time,
and posts the mean or the range of the sample on the control
chart. As long as reading are within control, no action is
taken. To help with making this decision, two control limits are
drawn on the chart, the upper control limit and the lower
control limit. As soon as reading fall outside the control limits,
corrective action is taken.
Upper Control Limit
Lower Control Limit
Central Line
Time
58
Control charts fall into two categories, those for variables (data
being measured on continuous scale, e.g., length, height,
time), and those for attributes (data being counted, e.g,
number of defectives, number of complaints, etc..)
Control Charts for Variables
For variables we would like to control the mean of the process
and the variability in the process. This is done using the mean
control chart and the range control chart. For a process to be
in control, it needs to be with limits on both these charts.
Mean Control Charts:
Take a number of samples, say M, each of size n, for a few days.
Inspect each sample, calculate the mean and the range R
Take the mean of the sample means, and the mean of the ranges
x
x = x/M
R= R/M
Then UCL =
LCL =
Where the constants are obtained from the table below.
Range Charts:
For the range charts,
UCL =
LCL=
x -A R
2
x +A R
2
D R
4
D R
3
Factors for X,R control charts
Sample Size A2 D3 D4
2 1.880 0 3.267
3 1.023 0 2.574
4 0.729 0 2.282
5 0.577 0 2.114
6 0.483 0 2.004
7 0.419 0.076 1.924
8 0.373 0.136 1.864
9 0.337 0.184 1.816
10 0.308 0.223 1.777
11 0.285 0.256 1.744
12 0.266 0.283 1.717
13 0.249 0.307 1.693
14 0.235 0.328 1.672
15 0.223 0.347 1.653
59
Example: Propeller blades shaft diameter should be 10+/-
0.025cm. 20 samples were taken, each with n=5 blade shafts.
Sample 1 Sample 2 ... Sample 20
10.010 10.018 10.004
9.989 9.992 9.998
10.019 9.996 9.990
9.978 10.014 10.019
10.008 10.005 9.983
Mean 10.0008 10.005 ... 9.9968
Range 0.041 0.026 ... 0.036
Here mean of means = (10.008+10.005+...+9.9968)/20=10.002
mean of ranges= (0.041+0.026+...+0.036)/20=0.032
For n=5, A2=0.58, D3=0, D4=2.11. Then
for mean chart for range chart
UCL=10.002+0.58(0.032)=10.020 UCL=2.11(0.032)=0.068
CL= 10.002 CL = 0.032
LCL=10.002-0.58(0.032)=9.984 LCL=0(0.032)=0
Where CL is the central line.
60
Control Charts for Attributes
These are for characteristics that can be counted rather than
measured. There are two kinds of attribute control charts.
Where defectives and non-defectives can be counted, e.g., error
transactions. Here proportion of defectives is to controlled. p-
charts
Where only defects can be counted, e.g., accidents that occur and
not accidents that dont occur. c-charts.
p-charts. These are used to control proportion defectives.
Take a few samples, inspect them, count defectives.
Compute proportion defectives, p. Then, the standard deviation is
p p
p p
p
z p LCL
z p UCL
n
p p
=
+ =
=
) 1 (
Example: Sportswear Company. The firm wants to control
defectives in order to minimize selling them as seconds.
Sample size, n=50.
Sample# #Defectives
1 2 p = 40/(20*50)=0.04
2 3 = sqrt(0.04*0.96/50)=0.028
3 4 The 3 limits then are
: : UCL=0.04+3(0.028)=0.124=6.2 def.
: : CL=0.04 = 2 defectives
19 1 LCL=0.04-3(0.028)=0 (as negative)
20 2
Total 40
If the LCL is negative, take it as zero.
61
c-Chart
Since only defects can be counted (not non-defects), a Poisson
Distribution holds here. Count mean number of defects in the
sample, c. Then, the standard deviation is c. Then
Example: The number of errors in claims processing in 100 claims is
2,0,1,1,2,...,1,2 for a total of 135 errors.
Then, c = 135/100=1.35, and std. deviation is = 1.16
and for 95.5% coverage, z=2, giving
UCL = 1.35+2(1.16)=3.67
CL=1.35
LCL=1.35-2(1.16)=0 (since negative)
c z c LCL
c CL
c z c UCL
=
=
+ =
c
Once the operator starts using the control charts, periodically
work is sampled and the reading plotted on the control chart.
If any points are outside the limits, the process is not is
control.
Both mean and range charts should be in control (for
variables)
Even if in control, are the points randomly spread? If not,
there may be an assignable cause at work. For example,
are many points on one side of the chart? This may mean the
setting is wrong.
do the points have a consistent upward or downward trend?
Maybe because of tool wear.
are the points cyclic? Maybe because of shift change, seasonal
variation, etc..
Interpretation of Control Charts Interpretation of Control Charts
62
Specifications (or Tolerances) are established by engineering
design or customer requirement.
Control limits are statistical limits that highlight when the
process is not in control.
Process variability is the inherent random variability in the
process.
Control limits and process variability are related. Control limits
are set using samples of the process output, which is
influenced by process variability. Specifications have no
relation to control limits or process variability.
Specifications, Control Limits and Process Variability Specifications, Control Limits and Process Variability
Capability Analysis
In the third case, the specifications are tighter than the process
is capable of generating. Therefore we cannot assume that a
process in control will be automatically generating desirable
output. In such cases (as the third above) the manager should
consider redesigning the process, use an alternate process,
retain the current process but do 100% inspection to eliminate
bad output, or explore whether the specifications are too tight
and can be relaxed without hurting sales or customer
satisfaction.
63
C
p
and C
pk
These measures should be greater than 1 for the process to be
capable.
C
p
is used when the process is centered and C
pk
is used when
the process is not centered.
6
ion width Specificat
C ratio, capability process The
p
=
3
Mean - Spec Upper
3
Spec Lower - Mean
C ratio, capability process The
pk
Min
Example: A process has a mean of 9.2grams and a standard
deviation of 0.3 grams. The lower spec is 8grams and the
upper spec is 10 grams. Then
Note that the process is not centered, and hence C
pk
is used and
shows that the process is not capable, even though the C
p
shows that the process is capable.
11 . 1
) 3 . 0 ( 6
2
C
p
= =
89 . 0
89 . 0
) 3 . 0 ( 3
9.2 - 10
33 . 1
) 3 . 0 ( 3
8 - 9.2
C
pk
=
=
=
= Min
64
Continuous Improvement Continuous Improvement
As we saw in JIT, it is not sufficient to improve the process as a one-shot
project, but the aim should be continuous improvement (kaizen). And
this is possible if done systematically. It should have the full support
of management to succeed.
The continuous improvement process typically involves
Select a process for improvement (use Pareto analysis perhaps)
Study and document the process (Flow charts, etc..)
Critically examine the process
Why is it done, how, why there, by whom, why him, why at that time, can it
be eliminated, combined, modified?
Design an improved process (There is always a better method!)
Implement the improved system.
Evaluate it.
Document it, standardize it, communicate to all. Train.
Once the new process settles down, re-examine the process, and
start over.
Among the tools used for analysis is the Ishikawa Diagram or the
Fishbone Diagram.
65
Project Management Project Management
PROJECT: New Drug Development PROJECT: New Drug Development
Typical Duration 10 years
Cost $897 million
STEPS
Preclinical Trials (on animals)
Investigative New Drug (IND) Application
Human Clinical Testing
Phase I: Pharmacological Profile (Dosage, Absorption, Excretion,
Metabolism, Side effects)
Phase II: Pilot Efficacy Study on 200-300 human volunteers
Phase III: Extensive Clinical Testing (1000-3000 patients)
New Drug Application (NDA)
Thousands of pages long!!!
66
Drug Development: 10 years - $897 million
Understanding the disease state
Isolating the molecular target
Screen and identify a lead compound
Refining compound
Animal safety studies
IND
Phase I
Phase II
Phase III
NDA
Scale up manufacturing
Containment
QA/QC
Environmental Health and Safety
Competitive analysis and patenting
Message and positioning
Generic strategy
Life Cycle Management - post launch studies
Pricing
Reimbursement
Medicare, Medicaid, managed care
Compassionate use
Government pricing in global markets
Discover
Develop
Make
Market
Sell
Years
1
1
1
1
1-2
2-3
3-5
1*
11-15
Compounds
10,000
1000
100
10
5
3
1
?
Source: http://csdd.tufts.edu/
* FDA approval can take
up to a year or more
Drug Development: 10 years - $897 million
Discover Develop
Make
Market
Sell
Launch
Patent
Expiration
ROI
Window
Patent Life = 17 years
3-5 years
and
shrinking
Keys to Success
File patent as late as possible being mindful of competition
Shorten Discovery and Development times as much as legally possible without sacrificing safety or
efficacy
Parallelize as many activities as possible
Source: http://www.phrma.org/publications/publications/profile02/index.cfm
67
Shortening Period of Exclusivity Shortening Period of Exclusivity
Source: Scrip Magazine
Years of Exclusivity Years of Exclusivity
Invirase 1995
Recombinate 1992
Diflucan 1990
Prozac 1988
Mevacor 1987
AZT 1987
Seldane 1985
Capoten 1980
Tagamet 1977
Inderal 1968
Celebrex 1999
0 2 4 6 8 10 12
PROJECT MANAGEMENT PROJECT MANAGEMENT
Managers in all functional areas are responsible, at some point in
their careers, in managing projects. Managing projects needs
different skills than managing daily operations.
There is a difference between daily operations and projects. Projects
are a one of a kind activity. One may not have much experience in
similar work before. For example, putting together the Annual
Report, constructing a house, new product development,
introducing a new financial product, etc.
Programs are groups of projects, e.g., the space shuttle program.
Projects may vary in duration and complexity from small ones, e.g.,
designing and administering a questionnaire, to very large ones,
e.g., building a new airport. As projects become large, it becomes
necessary to have a systematic procedure for managing them.
68
Progress and outcomes of projects are measured based on
various factors:
Technology - specs, performance, quality
Time - when can the project be completed, what activities need
expediting, etc.
Resources - people, equipment, money, materials
Cost - direct and indirect costs, penalties, bonuses for early
completion.
Market acceptance of product
Projects may have various goals such as technical and
operational requirements,delivery dates, and cost. The
weightages for each may be different in different projects.
The project on the left has equal weights for all goals (specs are
well defined, costs are fixed - a typical construction type
project). The project on the right has technological
uncertainties, and schedule and budget performance are not
as important. ( a cost-plus type project- typical of R&D type
projects). The choice of performance metrics and organization
structure depends on these goals as well.
Project 1
Perf ormance
Schedule
Cost
Project 2
69
The types of organizations used for projects are:
Functional organizations: Typical hierarchy with functional
specialization and budgets. Projects are broken down into
functional parts, and the parts and funded and managed within
the unit.
Pros: Efficient use of technical personnel
Career continuity, security
Good technology transfer between projects
Cons: Weak customer interface
Weak project authority
Discipline (technology) rather than project oriented
Project coordinator: As above with an appointee to coordinate
work. The coordinator meets with functional managers to
assess progress and coordinate tasks.
Matrix organization: Project manager is responsible for a
project and is assigned a budget. The project manager
essentially contracts with the functional managers for
completion of specific tasks, and coordinates effort across
functional units.
Project team: A particularly significant project that will have
along duration may be supervised by a project team with full-
time personnel, co-located with other members of team.
Project has its own management structure and budget as
though it were a separate division.
Pros: Good project schedule and cost control
Single point of customer contact
Rapid reaction time, better communication
Cons Inefficient use of specialists
Insecurity regarding future job assignment after project
completion.
70
Project Management uses the following methodology
Project initiation
identification of needs
develop alternatives, evaluate alternatives, select best
assess risk, sell to management, get approval
Project organization
selecting participating organizations
structuring work content into a work breakdown structure (WBS)
a organization chart like breakup of the project into smaller tasks.
develop a project organizational structure and communication
and reporting structure
allocation of WBS to participating organizations
Project formulation
decompose the project into activities
specify precedence between activities
construct a network for the project
Resource planning
estimate resources required for each activity
time, personnel, money, equipment, materials
specify start and end times for each activity (earliest and latest)
identify the critical path.
Project budgeting
estimation of direct and indirect costs
develop cash flow forecasts
Project execution and control
monitoring progress, monitor actual cost with budget
incorporating changes from plan
71
There are two techniques used in project formulation, resource
planning and scheduling:
PERT - Program Evaluation and Review Technique developed
in the late fifties by Lockheed, Navy and Booz Allen for the
Polaris Missile Program. Assumed activity times were
uncertain.
CPM - Critical Path Method developed at Dupont around the
same time as PERT, to plan and schedule maintenance of
chemical plants. Assumed activity times were known.
Nowadays, the distinction between PERT and CPM is not made,
and they are called PERT/CPM.
PROJECT DEFINITION
In this step we define the project, identify the activities involved
and specify the precedence between the activities.
Activities are tasks that consume time and resources. Events are
points in time that represent start or completion of a set of
activities.
Example: Construction of a House
Activity Description Immed. predecessor
A Pour foundation -
B Erect Walls A
C Install Floor A
D Close-in walls B
E Add roof B
F Finish interior C,D
G Finish exterior E
72
Begin house project is an event. The above project has 7
activities.
The immediate predecessor/s must be completed before an
activity can start.
Once the activities and their precedence relationships are
specified, we can construct a graphical representation of the
project, called the project network.
There are certain basic network configurations.
In the above example, B cannot start unless activity A ends. The
activity is written within the nodes. This is called the Activity
on Node network (AON).
A B
In the above example, activity C cannot start unless both
activities A and B end.
In the above example, neither C nor D can start unless both A and
B have been completed.
In addition to the nodes for the activities, it may be necessary to
add nodes for start and end of the project.
B
C
A
B
C A
D
73
Example: Construction of a House
Activity Description Immed. predecessor
A Pour foundation -
B Erect Walls A
C Install Floor A
D Close-in walls B
E Add roof B
F Finish interior C,D
G Finish exterior E
Exercise: Draw a network for the following project
Activity ImmPred
A -
B -
C A
D B
E B
F C,D
G A,E
H F,G
74
RESOURCE PLANNING RESOURCE PLANNING
Once the project network is drawn, one has to estimate the
resources necessary for each activity. The most important
resource for planning and scheduling purposes is time.
Depending on the type of activity, time may be either known
with certainty (i.e., constant or nearly constant, this is the
situation for which CPM was designed). Or, the times may
be uncertain (for which PERT was designed).
If the times are certain, then we use them as such. If the times
are uncertain, we first compute an expected time for the
activities. Let us see how this is done.
Probabilistic Time Estimates: When activity times are
uncertain, it is customary for the project team to estimate
three time estimates for such activities.
the optimistic time estimate, o. The time the activity would
take under ideal conditions. The best one could realistically
hope for. Avoid blue sky estimates.
the pessimistic estimate, p. Duration under problem
conditions. The worst it could realistically get. Look out for
sandbagging of time estimates to cushion team performance.
the most likely time, m. Duration under normal conditions.
Given these time estimates for each activity, we could compute
the expected time, t and the variance,
2
, for each activity.
Once we have expected times, we could schedule the project as if
times were known with certainty, using these expected times.
6
4 p m o
t
+ +
=
2
2
6
|
.
|
\
|
=
o p
75
Example:
Act Description o m p t var
A Pour found 2 4 6 4 0.44
B Erect Walls 3 5 13 6 2.78
C Install Floor 1 5 9 5 1.78
D Close-in walls 2 5 14 6 4
E Add roof 4 4 4 4 0
F Finish interior 6 11 22 12 7.11
G Finish exterior 6 7 14 8 1.78
In addition to estimating the time required for each activity, other
resources such as personnel, equipment, capital, etc., are also
estimated at this stage.
Once we have calculated these expected time for each activity,
we can post these on the network and then use the network to
identify the critical path for the project.
Example (contd.)
A path is a sequence of activities performed in order from the
project start node to the project end node. Our project has 3
paths,
A-B-E-G 22
A-C-F 21
A-B-D-F 28
A critical path is that path on which if there is delay in any
activity, it will delay the subsequent activities, and the
completion of the project itself. This will be the longest
duration path.
Fin
B
6
E
4
G
8
F
12
D
6
C
5
A
4
76
In our project, path ABEG has a duration of 22 days, ACF of 21
days, and ABDF of 28 days. Hence, ABDF is the critical path.
The project will take 28 days to complete.
There is another method for identifying the critical path and
obtaining other useful information about the project. This
method involves first calculating for each activity
the earliest start time (ES)
the earliest finish time (EF). EF=ES+t
We do this by starting from the project start node, and assigning
ES=0 for the first activity/ies. We add the duration t to get the
EF, and then that would be the ES for the next activity, and so
on.
The procedure works until you have more than one activity
coming into a node. The the ES for the activities going out of
the node will be the largest of the EFs of the activities coming
in.
This procedure is called the forward pass.
Fin
B
6
E
4
G
8
F
12
D
6
C
5
A
4
77
The next step is to calculate for each activity
the latest start time (LS)
the latest finish time (LF). LS=LF-t
We do this by starting from the project completion node, and
assigning LF=T, where T is the completion time of the project.
In our case, we start with LF=28. We then subtract the activity
duration t to get the LS, and then that would be the LF for the
previous activity, and so on, until the start of the project.
Again, the procedure works until you have more than one
activity coming out of a node. The the LF for the activities
going into the node will be the smallest of the LSs of the
activities coming out of that node.
This procedure of going from the end of the project to the start
is called the backward pass.
Fin
B
6
E
4
G
8
F
12
D
6
C
5
A
4
78
We now know what is the earliest time an activity should start
and end, and the latest time the activity can start and end.
When the ES and LS is different, we say that the activity
has some slack.
Slack=LS-ES=LF-EF
For example
Slack(activity E) = 16-10=6
The activities that do not have any slack, i.e., slack=0, are
critical, and the path on which they lie is the critical path.
In our case, the critical path is ABDF.
The critical path activities have to be carefully monitored and
controlled by the project manager to ensure prompt
completion of the project. Delays on non-critical activities,
up to the extent of the slack is permissible, and hence these
activities need less control and monitoring.
Exercise: Identify the critical path for the following project.
What is the duration, and slack on activity B?
Activity ImmPred Exp time
A - 4
B - 2
C A 4
D B 5
E B 1
F C,D 1
G A,E 2
H F,G 2
79
At times it may be possible to spend additional money and resources
to speed up some activity. The firm would gain by decreases in
indirect costs and bonuses for early project completion. If these
savings are greater than the costs of reducing activity times, then
reducing activity times makes sense. This is called project
crashing.
Example: Crashing the house construction project.
Activity Normal Crash Crash Cost
time time $/day
A 4 3 300
B 6 5 400
C 5 3 300
D 6 2 500
E 4 4 -
F 12 9 200
G 8 5 200
Time Time- -Cost Tradeoffs (Crashing) Cost Tradeoffs (Crashing)
One need crash only critical activities. Of these, first crash the
least expensive ones.
Eligible Activity Paths Cost
Acts Chosen ABDF ABEG ACF $
- - 28 22 21
A,B,D,F F 27 22 20 200
A,B,D,F F 26 22 19 200
A,B,D,F F 25 22 18 200
A,B,D A 24 21 17 300
B,D B 23 20 17 400
D D 22 20 17 500
D D 21 20 17 500
D D 20 20 17 500
D &G D,G 19 19 17 700
If the savings is $600/day, then crashing should stop at 20 days.
80
Up until now we did not worry about resources required for the
project, other than time. At times other resources such as
equipment or skilled personnel may be in short supply. One
needs to plan the project under these resource constraints.
On occasion, the project duration may increase once these
resource constraints are considered.
At other times, though there is no real resource constraint, we
may not want the usage of resources to vary too much over
time. It is always better to administer a project if the cash
requirements, equipment requirements, and personnel
requirements are fairly steady over the duration of the
project. Adjusting the project schedule to make resource
requirements steady over the duration of the project is
called resource leveling.
RESOURCE CONSTRAINTS AND RESOURCE CONSTRAINTS AND
RESOURCE LEVELING RESOURCE LEVELING
Example: Suppose for the house construction project, a
critical resource is skilled carpenter-cum-masons(C/Ms).
Activity Normal C/M Reqd/day
time
A 4 3
B 6 6
C 5 3
D 6 3
E 4 3
F 12 3
G 8 3
Suppose also that only 6 C/Ms are available. The number of
C/Ms required every day (the load) can be calculated using
a Gantt chart.
81
The procedure for incorporating resource constraints and/or
resource leveling is by optimization, simulation or trial-and-error.
The first priority should be to leave the critical activities alone and
shift the non-critical activities around (using information on
slacks). If still the resource constraint is not satisfied, the project
may take longer to complete than earlier planned.
Fin
B
6
E
4
G
8
F
12
D
6
C
5
A
4
3; 0
6; 4
3; 4
3; 10
3; 16
3; 10
3; 14
ResReqd; ES
Before Resource Leveling (Based on ES times)
GANTT CHART
A 3
B 6
C 3
D 3
E 3
F 3
G 3
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
LOAD PROFILE
9
8
7 Capacity
6
5
4
3
2
1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
82
After Resource Leveling
GANTT CHART
A 3
B 6
C 3
D 3
E 3
F 3
G 3
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
LOAD PROFILE
9
8
7 Capacity
6
5
4
3
2
1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
Priority rules may be used for resource allocation amongst
competing activities requiring the same resource. Common
priority rules are:
activity with smallest slack
activity with minimum late finish
activity that requires the greatest number of resource units (or
the smallest number)
shortest activity (or longest activity)
Check to see if some inexpensive resource is a bottleneck
and causes low utilization of an expensive or scarce
resource.
83
Exercise: Suppose the crash costs on various activities are as
shown below:
Exp Crash Crash
Activity ImmPred time Cost/day Time
A - 4 400 2
B - 2 100 1
C A 4 600 3
D B 5 200 4
E B 1 1
F C,D 1 1
G A,E 2 300 1
H F,G 2 700 1
If you wished to reduce the expected duration of the project by 2
days, which activities would you crash? What would be the total cost
of crashing?
Probability Calculations for Project Completion Probability Calculations for Project Completion
In our example, the expected duration of the project is 28 days.
However, since this is the expected or mean time, there is some
probability that the project will take longer or less than 28 days.
What is the chance that the project will be complete in 32 days?
Assuming the project duration follows a Normal Distribution (a
reasonable assumption), we can calculate probabilities using the
familiar formula
where X is the duration of interest, m is the expected duration of the
path, and
where a,b,c... are the activities in the path. For example
Similarly, (ACF)=3.05 and (ABDF)=3.79
z X + =
...
2 2 2
+ + + =
c b a

24 . 2 78 . 1 0 78 . 2 44 . 0 ) ( = + + + = ABEG
84
Then, the probability of the project being completed in 32 days can be
calculated as follows:
For path (ABEG),
32=22+z(2.24), or z=4.47. From Appendix B, Table B, p(ABEG)=1.
For path (ACF),
32=21+z(3.05), or z=3.61. Then p(ACF)=1
For path (ABDF)
32=28+z(3.79), or z=1.06, and p(ABDF)=0.8554
Then the probability of the project being completed in 32 days is the
probability that all these paths are completed in time. Assuming
paths are independent, we have
p(Project)=p(path1)*p(path2)...=1*1*0.8554=0.8554 or 85.54%.
Exercise: What is the probability that the project will be complete in 25
days?
Exercise: What is the duration that can be achieved with 95%
probability?
Exercise: If variances are 2 for each activity, what is the
probability that the project will be done in 13 days?
Exp
Activity ImmPred time Var
A - 4 2
B - 2 2
C A 4 2
D B 5 2
E B 1 2
F C,D 1 2
G A,E 2 2
H F,G 2 2
EXECUTIVE EDUCATION PROGRAMS
T
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E
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P
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s

T
he success continuum. Its constant
forward motion. Never backtracking
over well-worn paths and always sidestep-
ping plateaus to fnd alternate routes to
achievement. Goals are set, met and reset.
For while the best success stories dont have
an ending, they can all start and continue
with UConn School of Business Executive
Education Programs.
Te Success Continuum
2100 Hillside Road, Unit 1041 | Storrs Connecticut 06269
P: (860) 486-0493 | F: (860) 486-9102 | www.business.uconn.edu/execed | execed@business.uconn.edu

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Prof. Suresh Nair 92 Operations Management OPIM 310

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