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14.1 Introduction
Objectives
14.6 ABC Inventory Control 14.7 Process Control and Acceptance Sampling
14.7.1 Process Control with Attribute Measurement 14.7.2 Process Control with Variable Measurement 14.7.3 Method for Constructing X and R Charts 14.7.4 Acceptance Sampling
14.1 INTRODUCTION
Production management is defined as the management of an organizations production system, which converts inputs into the organizations products and services. A production system takes inputs such as raw materials, personnel, machines, buildings, technology, cash, information, and other resources and converts them into outputs, such as products and services. This process is the predominant step in the production management. In companies that manufacture goods, the production activities that create goods are usually quite oblivious. For instance, we can watch the creation of a tangible product such as Sony television set or a Tata truck. When referring to such activity, we tend to use the term production management. This unit will deal with the control functions related to production management, Inventory planning, Economic order quantity and Safety stock. The objectives of this unit are detailed as follows.
Objectives
After studying this unit, you should be able to understand control functions of production management and various decisions taken by designers, inventory control policy followed by the firms, significance of economic order quantity, establishment of safety stock level, and ABC classification of materials. 5
Above mentioned factors affect the operations managers in the sense of not providing protection to countrys border from foreign imports. Day-by-day competition is increasing and to withstand in such a competitive environment, companies must take a commitment to customer responsiveness and continuous improvement towards the goal of quickly developing innovative products. A production system model is illustrated in Figure 14.1. Inputs are classified into three categories viz. external, market and primary resources. External inputs generally are informational in character and are inclined more towards providing knowledge about conditions outside the production system to operations managers. In spirit similar to external, market inputs are inclined towards informational character. Information regarding product design, competition and other aspects of the market is necessary. In contrast to this, primary resources are referred as those inputs that directly support the production and delivery of goods and services. The output directly obtained from production system may be either in tangible or
intangible form. Outputs such as automobiles, hair dryers, calculators, clothes, cakes, soap are daily manufactured in enormous amount and are known as tangible goods while the intangible outputs are those which pour from production system like education, health service, public service and transportation facility.
Conversin Subsystem
Inputs
Output
Physical (Manufacturing, Mining) Locational Services (Transportaron) Exchange Services (Retailing/Wholeseling) Storage Services (Warehousing) Other Services (Insurance, Finance, Utilities, Real Estate, Health, Bussiness Service, and Personal Service) Government Services (Local, State, Federal) Feedback Information Control Subsystem Direct outputs Products Services Indirect Outputs Taxes Wages and Salaries Technological developments Enviornmental Impact Employee Impact Societal Impact
Primary Resources Materials and Supplies Personnel Capital and Capital Goods Utilities
The task of production management and its working is controlled and governed by various factors and schemes. Usually, operation managers are in very hasty situation as their decision plays a vital role in deciding the progress of a firm. Their decision falls into three categories namely strategic decision, operating decision and control decision. Strategic Decision These decisions are related to products, processes and facilities. They carry a strategic importance and have a long-term significance for the organization. These decisions are so important that people from every sector get together and study the business opportunities carefully and finally arrive at a decision that put the organization in the best position for achieving its long-term goals. Examples of such a planning decision are : Deciding on the launch of a new-product development project. Deciding on the design of a production process for a new product. Deciding the need of new factories and where to locate them. Deciding how to allocate scarce raw materials, utilities, production capacity, and personnel among new and existing business opportunities.
Operating Decisions The decision related to planning production to achieve the desired demand. The main function of operations is to take the orders generated by marketing function for products and services from customers and deliver products and services in such a way that there are satisfied customers at reasonable costs. Examples of such a planning are as follows (Figure 14.2) :
Deciding what products and quantity of each item to be included in next months production schedule. Deciding the quantity of finished goods inventory to carry for each product. Deciding whether increase production capacity next month on the basis of working overtime or giving subcontract of production to suppliers. Deciding the details of a plan for purchasing raw materials to support next months production schedule.
Error!
Enviornmental Analysis Identify the threats, opportunities, weaknesses and strengths. Understand the environment, customers, industry and competitors.
Determine corporate mission State the reasons for the firms existence and identify the value it creates
Form a strategy Build a competitive advantage, such as low price, design or volume flexibility, quality, quick delivery, dependability, after-the-sale services, broad product lines.
Decisions Quality Product Process Location Layout Human resource Procurement Inventory Scheduling Reliability and Maintenance
Simple Options Define customer expectations with performance measures Customized or standarized Facility size, technology Near supplier or near customer Work cells or assembly line Specialized or enriched jobs Single or multiple source suppliers When to reorder; how much to keep on hand Stable or fluctuating production rate Repair as required or preventive maintenance
Control Decision These decisions are pertaining to the variety of problems arising in operations, mainly it handle planning and controlling operations. Decisions concerning with day to day activities of workers, quality of products and services, production and overhead costs and maintenance of machines come in the category of control decisions. Operation managers get engaged in planning, analyzing, and controlling activities so that poor work performance and inferior product quality do not interfere with the profitable operation of the production system. Examples of this type of decision are as follows : 8 Deciding the frequency of performing preventive maintenance on a key piece of product machinery.
Deciding the steps to be taken for the departments failure to meet the planned labour cost target. Developing labour cost standards for a revised product design that is about to go into production. Deciding what the new quality control acceptance criteria should be for a product that has a change in design.
The day-to-day decisions about workers, product quality, and production machinery, when taken together, may be the most pervasive aspect of an operation managers job.
SAQ 1
(a) (b) What are the basic functions performed by the managers in a firm? Elaborate the need of strategic and controlling decision taken by managers.
14.3.1 Inventory
The word inventory resembles the stock of any item or resources used in an organization. An inventory system is the set of policies and controls that monitors levels of inventory and determines what level should be maintained, when stock should be replenished and how large orders should be. The prime motive of inventory analysis in manufacturing and stock keeping services is to satisfy the following needs : (a) (b) When items should be ordered, and How large the order should be.
Most of the firms are engaged in longer-term relationships with vendors to supply their needs for the entire year. The inventory purposes are discussed in next subsection. Purposes of Inventory Inventories kept by all firms are due to following reasons : (a) (b) (c) (d) interdependence between operations. variation in product demand. flexibility in production scheduling. variation in raw material delivery time.
Due to above reasons, all firms have more inclination towards inventory. There are various costs associated with inventory and are given as follows : 9
Holding Cost It includes the cost for storage facilities, handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes and the opportunity cost of capital. This implies that high holding costs tend to favour low inventory levels and frequent replenishment. Setup (or Production Change Cost) Manufacturing of a product require the necessary materials, arranging specific equipment setups, filling out the required papers, appropriately changing time and materials and moving out previous stock of materials. This all contributes to the setup cost. Ordering Cost These costs refer to the managerial and administrative costs to prepare the purchase or production order, transportation cost, receiving and inspection cost. Shortage Costs When the stock of an item gets exhausted, an order for that item must either wait until the stock is replenished or be canceled. These cost accounts for the shortage cost. This is of two types (i) Lost scale, and (b) Back orders. Besides costs, the timing of these orders is a critical factor that has impact over inventory cost. There are two ways of classifying inventory systems viz. fixed-order quantity models (known as Economic order quantity and Q-model) and fixed-time period models (also known as periodic system and P-model). The main distinction between these two models is that Q-models are event triggered whereas P-model are time-triggered. The key differences between them are tabulated in Table 14.1. A brief discussion on Q-model is detailed now in coming paragraphs. Table 14.1 : Differences between Q-model and P-model
Feature Order quantity When to place order Size of inventory Record keeping Types of Item Q-model or Fixed Order Quantity Model Q-constant (same amount ordered each time) R-when inventory position drops to the reorder level Less than fixed-time period model Each time a withdrawal or addition is made A class P-model or Fixed-time Period Model Q-variable (varies each time order is placed) T-when the review period arrives Larger than fixed-order quantity model Counted only at review period B and C class
such large numbers individual economic order quantities cannot be calculated for each item by hand. Purchasing of housewares is generally done from distributors rather than from manufacturers. Distributor handles products from various manufacturers and has the advantage of fewer orders and faster shipping time. Moreover, the distributors sales personnel may visit the housewares weekly and count all the items they supply to this department. Then, in line with the replenishment level that has been established by the buyer, the distributors salesperson places orders for the buyers. This saves the department time in counting inventory and placing orders. The lead time for receipt of stock from a housewares distributor is two or three days. The safety stock, therefore, is quite low, and the buyer establishes the replenishment level so as to supply only enough items for two to three day lead time, plus expected during the period until the distributors salespersons next visit. Maintaining Parts Inventory of Automobile Repair Shop A firm in the automobile service business purchases most of its parts supplied from a small number of distributors. Franchised new car-dealers purchase the great bulk of their supplies from the auto manufacturer. A dealers demand for auto parts originates primarily from the general public and other departments of the agency, such as the service department or body shop. For this case, problem is to determine the order quantities for the several thousand items carried. Most of the dealers order their inventory by computers and software packages. For both manual and computerized systems, an ABC classification works well. Expensive and high-turnover supplies are counted and ordered frequently; low-cost items are ordered in large quantities at infrequent intervals. The drawback associated with frequent order placement is the extensive amount of time needed to physically put the items on the shelves and log them in. The computer output provides a useful reference file, identifying the item, cost, order size and the number of units on hand. The output itself constitutes the purchase order and is sent to the distributor or factory supply house. This simple procedure is attractive because once the forecast weighting is selected; all that needs to be done is to input the number of units of each item on hand. Thus, negligible computation is involved and very little preparation is needed to send the order out.
SAQ 2
(a) (b) What are the main reasons for controlling inventory? What kind of policy or procedure would you recommend to manage the inventory operation in a department store? What advantages and disadvantages does your system have vis-a-vis for the department store inventory operation described in this section?
There exist certain assumptions for the basic EOQ model that are summarized as follows : (a) (b) (c) (d) (e) (f) (g) The items price or cost (p) is independent of the quantity ordered. The demand for or usage of the item follows a relatively constant rate of D units per unit time. C0 is a fixed cost that is used for executing an order that is independent of the quantity ordered (Q). There exists a proportional relationship between holding cost for inventories and Quantity stored. Whenever a demand arises in the market, it should be fulfilled. No shortages are allowed. Lead time is known with certainty and is a constant quantity. It is referred to that time from when an order is placed until it gets delivered. All items ordered are delivered at the same time, there are not split deliveries.
The definitions of variables and list of cost formulas are given in Table 14.2. Table 14.2 : List of Variable Definitions and Cost Formulas
Variable Definitions D = annual demand for a material (units per year) Q = quantity of material ordered at each order point (units per order) C = cost of one unit of the material S = average cost of completing an order for a material (Rs. per year) TC = Total annual cost H = Annual holding and storage cost per unit of average inventory (Rs. unit per year) R = Reorder point L = Lead time Cost Formulas Annual holding cost = Average inventory level carrying cost = (Q/2) H Annual ordering cost = Orders per year ordering cost = (D/Q) S Total annual stocking cost = Annual carrying cost + Annual ordering cost = (Q/2) H + (D/Q) S Total annual cost = Annual purchase cost + Annual ordering cost + Annual holding cost TC = DC + (D/Q) S + (Q/2) H
These cost relationships are shown in Figures 14.3 and 14.4. The order quantity (Qopt) at which total cost is minimum can be visualized from Figure 14.4. It tells that the total cost is minimal at the point where the slope of the curve is zero. With the help of calculus, we take the derivate of total cost with respect to zero and set this equal to zero. The calculations involved in this are shown below. To illustrate the above formula of economic order quantity model, we had taken an example. These will demonstrate the use of the formula derived.
D Q TC = DC + S + H 2 Q
. . . (14.1)
12
DS H dTC =0+ 2 + dQ Q 2
. . . (14.2)
Qopt =
2DS H
R = dL
. . . (14.3)
where d is average daily demand (constant) and L is the lead time in days. Error!
Q - Model
Inventory on Hand
L Time
Total Cost
C o s t
Holding Costs
Ordering Costs
Example 14.1 Find the economic order quantity and the reorder point. Given Annual demand (D) = 2,000 units Average daily demand (d) = 2,000/365 Ordering cost (S) = Rs. 4.2 per order Holding cost (H) = Rs. 1.75 per unit per year 13
Lead time (L) = 5 days Cost per unit (C) = Rs. 10.75 What quantity should be ordered? Solution The optimal order quantity is
Qopt = =
The reorder point is
R = dL =
Rounding to the nearest unit, the inventory policy is as follows : When the inventory position drops to 28, place an order for 97 more. The total annual cost will be
SAQ 3
(a) (b) (c) What are the assumptions of the EOQ model? What are the main differences between fixed-order quantity model and fixed time period model? How sensitive is EOQ to variations in demand or costs?
The main difference lying between a fixed-order quantity model where demand is known and one where demand is uncertain is in computing the re-order point. The amount of order quantity remains same in both cases. The uncertainty element is taken into account in the safety stock. The reorder point is given by
R = dL + z L
where
The term z L accounts for the amount of safety stock. The positive sign of safety stock indicates that its effect is to place a reorder is sooner. Computation of d , L and z Demand arising during the replenishment lead time is helpful in estimating the expected use of inventory from the time an order is placed to when it is received. For example, if a 30-day period was used to calculate d, then a simple average would be
15
d =
i =1
di =
d
i =1
30
30
Where n is the number of days. The standard deviation of the daily demand is given by
d =
(d
i =1
d )2
(d
i =1
30
d )2
30
Since d refers to one day and if lead time extends over several days, we can use the statistical premise that the standard deviation of a series of independent occurrences is equal to the square root of the sum of the variances. Mathematically, it can be written as
2 2 2 2 s = 1 + 2 + 3 + . . . n
Afterwards we need to find z, the number of standard deviations of safety stock. Let our probability of not stocking out during the lead time is to be 0.90. The z-value corresponding to 90 per cent probability of not stocking out is 1.52. The standard deviation for 5 days is then calculated as s = 102 + 102 + 102 + 102 + 102 = 22.36 Now, the safety stock is calculated as follows
SS = z L = 1.52 22.36 = 33.9872
Now two examples are given that will demonstrate and differentiate the variation in demand in terms of standard deviation.
Example 14.2 : Economic Order Quantity
Consider an economic order quantity case where annual demand D = 500 units, economic order quantity Q = 100 units, the desired probability of not stocking out P = 0.95, the standard deviation of demand during lead time L = 20 units, and Lead time L = 12 days. Determine the reorder point. Assume that demand is over a 250 = workday year.
Solution
d in above example is
d = 500 = 2 and lead time is 12 days. 250
R = dL + z L = 2(12) + z (20)
Since, in this case z is 1.64. Substituting this value of z, we get R = 2 (12) + 1.64 (20) = 24 + 32.8 = 56.8 units This shows that when the stock on hand gets down to 56 units, order 100 more.
Example 14.3 : Order Quantity and Reorder Point 16
Daily demand for a certain product manufactured by ABC company is normally distributed with a mean of 30 and standard deviation of 5. The source of supply is reliable and maintains a constant lead time of 6 days. The cost of placing the order is Rs. 8.5 and annual holding cost are Rs. 0.75 per unit. There are no stockout costs, and unfilled orders are filled as soon as the order arrives. Assume sales occur over the entire 365 days of the year. Find the order quantity and reorder point to satisfy a 95 per cent probability of not stocking out during the lead time.
Solution
For this problem, we will first calculate the order quantity Q as well as the reorder point R. Given data are
Qopt =
2 DS = H
For computing the reorder point, we need to calculate the amount of product used during the lead time and add this to the safety stock. The standard deviation of demand during the lead time of six days is calculated from the variance of the individual days. Since each days demand is independent d = Since, z is 1.64,
i =1
2 di
= 6(5) 2 = 12.2474
Ordering Costs
Number of Orders
Number of Orders
Figure 14.6 : Cost to Place Orders Versus the Number of Orders Placed : Linear Assumption and Normal Reality
SAQ 4
(a) (b) Does the production model or the standard EOQ model yield a higher EOQ if set up cand holding costs are the same? What happens to total inventory costs and EOQ if inventory holding costs per unit increases? 17
(c) (d)
What is safety stock? Briefly explain its probability aspect? How the Economic order Quantity Model with safety stock differs from normal one?
The ABC approach divides this list into three categories by value : A items constitute roughly the top 15% of the items, B items the next 35%, and C items the last 50%. From observation, it appears that the list in Table 14.3 may be meaningfully grouped with A including 20%, B including 30%, and C including 50%. These point show clear delineations between sections. The result of this segmentation is shown in Table 14.4.
Table 14.4 : ABC Grouping of Inventory Items
Classification Item Number Annual Usage Percentage of
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The objective of classifying items into groups is to establish the appropriate degree of control over each item. Figure 14.7 illustrates the fundamental aspect of ABC method. Following observations can be made from Figure 14.7. (a) (b) (c) The inventory portion and inventory value captured by the A materials constitutes only 20% and 75% respectively. Class B of materials represents 30% of the materials in inventory and 20% of the inventory value. Similarly Class C of materials represents 50% of the inventory material and only 5% of inventory value.
On account of the above classification, following inference can be made that with the increase in inventory value of a material, extent of analysis also rises. Ordinarily, Class A materials would be analyzed extensively as compared to the Class C of the materials. The implementation of this classification requires an intelligent decision and judgment that is based on under mentioned points.
Materials Critical to Production
Large inventories are justified because of the effects of these materials as they are capable of break down the entire production lines.
Materials having Short Span of Lives
For such materials, small inventories are suitable because these materials may be subject to very fast obsolescence or deterioration.
Very Large and Bulky Materials
Small inventories are justified for such materials because of the large space occupied by them.
Materials with Highly Erratic Lead Times
Materials having unpredictable demand require large order quantities and order points.
Valuable Materials Subject to Pilferage
If order size departs from norm, quantities other than Economic order quantity are suitable for them.
120 100 80 60 40 20 0
0 3 5 8 10 20 30 40 50 60 70 80 90 100
SAQ 5
(a) Why is it desirable to classify items into groups, as the ABC classification does? 19
(b) (c)
Differentiate between the Classes A, B and C of inventory planning. List five intelligent decision necessary before implementing ABC classification scheme.
p= sp =
Total number of defects from all samples Number of samples Sample size p (1 p ) n
. . . (14.4)
UCL = p + z s p LCL = p z s p
where, p is the fraction defective, sp is the standard deviation, n is the sample size and z is the number of standard deviations for specific confidence.
Example 14.4
ABC insurance company wants to design a control chart to monitor whether insurance claim forms are being completed correctly. The company intends to use the chart to see if improvements in the design of the form are effective. To start the process the company collected data on the number of incorrect completed forms over the past 10 days. The insurance company processes thousands of these forms each day, and due to the high cost of inspecting each form, only a small 20
representative sample was collected each day. The data and analysis are given in Table 14.5.
Solution
To construct the control chart, first calculate the overall fraction defective from all samples. This sets the centerline for the control chart.
p=
91 = 0.03033 3000
sp =
Finally calculate the upper and lower control limits. For z = 3, we have UCL = p + 3s p = 0.03033 + 3 (0.00990) = 0.06004 LCL = p 3s p = 0.03033 3 (0.00990) = 0.00063
Table 14.5 : Insurance Company Claim Form
Sample 1 2 3 4 5 6 7 8 9 10 Total Number Inspected 300 300 300 300 300 300 300 300 300 300 3000 Sample standard deviation Number of Forms Completed Incorrectly 10 8 9 13 7 7 6 11 12 8 91 Fraction Defective 0.0333 0.02667 0.03 0.04333 0.02333 0.02333 0.02 0.03667 0.004 0.02667 0.03033 0.00099
For industrial application in process control involving the measurement of variables, it is preferable to keep the sample size small. There are two main reasons. First, the sample needs to be taken within a reasonable length of time; otherwise, the process might change while the samples are taken. Second, larger the sample, the more it costs to take.
Number of Samples
21
Once the chart has been set up, each sample taken can be compared to the chart and a decision can be made about whether the process is acceptable or not.
Frequency of Samples
It depends on the trade-off between the cost of sampling and the benefit of adjusting the system. Usually, it is best to start off with frequent sampling of a process and taper off as confidence in the process builds.
Control Limits
Standard practice in statistical process control for variables is to set control limits i.e. three standard deviations above the mean and three standard deviations below. This implies that 99.7% of the sample means are expected to fall within these control limits. Thus, if one sample mean falls outside this wide band, we have strong evidence that the process is out of control.
and R Charts
For a known value of standard deviation of the process distribution, the X chart may be defined as
. . . (14.8)
z = number of standard deviations for a specific confidence level (z = 3). An X chart is simply a plot of the means of the samples that were taken from a process, whereas, R chart is a plot of the range within each sample. The range is the difference between the highest and the lowest numbers in that sample. Mathematically, it can be defined as :
Xi
X =
i =1
. . . (14.9)
where, X is the mean of the sample, i is the item number and n is the total number of items in the sample.
Xj
X =
j =1
. . . (14.10)
where, j is the sample number, m is the total number of samples, Rj is the difference between the highest and lowest measurements in the sample and R is the average of the measurement differences R for all the samples, or
Rj
R=
j =1
. . . (14.11)
Thus, upper and lower control limits can be defined as Upper control limit for X = X + A2 R 22 . . . (14.12)
Lower control limit for X = X A2 R Upper control limit for R = D4 R Lower control limit for R = D3 R
ABC industries manufactures X-band radar scanners used to detect speed traps. The printed circuit boards in the scanners are purchased from an outside vendor. The vendor produces the boards to an AQL of 2% defectives and is willing to run a 5% risk of having lots of this level or fewer defectives rejected. The company considers lots of 8% or more defectives (LTPD) unacceptable and wants to ensure that it will accept such poor quality lots not more than 10% of the time (). A large shipment has just been delivered. What values of n and c should be selected to determine the quality of this lot?
Solution
It is given in the problem that AQL = 0.02, = 0.05, LTPD = 0.08 and = 0.1. We can use table 14.6 to calculate c and n. Thus, the appropriate sampling plan is C = 4 and n = 100. Up to four defects found in the lot, the lot will be accepted. Table 14.6 shows various acceptance numbers C. Corresponding to the particular C values, sample size is constant.
Table 14.6 : Data for Deriving a Single Sampling Plan (Derived from Poisson Cumulative Table with = 0.05 and = 0.10)
C
n
p0.95
p0.10
p0.10/np0.95
23
0 1 2 3 4 5 6 7 8
p0.10 p0.95
p0.10 = 7.99
SAQ 6
(a) (b) Discuss the differences between p-charts and X and R charts. Describe the trade-off between achieving a zero AQL (acceptable quality level) and a positive AQL.
14.8 SUMMARY
Controlling is a sub system of the production system where a portion of the output is monitored for feedback signals to provide corrective action, if required. The management and control of inventory is a common problem to all types of organisations. Inventory control refers to the planning for optimum quantities of materials at all stages in the production cycle and envolving techniques which would ensure the availability of planned inventories. Quality control assure that resulting product will perform its intended function. Therefore, it is concerned with the prevention of defects so that items may be made right at the first time. To achieve this several activities are required to performed. Inspection and control of raw materials ensure that they meet specification. Statistical quality control (SQC) attempts to evaluate machines, materials by observing capabilities and trends in variation so that continual analysis and production may be made to the desired quality level.
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Manufactures Risk
Purchasers Risk
Sample
Control Charts
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