COURSE MANUAL

C4: Operations Management

Module 4

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Acknowledgements
The Commonwealth of Learning (COL) wishes to thank those below for their contribution to
the development of this course:

Course author David Gardiner

Gardiner Consulting Group
Operations Management Consultants
Christchurch, New Zealand

Course content specialist: Olga Kaminer, PhD

Professor, Supply Chain/Logistics/Operations Management
Faculty of Business
Sheridan Institute of Technology and Advanced Learning,
Canada

Subject matter experts: Fook Suan Chong

Wawasan Open University, Malaysia

Maurice Fletcher
University College of the Caribbean, Jamaica

Araba Intsiful
Kwame Nkrumah University of Science and Technology,
Ghana

S. A. D. Senanayake
Open University of Sri Lanka, Sri Lanka

Educational designers: Symbiont Ltd.

Paraparaumu, New Zealand

Course editor: Symbiont Ltd.

Paraparaumu, New Zealand

Course formatting: Kathryn Romanow

Commonwealth of Learning

COL would also like to thank the many other people who have contributed to the writing of
this course.
 Contents

Contents
Module 4 1 
Unit 9  
Inventory planning and management ................................................................................ 3 
Activity 4.1 ........................................................................................................................ 9 
Activity 4.2 ...................................................................................................................... 19 
Activity 4.3 ...................................................................................................................... 25 
Unit summary 25 
References 26 
Readings for further study 26 
Unit 10 27 
Supply chain management ............................................................................................... 27 
Activity 4.4 ...................................................................................................................... 38 
Unit summary 38 
References 39 
Readings for further study 39 
Unit 11 40 
Project management ........................................................................................................ 40 
Activity 4.5 ...................................................................................................................... 52 
Unit summary 52 
References 53 
Readings for further study 53 
Unit 12 54 
Performance measurement .............................................................................................. 54 
Activity 4.6 ...................................................................................................................... 66 
Unit summary 66 
References 67 
Readings for further study 67 
Activity feedback............................................................................................................. 69 
 C4: Operations Management

Module 4
Introduction
This module is about inventory, supply chain management, projects
and performance measurement.
At first sight this may appear a real mix of topics, however, the
whole course has been building towards this end. We have
developed processes and improved processes so we can deliver
products and services to satisfy customer requirements.
Inventory is the output of a production system and is used as inputs
to other production systems and during service delivery. The
supply chain describes the flow of raw material inventories from
suppliers through plants that transform them into useful products
and finally to distribution centres that deliver those products to end
customers.
So that takes care of inventory and supply chain management.
In a modern business, most process improvement initiatives are
undertaken as a project. This is particularly true for six sigma
quality projects. A project is a once-only activity and can change
the way a business operates and sometimes this change is
irreversible. That makes project success so important.
Finally, performance measurement provides the means for
determining progress and measuring success (or failure). Business
organisations regularly report on their financial achievements and
not-for-profit organisations have to achieve results within limited
expense budgets that have to be contained.
Traditional performance measurement that measures profit, or
return on investment, is relatively easily understood. The approach
today requires a proliferation of measurements and these include
dimensions that are quantitative as well as qualitative.

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Module 4

Upon completion of this module you will be able to:

 Explain the reason for having inventory.
 Explain various inventory models including sales and
operations planning, material requirements planning (MRP)
and manufacturing resource planning (MRP II).
Outcomes  Discuss the theory of constraints.
 Define supply chain management from a strategic view.
 Discuss the bullwhip effect or demand amplification.
 Define collaborative supply chains.
 Describe the nature of project management and the strategic
nature of projects.
 Describe project organisation structures.
 Discuss the critical chain method.
 Describe measurements for business excellence.
 Describe the Hoshin process for setting goals and using
measurement systems.
 Describe the balanced scorecard approach to performance
measurement.

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 C4: Operations Management

Unit 9

Inventory planning and

management
Introduction
The terms “stock” and “inventory” are synonymous as far as
operations management is concerned. The term stock is possibly
more widely, although not exclusively, associated with finished
goods. In retailing, for example, the goods in store and on the
shelves are referred to as stock. Both terms are employed in
manufacturing industries although the term inventory is probably
more widely used.
In some applications inventory is held to provide immediate supply
but in manufacturing, inventory is not restricted to finished
products. Manufacturers use raw material inventory, work in
process inventory as well as maintenance and operating supplies.
Managing how much to order, and when, occupies considerable
attention within the operations function. By planning the time when
specific types of material are available or requesting specific
products to be made, we can co-ordinate the work within the firm.
This is usually provided by material requirements planning and
enterprise resource planning systems. This leads directly to ideas
about different lot-sizing rules and the different ways of controlling
the system in long, medium and short time frames.
The theory of constraints is implemented in many organisations
and is often combined with lean thinking ideas to provide hybrid
implementations.
In this unit we start by defining inventory and explaining why an
organisation should have inventory. This is followed by an
explanation of why the economic order quantity is not appropriate
for modern business, even though it is widely used and accepted.
Several models, including a fixed-order quantity model and a
periodic review model, are introduced and lead times and safety
stocks are discussed.
The processes for sales and operations planning, material
requirements planning (MRP) and manufacturing resource planning
(MRP II) are discussed and put in perspective.
The theory of constraints is introduced by describing a bottleneck
process. This is followed by an explanation of the theory of

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Unit 9

constraints, logical thinking process and the drum-buffer-rope

concepts.
We conclude by describing the operations scheduling process
including backward and forward scheduling and finite and infinite
loading.
Upon completion of this unit you will be able to:
 Explain the reason for having inventory.
 Explain why the economic order quantity is not appropriate for
modern business.
 Describe a fixed-order quantity model and a periodic review
Outcomes model.
 Describe how lead times and safety stock affect inventory
management.
 Describe the process for sales and operations planning.
 Describe material requirements planning (MRP).
 Describe manufacturing resource planning (MRP II).
 Explain a bottleneck process.
 Discuss the theory of constraints.
 Explain the theory of constraints logical thinking process.
 Discuss the drum-buffer-rope.
 Describe the operations scheduling process.
 Differentiate between backward and forward scheduling.

Bill of materials Bill of materials (BOM) is a listing of the

(BOM) number and type of sub-assemblies,
components and raw materials needed to make
Terminology
an assembly. Bills of materials are also called
formulas, recipes, formulations or ingredient
lists.

Bottleneck Bottleneck is an operation, resource, function

or facility that has insufficient capacity to
meet demand.

Carrying cost Carrying cost is the cost of carrying or holding

inventory. Carrying cost depends mainly on
the cost of capital invested in the inventory but
also includes insurance, obsolescence,
spoilage and space occupied. It includes all
warehouse operational expenses such as
receiving, putting away, picking and delivery
functions. If, for example, the inventory
requires temperature and atmosphere-
controlled storage, the carrying cost is
considerably higher than inventory that can be

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 C4: Operations Management

stored in ambient conditions.

Capacity Capacity-constrained resource is a resource

constrained that is not a constraint but can become a
resource (CCR) constraint unless scheduled carefully.

Constraint Constraint, in theory of constraints, is any

resource lack that prevents the system from
achieving continuously higher levels of
performance.

Finished goods Finished goods inventory are the items for

inventory which all the production processes have been
completed.

Fixed order Fixed order quantity is a lot-sizing technique

quantity that sets the order quantity to a fixed quantity
or a multiple of a fixed quantity.

Inventory Inventory is the stock of items used to support

production processes (raw material and work
in process), customer service (finished goods
and spare parts) and other activities such as
maintenance and repairs.

Lead time Lead time is the time between recognition of

the need for an order and the receipt of that
order.

Material Material requirements planning (MRP) is a set

requirements of techniques that uses bills of material,
planning (MRP) inventory data and the master production
schedule to calculate the requirements of
component materials. MRP starts with each
specific item and quantity listed in the master
production schedule and calculates the
quantities of all components and materials
required to make those items, and the date
those items must be available for use. MRP
explodes the bill of material, makes
adjustments for inventory quantities that are
on hand or already on order, and calculates net
requirements that are offset by the lead time.

Manufacturing Manufacturing resource planning (MRP II) is

resource a method for the effective planning of all
planning resources of a manufacturing company.
(MRP II) Ideally it addresses operational planning in

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Unit 9

units, financial planning in dollars, and has a

simulation capability to answer what-if
questions.

Ordering costs Ordering costs are the costs incurred because

of the work involved in placing purchase
orders with suppliers and organising the
ordered items for production within a plant. It
includes costs associated with preparing,
releasing, monitoring, receiving and payment
of orders.

Periodic review Periodic review system is an inventory

system management system in which the inventory
position is checked only at fixed intervals. It is
synonymous with fixed order period inventory
model.

Planned order Planned order is a suggested order quantity,

release date and due date created by the logic
of a planning system when it encounters a net
requirement in MRP. Planned orders are
created by the computer, exist only within the
computer and may be changed or deleted by
the computer during subsequent processing if
conditions change.

Raw material Raw material inventory was originally the raw

inventory material extracted from the ground to start a
production process. Now it is any purchased
or extracted item used as input to the
production process and converted into
components and finished products.

Reorder point Reorder point is a predetermined inventory

level where, if the total stock on hand plus on
order reaches this point or falls below it, a
replenishment action is initiated. The order
point is usually calculated as the demand
during replenishment lead time plus safety
stock.

Safety stock Safety stock is a quantity of inventory used to

protect against fluctuations in demand and/or
supply. Supply and usage fluctuations include
an allowance for a known percentage of reject
material. So, when a material consistently
contains a small percentage of reject, this
percentage should be factored into safety

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 C4: Operations Management

stock.

Sales and Sales and operations planning is a business

operations process that helps companies keep demand
planning and supply in balance. It does that by focusing
on aggregate volumes (product families and
groups) so that mix issues (individual products
and customer orders) can be handled more
readily.
It occurs on a monthly cycle and displays
information in units and dollars. It links the
company’s strategic plans and business plan to
its detailed processes. Used properly, it
enables the organisation’s managers to view
the business holistically and gives them a
window into the future.

Service level Service level is the probability that customer

demand will be satisfied by current inventory
or planned production in time to meet
customer-requested delivery dates and
quantities.

Set-up costs Set-up costs are the fixed costs associated with
production that include paperwork, machine
set-up, calibration, downtime and start-up
scrap that can be associated with the
changeover from one product to the next.

Target inventory Target inventory level is the quantity set as the

level target level and equals the order point plus a
variable order quantity.

Theory of Theory of constraints (TOC) is a philosophy

constraints of continuous improvement based on the
premise that constraints determine the
performance of any system.

Work in process Work in process (WIP) inventory is the

(WIP) inventory material and components in a production
process between the first input (raw material)
and the final output stage (finished goods).
Terminology sourced from Gardiner (2010).

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Unit 9

Inventory – definitions and purpose

Inventory is the stock of items used to support production processes
(raw material and work in process), customer service (finished
goods and spare parts) and other activities such as maintenance and
repairs.
Raw material inventory was originally the raw material extracted
from the ground to start a production process. Now it is any
purchased or extracted item used as input to the production process
and converted into components and finished products.
Work in process (WIP) inventory is the material and components in
a production process between the first input (raw material) and the
final output stage (finished goods).
Finished goods inventory are the items for which all production
processes have been completed.
Inventory management is the process of planning and controlling
physical inventory.
Nearly all organisations have inventory although some service
organisations may not call it inventory and may not visualise
inventory as a problem.
It is easy for production organisations to visualise inventory since
they are purchasing raw materials in (large) quantities and
transforming them into finished goods all the time. That is their
role in life. They survive by being able to manage the inflow of raw
materials, process them effectively through production processes
and sell the outputs to customers.
Service firms have inventory as well. Supermarkets have inventory
stocks on their shelves and constantly replenish empty spaces as
customers remove items from the shelves. Restaurants have food
items as inventory and the kitchen staff estimate how much is
required on a regular basis and purchase accordingly. Hospitals and
medical centres purchase medicines, pharmaceuticals, instruments,
dressings, food, blood supplies and cleaning materials. Banks and
financial institutions have stocks of stationery, information
technology equipment and other items. Property management
organisations hold an inventory of properties being managed.
Plumbers, builders, painters and maintenance companies carry
limited amounts of inventory with employees as they travel from
one job to the next. Domestic households have a refrigerator and a
pantry with food items waiting to be consumed by the household.
Service inventory refers to the tangible goods to be sold and
sometimes it is required to deliver the service. Service inventory
may be classed as goods for sale or rent, physical space, number of
workspaces, service personnel, productive equipment and supplies.

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 C4: Operations Management

All of these are inventory and all have the same inventory problems
to solve. What is the order quantity? When should the order be
placed?
Inventory management is the process of planning and controlling
physical inventory.

Activity 4.1
Now that we have introduced the subject, reflect on what
inventory does for an organisation. Think of an organisation with
which you are familiar and try answering these questions:
Activity 1. How much inventory should the organisation have?
2. When should you pay for it?
3. How much should you pay for it?
4. What happens if you have too much inventory?
5. What happens if you have too little inventory?
6. Where is inventory stored?
7. How much storage space is required?
8. How is inventory transported?
9. How much inventory is transported at one time?
10. How is inventory stored?
11. What happens if the inventory is a hazardous substance (or
dangerous to handle)?
12. How do you keep track of what inventory you have?
13. What is the value of the inventory you have?
14. What can you do with the inventory you do have?
15. We could consider many more questions at this stage but the
above give some idea of where we are heading.

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Unit 9

Why have inventory?

The main reason for holding inventory is because of demand
uncertainty. If an organisation knew exactly what demand would be
tomorrow it could take immediate steps to ensure it had exactly that
quantity ready for sale (or use) first thing tomorrow morning. By
evening, all would be sold (or used) and inventory would be zero.
The real situation is not as easy as this and the problem starts
because firms do not know exactly what demand will be tomorrow,
or the next day, so they hold extra stock to maintain a service level
or just in case.
Usually, demand varies from day to day and demand requirements
are available as a probability distribution. Safety stocks are
maintained to provide some level of protection against stock-outs.
One approach is to set the safety stock at a point that allows a
specified percentage of total demand to be met from stock on hand.
This is called the service level.
Service level is the probability that customer demand will be
satisfied by current inventory, or planned production, in time to
meet customer-requested delivery dates and quantities. Lead time is
the time between recognition of the need for an order and receipt of
that order. Organisations may carry some safety stock to protect
them from demand and lead time fluctuations.
If delivery was instantaneous and delivery quantities guaranteed,
there would be no need to store inventory. Electricity and water
supplies for individual consumers are replenished instantly and
whatever quantity is required is available (within reason). This
example is based on an organisation or a household in a town or
city in a developed country. It does not belittle the supply problems
of the generation, distribution and supply organisations as they
manage limited resources to maintain the instantaneous
replenishment and flexible volume requirements demanded of their
services.
Some organisations use lead time-based pricing as a way to
increase revenue when demand is random and capacity fixed.
Using this model, a make-to-order firm, operating in its own best
interests, can dynamically quote lead times and vary the associated
prices when customers accept, or reject, a delay in delivery. The
policies are both highly intuitive and provide delay guarantees for
all served customers. Shorter delivery periods carry higher prices.
Significant revenue benefits to the supplier can accrue by using
these dynamic policies and, likewise, cost benefits accrue to the
customer when they adjust their expectation of delivery time.
Food processing companies buy up the entire harvest during
harvest time and partially process the food so that it can be held for
some months before continuing the process. Therefore, the

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 C4: Operations Management

inventory is obtained during periods of abundance to compensate

for periods of restricted supply, or even no supply. Tomato
processing and green pea processing are examples of crops that are
usually owned by the processing company or contracted before the
seeds are sown. The contract might say the company will take the
lot regardless of available quantity at harvest. This provides
guarantee of a sale to the farmer, but provides processing
uncertainty to the processor.
Sometimes inventory is held so that it can appreciate in value. This
may be seen as an investment opportunity, but nevertheless is an
investment in inventory and requires the same management
decisions as regular purchases of depreciating inventory. Examples
of appreciating inventory are fine art, stamps and fine wines.
Some organisations obtain inventory in bulk to obtain a lower unit
price. This is referred to as a lot-size inventory and is a good
practice when the quantity obtained matches a shipping quantity
such as a pallet or a container and the quantity itself can be
consumed in a reasonable timeframe. It is not good practice when
storage costs, quality issues, obsolescence, pilferage and other
carrying costs are greater than the gain made with the initial
purchase.
Pipeline inventory is inventory in the transportation network and in
the distribution system. Someone owns it and someone is carrying
the cost of ownership. Pipeline inventory can be reduced when the
supplier is near the customer and delivery methods fast. Flow time
through the pipeline has a major effect on the amount of inventory
required in the pipeline. The quantity of inventory in a pipeline is
generally inversely proportionate to the flow time.

Economic order quantity model

The economic order quantity model considers ordering costs (set-
up), carrying costs (storage) and purchase costs (acquisition) and
calculates an optimum order quantity.
Ordering cost is the cost incurred to issue purchase orders with
suppliers and to issue manufacturing orders within a factory.
Typical costs include those associated with preparing, releasing,
monitoring, receiving and payment of orders, and the physical
handling of inwards goods.
Carrying cost is the cost of carrying or holding inventory. Carrying
cost depends mainly on the cost of capital invested in the inventory
but also includes insurance, obsolescence, spoilage and space
occupied.
The inventory debate has traditionally been cost-based. The total
cost of inventory is added up and inventory analysts attempt to

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Unit 9

minimise the total cost of inventory. Organisations try to cut

inventory costs by optimising the total cost equation.
This is a staple diet for nearly all books and courses on inventory.
However, the economic order quantity model is not appropriate for
modern business applications.
To calculate the optimum lot size requires the following
assumptions:
 All costs are assumed to be variables, when for most
organisations they are fixed. The permanent staff involved
with processing orders and fulfilling warehouse functions
are fixed (monthly salaries for example) and do not vary as
a function of order sizes and numbers of orders.
 Production is assumed to be instantaneous, suggesting that
capacity is not constrained.
 Delivery is assumed to be immediate, indicating no delay
between production and availability.
 Demand is assumed to be deterministic, which means there
is no uncertainty about quantity or timing of demand.
 Demand is assumed to be constant over time and so
constant that the demand curve is a straight horizontal line.
 Each production run is assumed to incur a fixed set-up cost,
which is the same regardless of actual quantity being made
and regardless of the previous job that was running.
 It is assumed the products can be analysed individually,
which suggests there is no sharing of resources.
Very rarely will these assumptions hold true. For most
organisations capacity is a constraint, at least for some of the time
and demand is not usually deterministic and definitely not constant
over time. As for set-up, the time to perform a set-up varies
according to the previous product being made and the teardown is a
function of the following product. Thus, set-up is a variable and not
a constant.
Additionally, it does not consider the cost of not having inventory.
Organisations that use the economic order quantity use an arbitrary
value for holding inventory and an arbitrary value for ordering.
These values are rarely reviewed and can be manipulated to force
long runs and large batches.

Sufficient inventory is enough

For want of a nail the shoe was lost
For want of a shoe the horse was lost

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 C4: Operations Management

For want of a horse the rider was lost

For want of a rider the battle was lost
For want of a battle the kingdom was lost
And all for the want of a horseshoe nail.
(Attributed to Benjamin Franklin, 1758)
The correct amount of inventory is sufficient to satisfy customer
demand. A balance is required between the cost of having
inventory and the cost of not having it.
Lead time is the time between recognition of the need for an order
and receipt of that order. The longer the lead time, the longer the
period of demand uncertainty and the greater the possibility of lead
time variation, therefore the greater the need for safety stock.
Safety stock is an overhead cost and when not being used on a
regular basis it acts as an additional storage and cost burden for the
organisation. The need for safety stock diminishes as demand
uncertainty and lead time decreases.
Inventory turnover is the number of times an inventory “turns over”
in a year. The usual method to calculate inventory turnover is to
divide the annual cost of sales by the average inventory value.
Inventory turnover or inventory turns is a common measure for
evaluating inventory. A higher number of turns are better. It is a
good check on how the inventory model is performing, even if the
calculations are not accurate.
A supermarket should experience inventory turnover of at least 50
per year or once a week. The metric measures inventory turnover
but excludes service level.

Inventory models
The demand for inventory can be either independent or dependent.
Independent items supply the demand that comes from outside the
organisation. These can be managed by fixed quantity, fixed
period, minimum-maximum, or budget allocation inventory control
systems. Dependent demand items supply requirements from inside
the organisation. They are components of other products so their
rate of use is dependent on the production schedule and the rate of
use of the parent items. Dependent demand items are managed by
material requirements planning and lean thinking approaches to
keep inventories as low as possible.
A reorder point is a predetermined inventory level where, if the
total stock on hand plus on order reaches this point or falls below it,
a replenishment action is initiated. The order point is usually
calculated as the demand during replenishment lead time plus
safety stock.

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Unit 9

Fixed order quantity is a lot-sizing technique that sets the order

quantity to a fixed quantity or a multiple of a fixed quantity. In this
system, a predetermined constant quantity is ordered whenever the
number of units on hand reaches a specified reorder point. This
means the same amount is ordered each time.

(Gardiner, 2010, p. 276)

The diagram above illustrates the fixed order quantity model. The
quantity ordered each time is a constant. As an example, an
organisation orders 100 units every time (or multiples of 100). The
reorder point can be calculated and equals the demand during the
lead time plus any safety stock requirements.
This model works when the predicted demand during the lead time
is close to actual demand and the safety stock is sufficient to cover
variations of demand. This model fails, however, when actual
demand exceeds predicted demand by more than the safety stock.
The stock-out problem is alleviated by short lead times, reliable
suppliers and a dynamic safety stock calculation.
Periodic review is an inventory management system in which the
inventory is checked only at fixed intervals. In this system, an order
is placed at the end of a specified period and the quantity is
adjusted to bring inventory up to a predetermined level. This
system is very common with small retail outlets that deal with high
volumes of low-valued items. They may check their inventory once
a week or when the supplier representative calls for an order.
The order quantity has to be sufficient to last from the time the
order is received until the next order is received. The quantity
ordered considers the demand during the review period plus the
demand during the lead time.

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 C4: Operations Management

(Gardiner, 2010, p. 277)

The diagram above illustrates the periodic review model. The time
between placing each order is a constant (for example, an order is
placed every Wednesday morning).
Calculations based on the periodic review system use target
inventory level which is the quantity set as the target level and
equals the order point plus a variable order quantity.
Most inventory models use a reorder point. As inventory is
consumed the quantity on hand diminishes until it reaches some
arbitrary point called the reorder point. When this point is reached a
trigger of some sort initiates a replenishment order. Possibly the
most common trigger signal is the orange light on a motor vehicle
dashboard to indicate low fuel levels. When interpreted correctly, it
signals that the vehicle requires additional fuel. Some drivers may
estimate how long they have before they run out and this may be
50–100 kilometres. Depending on the driver, the conditions and the
level of risk that can be tolerated and the level of excitement
required, this trigger might indicate two or three days of driving.
Whichever way you look at it, it is a reorder point.
With inventory models the key questions relate to order quantity,
order time, lead time and time of order receipt. Quantitative
analysis becomes complicated and convoluted as analysts attempt
to find the optimum quantity to be placed at the optimum time so
that optimum performance is achieved. The complication develops
with demand uncertainty. When demand is known the calculations
become easier. The other difficulty is lead time uncertainty. When
lead time is known and reliable the calculations become easier.

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Unit 9

Sales and operations planning (S&OP)

Sales and operations planning is a business process that helps
organisations balance demand with supply. It does that by focusing
on aggregate volumes (product families and groups) so that mix
issues (individual products and customer orders) can be handled
more readily.
It usually occurs on a monthly cycle and displays information in
quantity units and financial units. It links the organisation’s
strategic plan and business plan to its detailed processes. Used
properly, it enables the organisation’s managers to view the
organisation holistically and gives them a window into the future.
The monthly process starts with an unconstrained baseline demand
forecast. The sales team captures actual customer demand,
regardless of any influencing factors (in other words,
unconstrained). The demand capture process involves working
collaboratively with end customers to understand the true demand
drivers. This demand is presented at an aggregate or family level,
and extends from three months to three years. Typically, an
organisation would have between six and 12 groups or families.
The sales and marketing function makes adjustments based on
planned advertising and promotional activity and considers any
new product launches, competitive activity, economic conditions
and industry dynamics before releasing the plan to operations and
supply chain for their inputs.
The operations and supply chain function uses the demand data
from sales and marketing and attempts to balance supply with
demand. Key information such as the business inventory strategy,
production throughput capacity, production constraints, supply
chain capacity and all internal constraints such as workforce, health
and safety, shifts and so on are brought into the mix.
Supply attributes are considered on a rough-cut basis which does
not consider inventory levels and production lead times. Accuracy,
reliability and consistency of all demand and supply data is critical
and has to represent what can and will be delivered. This analysis
may identify demand which cannot be met or supply that exceeds
demand. Data used to identify supply constraints must represent
reality and provide some credibility to the decisions made in
subsequent planning meetings. Demand, supply, financial, new
product development and performance measurement data has to be
consistent and accurate to maintain the integrity of the entire
process.
The sales, operations and supply chain functions meet regularly to
develop the final operating plan for the following periods. This
team is cross-functional and includes sales and marketing (demand

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 C4: Operations Management

management, forecasting), operations (purchasing, inventory

management, supply chain, operations, master production
scheduling, warehousing, transport), new product development and
finance.
Sales and operations planning sets the volume of production
required to meet demand and subsequent steps disseminate the
volume figures into specific product, quantity and date.
Various scenarios are discussed until agreement on the final
volume plan is reached. When agreement cannot be reached, the
planning meeting documents the issues, researches the options and
presents these for senior management to resolve.
Upon agreement, both the demand and the supply numbers are
disseminated for detailed planning by the operations, supply chain
and sales functions. A mature planning process is capable of
highlighting potential issues and constraints, and communicating
collaboratively with customers and suppliers. This allows external
parties full visibility of the confirmed plan so they in turn can plan
more accurately.
A formal meeting to sign off the plan is convened, usually towards
the end of the planning month. All functions attend and sign off on
the plan for the next period. Moreover, the signing process is
indicative that they are prepared to deliver precisely to that plan.
Often this step is described as “signing with blood” and because of
this connotation, senior executives should champion the whole
process to ensure it maintains the correct focus.
Organisations often struggle to implement sales and operations
planning processes due not only to the need to develop new
business processes, but also the need to develop a new internal
collaborative culture and a breaking down of functional, isolating
silos. When developed, the model needs to be continuously
improved to incorporate gradual changes in the understanding and
requirements. This framework moves from the silo-driven to event-
driven collaboration and the organisation moves from limited
integration to a seamlessly integrated organisation that focuses on
organisation profit optimisation rather than using a cost/profit-
centre approach.

Material requirements planning (MRP)

Manufacturing requirements planning (MRP) was developed in
1960 by Joseph Orlicky (1975). Before this, manufacturing
companies managed all inventories as if they exhibited independent
demand. They relied on the reorder point to trigger the need and
fixed order quantities to satisfy that need. Manufacturers relied on

17
Unit 9

excess stocks, rough estimates and hoped that they had enough
materials.
Orlicky used a computer (albeit very slow by today’s standards) to
calculate the requirements of each component that made up the
finished product. Starting with a statement of the specific quantity
of each specific product for each specific required date, called the
master production schedule, he exploded the bills of material to
calculate the quantities of components. He considered the lead time
for each item and offset the release of the replenishment order to
compensate for the lead time. Progressively, this built up gross
requirements at the next level down the bill of material so he
subjected these to the same logic.
This development had profound implications for manufacturing
systems.
The driver to this method is the master production schedule, which
has to be realistic and achievable. At the finished goods level, it
reflects the quantities of finished products that must be available
for sale in each time period. If this is a true statement the
subsequent calculations may deliver meaningful results.
The bill of materials should reflect actual material requirements per
item. The bill of materials is like a recipe or a formula. In fact,
some industries, such as pharmaceuticals and food processing, refer
to their bills of materials as recipes and formulas. Some
compensation is introduced to allow for variation, scrap, wastage,
shrinkage, loss, pilferage and misplacement. The quantity for each
is the quantity of the component for one of the parent items. This
number has to be correct.
Lead times are usually entered as fixed numbers and these offset
the release of each replenishment order. So an item will be
reordered next week if it is required in four weeks and it takes three
weeks to be delivered. This allows raw material supply to be
calculated and delivered at the latest possible due date.
Inventory accuracy of quantities on hand and on order is required.
If the computer shows an item is in plentiful supply, the MRP
system will not suggest replenishment. If the storage bin is empty,
it remains empty until the item is required, at which time it is too
late to obtain replacement.
This capability reduces inventory, reduces idle time, reduces set-up
and tear-down costs, increases sales and provides better customer
service and response to market demands.
MRP systems are well developed and the logic is quite
straightforward. The theory of MRP is right, but the execution
leaves a lot to be desired. The variables are too great for many
organisations to manage.

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 C4: Operations Management

Activity 4.2
Now that we have introduced the subject of material requirements
planning, try answering this question:
What data is required to develop a very basic MRP?

Activity
Activity feedback can be found at the end of this module.

Material resource planning (MRP II)

Manufacturing resource planning (MRP II) is a method for the
effective planning of all resources of a manufacturing company.
Ideally it addresses operational planning in units, financial planning
in money units (dollars) and has a simulation capability to answer
what-if questions.
Oliver Wight and George Plossl (Orlicky 1975) pioneered the
concept of manufacturing resource planning (MRP II) which is
linked to MRP but adds all the activities of a manufacturing
company, including sales, purchasing, finance, maintenance, design
and engineering.
Manufacturing resource planning (MRP II) plans all the resources
of a manufacturing company including business planning, sales and
operations planning, master production scheduling, material
requirements planning, capacity requirements planning, and the
execution support systems for capacity requirements planning and
production. Output of these systems is integrated with financial
reports such as the business plan, purchasing commitment plans,
logistics budgets and inventory projections. Manufacturing
resource planning (MRP II) is a direct outgrowth and extension of
MRP.

Constraint management
When a process is flowing, the inputs are processed as they arrive
and the outputs delivered to customers as they demand them. It
would be marvellous if this actually happened.
Bottleneck processes hold up production and are usually easy to
identify because a queue forms in front of the process because the
process has insufficient capacity to meet demand.
By definition, a bottleneck process is slower than other processes.
When non-bottleneck processes get behind, they have the ability to

19
Unit 9

catch up because they are not the slowest. However, the slowest
process can never catch up because other processes are faster.
Thus, the bottleneck becomes the constraint that limits system
performance and total output can never exceed the average output
from the constraint.
A non-bottleneck is a resource whose capacity is greater than the
demand placed upon it and it contains idle time. A capacity-
constrained resource is one whose utilisation is close to capacity
and could become a bottleneck if not scheduled carefully.
The theory of constraints emphasises the need to identify and
manage constraints or bottlenecks within the production system,
the organisation itself, or the network of supply and distribution
activities.
Common constraints involve machines and people. Each machine
is capable of producing a volume of output which is its capacity.
People are capable of delivering an amount of work, which is their
capacity. When these capacities are insufficient to meet demand
they become constraints or capacity-constrained resources.
Effective planning and management of capacity-constrained
resources uses realistic production goals that consider capacity
constraints. Production plans, master production schedules and all
other plans should focus on bottleneck activities since these limit
system outputs. Unrealistic demands on bottleneck resources create
unrealistic demands and expectations on the entire system.
Operations managers should adapt work flows to encourage
effective use of capacity-constrained resources.

Theory of constraints
Eliyahu Goldratt and Jeff Cox (1984) introduced the theory of
constraints in the book, The Goal: A Process of Ongoing
Improvement. The book is a novel as well as a powerful textbook.
It is about creating and accepting improvements, making
continuous progress and changing for the better.
Theory of constraints (TOC) is a philosophy of continuous
improvement based on the premise that constraints determine the
performance of any system.
The philosophy is based on three very interesting definitions:
throughput, inventory and operating expense.
 Throughput is the rate at which the firm generates money
through sales.
 Inventory items purchased for resale including finished
goods, work in process and raw materials. In the theory of
constraints, inventory is valued at purchase price and

20
 C4: Operations Management

includes no added-value costs. This is in contrast to the

traditional cost accounting practice of increasing the value
of inventory as the item progresses through production.
 Operating expense is the money spent in converting
inventory to throughput.
Goldratt and Cox (1984) explain that the goal of the firm is to make
money by:
 Increasing throughput, which is the rate at which money is
generated by sales.
 Reducing inventory, which is the money spent on buying
items for subsequent sale.
 Reducing operating expense, which is the money spent to
convert inventory into throughput.
Traditionally, management emphasises reducing operating expense
and reducing inventory. Organisations take pride in proclaiming
they are on a “cost-cutting drive”. They target opportunities to cut
expenses and reduce inventory. Expenses are easy to cut when the
organisation stops spending money. Likewise, inventory is easy to
reduce when the organisation stops replenishing supplies.
Looking at both operating expense and inventory, what happens
when the organisation reaches zero? Managers argue that they will
not actually reach zero and they will stop before they reach that
limit. But they do not tell anyone where to stop, when to stop or
how to stop. They just say, “Reduce operating expenses and
inventory!” The finite limit is zero.
What kind of organisation have you built when operating expense
is zero and inventory is zero?
There is no finite limit to increasing throughput, which is defined
as the rate at which money is generated by sales.
The theory of constraints uses a logical thinking process to evaluate
a system and seek to improve its performance by following these
steps:
1. Identify the system constraint.
2. Decide how to exploit the constraint.
3. Subordinate everything else to the constraint.
4. Elevate the constraint in the system.
5. If the constraint is broken, return to step 1.
Drum-buffer-rope is a finite scheduling process that balances the
flow of the system. The drum is a system constraint or other critical
resource that sets the pace that drives the rest of the schedule.
Buffers are work in process inventories maintained just in front of
the resource. The ropes are schedules that tie the release of raw

21
Unit 9

materials and customer promise dates to the production at the

drum.
Production is controlled using a drum at the bottleneck. This is a
figurative term because the drum strikes the beat for the rest of the
system. All parts of the process influenced by the drum respond to
the drum beat. If there is no bottleneck, then the drum is located at
a capacity-constrained resource.
Two things happen at the drum:
1. A buffer inventory (or time buffer) is placed in front of the
bottleneck or capacity constrained resource to make sure it
never runs out of work. If it does run out of work it will
never catch up so it should always have something to work
on.
2. A rope or communication link is established upstream to
the material release point so new work is released to the
system at the rate it is passing through the bottleneck or
capacity-constrained resource. It releases work to the beat
of the drum.
The buffer is used to decouple, or eliminate, direct dependencies
between resources. A time buffer creates a physical amount of
stock which is sufficient to last for an order delivery period. A
constraint buffer is placed immediately before the constraint to
make sure the constraint does not run out of work. An assembly
buffer uses non-constraint parts before an assembly to make sure
any assembly can be put together. A shipping buffer is placed
immediately before shipping to absorb disruptions that could delay
shipment.

In the diagram above, the material is flowing from left to right and
passes through six process steps. Process step four is by far the
longest and takes twice as long as step three. Assuming all process
steps keep working, it will not take long for a queue to form in
front of process step four. Process step four is the bottleneck. It
does not matter how fast or how long the other process steps
operate because the output of the total process is determined by the
performance at process step four.

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 C4: Operations Management

Knowing that process step four is the bottleneck, it is essential for

the production planner to ensure process step four does not run out
of work to do (assuming demand remains). Therefore, the
production planner puts a buffer stock of work in process between
process step three and process step four. The quantity of the buffer
stock can be calculated depending on demand but could. For
example, be equivalent to one day’s production.
A number of operating guidelines develop from the theory of
constraints.
 The material flow through the factory should be balanced,
rather than balancing the capacity.
 An hour lost at a bottleneck is an hour lost to the entire
system since it can never catch up.
 An hour lost at a non-bottleneck can catch up since the non-
bottleneck is faster than the bottleneck.
 Bottlenecks govern throughput, inventory and quality.
 Processing batch sizes should be allowed to vary both along
an order’s route and over time.
 Lot sizes should be variable and not fixed. Lot sizes are a
function of the schedule and thus should not be fixed over
time or from one operation to the next. When different
components are manufactured on different machines, the lot
size should be varied to achieve a smooth and timely flow
of products to the customer.
 Production schedules should simultaneously accommodate
all constraints.
 Lead times result from scheduled sequences, so planners
cannot determine them in advance. Lead times are usually
determined before the product is made and is often
communicated to the customer in advance. These are usually
accepted as fixed periods.
The theory of constraints requires that schedules are established
once all the system constraints are known and this suggests that
perhaps, by adjusting the schedule, client lead times in the supply
chain can be improved.
The objective of operations scheduling is to meet customer delivery
promise dates. Inherent in this objective is the need to minimise
lead times, set-up time, work-in-process inventory and use of
resources.
Scheduling and controlling operations involves the dynamic
interaction of a constantly changing variety of jobs that are usually
competing for the same resources. Many random variables, such as

23
Unit 9

differences in materials, skills, attitudes and machine breakdowns

influence performance. Many criteria could be used and some are
mutually conflicting.
The process of determining which product is started on a particular
machine or process is known as priority sequencing.
The scheduling problem in service organisations concentrates on
staffing levels and scheduling each work period. Various cut-and-
try heuristics and optimising methods are used.
Load is the amount of planned work scheduled and the actual work
already released to a facility, or a work centre, for a specific period.
It is usually expressed in a common unit such as standard hours or
units of production.
Load profile is a graphical display of future capacity requirements
based on released orders and/or planned orders over a given time
period.
Forward scheduling is a technique that starts with a known start
date and schedules each activity to follow the finish of the previous
activity.
Backward scheduling is a technique that starts with a known order
due date and schedules each preceding activity to end at the start of
the following activity.

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 C4: Operations Management

Activity 4.3
Work through the following questions. You may need to go back
and reread the unit to help you.
1. Explain why the economic order quantity model is not
Activity appropriate for modern business.
2. Explain the difference between MRP and MRP II.
3. Explain the sales and operations planning process.
4. Explain why sales and operations planning is performed at the
aggregate level.
5. Explain the theory of constraints.
6. Explain how the drum-buffer-rope works.
7. Explain the difference between a capacity-constrained resource
and a bottleneck.
8. Explain why an organisation might carry safety stock.

Unit summary
In this unit you learned about the reason for having inventory and
why the economic order quantity is not appropriate for modern
business. We described a fixed-order quantity model and a periodic
Summary review model and how lead times and safety stock affect inventory
management.
The process for sales and operations planning, material
requirements planning and manufacturing resource planning were
discussed.
Under the general topic of theory of constraints, we explained a
bottleneck process, discussed the logical thinking process and
discussed the drum-buffer-rope method for production scheduling.
We described the operations scheduling process and differentiated
between backward and forward scheduling.

25
References

References
Franklin, B. (1758, June). The complete poor Richard’s almanacks.
Gardiner, D. (2010). Operations management for business
excellence (2nd ed.). Auckland, New Zealand: Pearson
Education.
Goldratt, E. M. & Cox, J. (1984). The goal: A process of ongoing
improvement. Croton-on-Hudson, NY: North River Press.
Orlicky, J. (1975). Material requirements planning: The new way of
life in production and inventory management. New York,
NY: McGraw-Hill.

Readings for further study

Gardiner, D. (2010). Operations management for business
excellence (2nd ed.) (pp. 263–298). Auckland, New
Zealand: Pearson Education.
Reading Goldratt, E. M. & Cox, J. (1984). The goal: A process of ongoing
improvement. Croton-on-Hudson, NY: North River Press.
Heizer, J. & Render, B. (2010). Operations management (10th ed.).
Upper Saddle River, NJ: Prentice Hall.
Hopp, W. J. & Spearman, M. L. (2008). Factory physics (3rd ed.).
New York, NY: McGraw-Hill.
Orlicky, J. (1975). Material requirements planning: The new way of
life in production and inventory management. New York,
NY: McGraw-Hill.

26
 C4: Operations Management

Unit 10

Supply chain management

Introduction
The role of collaboration and co-operation in operations needs to be
emphasised as something that should be designed into a product or
service from the onset rather than being considered as an
afterthought.
Customer requirements for flexibility, agility, cost efficiency and
product variety force companies to reconfigure their supply chains
to meet those requirements.
This unit will focus on external influences on operations looking at
how suppliers, and those that are supplied, affect the design of an
internal operation. It will also look at the operational implications
of partnerships; how they come about, how they can be managed
and how they evolve.
This study unit will introduce key concepts and strategies related to
the management of supply chains starting with a definition of
supply chains and examining supply chains from a strategic view.
The bullwhip effect (or demand amplification) is discussed.
The concept of collaborative supply chain is introduced with
reference to the Triple-A approach involving agility, adaptability
and alignment.
The purchasing function and replenishment programmes are
introduced.

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Unit 10

Upon completion of this unit you will be able to:

 Define supply chain management from a strategic view.
 Discuss the bullwhip effect or demand amplification.
 Define collaborative supply chains.
 Explain the triple-A approach to supply chains.
Outcomes  Discuss the strategic role of inventory in supply chains.
 Discuss the criteria for supplier selection.

Agility The ability to economically produce a variety

of products in any quantity with rapid
changeovers. Agility merges the four
Terminology
competitive capabilities: cost, quality, delivery
and flexibility.

Bullwhip effect Creates large oscillations of inventory in the

— demand supply chain network. Large changes in the
amplification supply position upstream are caused by small
changes in downstream demand created by
large numbers of players along the supply
chain. The effect, also known as demand
amplification, can be eliminated (or
minimised) by synchronising the supply chain.

Collaborative Collaborative supply chain is based on

supply chain collaborative planning, forecasting and
replenishment.

Supplier An entity that provides inputs to a process.

Supply chain A network that describes the flow of raw

materials from suppliers through plants that
transform them into useful products, and
finally to distribution centres that deliver those
products to end customers.

Supply chain An integrated approach to obtaining,

management producing, and delivering products and
services to customers, and includes the
management of materials, as well as
information flow and cash flows.
Terminology sourced from Gardiner (2010).

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 C4: Operations Management

What is supply chain management?

The supply chain is a network that describes the flow of raw
materials from suppliers through plants that transform them into
useful products, and finally to distribution centres that deliver those
products to end customers.
Supply chain management should be viewed as all of the
interactions that occur, starting at the point of original supply
through to the end customer or consumer.
Generally, the supply chain involves the flow of materials from
suppliers to customers until the product reaches the end consumer.
It is these linkages that constitute the supply chain.
Clearly the strength of the entire chain depends on its weakest link
and the end customer satisfaction depends on how well all linkages
in the supply chain work.
The supply chain involves more than just the flow of materials. It
involves market research data, customer requirements, the flow of
orders and the flow of cash in a reverse direction from customer to
supplier. Thus the flow of information and cash flows from end
customer back up the supply chain to original supplier.

(Gardiner, 2010, p. 303)

The diagram above illustrates a supply chain and shows the
material flow (from left to right) and the information flow (from
right to left).
In the same direction as the material flow, each supplier sends ideas
and design suggestions to satisfy the customer and credit facilities
are provided to customers.
Service companies often see themselves as different from supply
chain companies. The reality is that they are usually an integral part
of the supply chain. Transport companies supply transport services
over land, sea and air. Banks and finance companies provide credit
and other facilities at every interaction in a supply chain. Insurance

29
Unit 10

companies, import/export companies, advertising companies and

promotion companies ease the material and data flows of supply
chains.
Manufacturers, distributors and retailers provide services to ensure
service suppliers have the goods to provide to their customers.
Hotels and restaurants rely on inwards goods arriving at the end of
a supply chain. Health services need inwards goods such as
pharmaceuticals, food, uniforms, pens and papers and operating
supplies before they can even start providing care and attention to
patients.
Each firm has a set of suppliers and a set of customers. These are
referred to as first echelon suppliers and first echelon customers.
They represent the first tier of contact along the supply chain for
that firm. Additionally, each first echelon supplier may have their
own set of suppliers that supply goods and services to them.
Relative to the first firm, these are now the second echelon
suppliers. Similarly, a firm may have second echelon customers.
This sequence of supplier/customer linkages continues upstream as
far as the original supplier and downstream as far as the end
customer. When designing supply chains and thinking about the
dynamics of supply chains all these interactions need to be
considered.

(Gardiner, 2010, p 303)

The diagram above illustrates a supply chain involving service
organisations at the consumer interface. Service providers may
view themselves as unrelated to manufacturing, but they are a vital
link in the functioning of the entire supply chain.
The average manufacturer buys two thirds of what goes into the
final product — two thirds of the cost of goods sold. This
percentage is rising due to increasing use of technology and labour-

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 C4: Operations Management

saving devices. The effect of savings on the bought-in material

costs of most organisations has a disproportionate effect on their
profitability. The greater the proportion of their total costs devoted
to bought-in materials the greater the saving for a given reduction
in bought-in material costs. Therefore, through its philosophies,
knowledge of processes, knowledge of materials and vendor
selection, the purchasing department has many more opportunities
to affect quality as the production department does.

Supply chain management from a strategic view

A customer who walks into a retail store and purchases an item is,
by default, acknowledging all the interactions of the entire supply
chain that delivered the product to the retail store. The entire supply
chain should benefit from each retail transaction. A successful
retailer demands more goods and services of wholesalers and
distributors. Successful wholesalers and distributors demand more
goods and services from manufacturers. Successful manufacturers
demand more goods and services of processors (or fabricators or
manufacturers of components). Successful processors demand
more goods and services from raw material suppliers.
Traditionally, when a retailer needed more supplies to fill up
shelves, they would place an order on their wholesaler or
distributor. They in turn would place an order on their
manufacturer when their warehouse levels reached a reorder point.
When the stock on hand of raw materials and components at the
manufacturer reached a level that necessitated additional supplies,
they would contact the raw material supplier and place an order.
This all takes time and is subject to quantity consolidation which
tends to amplify the true demand. This leads to a phenomenon
known as the bullwhip effect or demand amplification.

Bullwhip effect — demand amplification

The bullwhip effect, described by Lee, Padmanabhan and Whang
(1997) creates large oscillations of inventory in the supply chain
network. Small changes in downstream demand create large
changes in the supply position upstream. This effect can be
eliminated by synchronising the supply chain.
When each link in the supply does not fully understand the
dynamics of the consumer sales pattern, the pattern gets distorted
and amplified as demand is transmitted up the supply chain.
The effect can occur with any range of products and at any level in
the supply chain but is most noticeable with consumer commodity
products. If demand for an item is relatively constant at the
consumer level, then the available inventory in the retail store

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Unit 10

gradually diminishes until it is time for the retailer to place a

replenishment order with the wholesaler.
The wholesaler is expected to hold relatively large quantities of
products so they can meet supply demands from multiple retailers.
The wholesaler wants favourable pricing arrangements and this
encourages the wholesaler to order large quantities from the
manufacturer. The wholesaler may even hold off ordering from the
manufacturer until the order is large enough to secure even better
payment and delivery terms.
Thus, the manufacturer is removed from the actual demand at the
consumer level and confronted with a large order from the
wholesaler. This may indicate the demanded product is
experiencing an increase in popularity and, to compensate for that
popularity, the manufacturer schedules larger production runs.
However, to be able to make the larger production run the
manufacturer must secure raw material from its supplier. Original
suppliers supply in bulk and often have large minimum and large
multiple orders. Therefore, the manufacturer orders an even larger
quantity of raw material.
The bullwhip effect is a direct result of individuals making rational
decisions within the supply chain infrastructure. If firms want to
mitigate the effects, they first have to examine the infrastructure of
the supply chain rather than attempt to change the rational
behaviour patterns.

(Gardiner, 2010, p. 320)

The above diagram illustrates the bullwhip effect. It shows a
relatively stable environment at retail but a very dynamic
environment at supplier level.
Lee et al (1997) identified four major causes of the bullwhip effect:
1. Demand forecast updating.
2. Order batching.
3. Price fluctuation.
4. Rationing and shortage gaming.

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 C4: Operations Management

Demand forecast updating

Every supply chain firm needs to replace the products it sells. They
study their demand patterns and somehow forecast demand. The
quantity they order from their supplier will need to consider the
supplier lead time and anticipated demand during that lead time.
The firm will usually carry safety stocks in case demand exceeds
expectation or delivery lead time extends beyond what is expected.
The supplier at the next echelon up the supply chain studies the
demand pattern presented and somehow forecasts demand. Again,
they will usually carry safety stocks in case demand exceeds
expectation or delivery lead time extends beyond what is expected.
Order batching
In a supply chain most firms calculate order sizes based on price
breaks for higher volumes, minimum order sizes introduced by the
suppliers, or lot sizes such as full container loads. Often the cost of
placing orders and receiving orders forces firms to change
behaviour and place larger orders less frequently. This is the
opposite effect to that encouraged by lean thinking.
This encourages a highly erratic stream of orders with spikes often
appearing at the beginning of the month. This method of periodic
ordering and batching of orders amplifies variability and
contributes to the bullwhip effect.
Price fluctuation
Suppliers may introduce inducements to encourage buying more
than is required in the short term and buying sooner than actually
required. The supplier will offer incentives such as quantity
discounts, end-of-year specials, clearance sales, stock-take specials,
rebates and — although they may not admit it — will sometimes
offer personal kickbacks to the purchaser. Thus, the customer buys
in quantities greater than needed and before they are needed.
This is the opposite effect to that encouraged by lean thinking and
encourages the bullwhip effect.
Rationing and shortage gaming
During times of supply shortage, the supplier may choose to ration
supply. They may, for example, limit supply to 50 per cent of each
order. As soon as the customer realises this behaviour is present
they will order twice as much as they need and be presented with
50 per cent of that quantity, which is what they wanted anyway.

How to counteract the bullwhip effect

Demand forecast updating can be minimised when every firm in
the supply chain understands the system dynamics. Rather than

33
Unit 10

have every firm base their demand forecast on just those parts of
the supply chain that they can see, it would benefit all participants
if the demand data occurring downstream is made available
upstream. In this way both firms use the same demand data.
Order batching can be minimised by encouraging firms to order
regular smaller batches. In a traditional supplier–customer
relationship, pricing may depend upon purchase order volumes. If
the quantity discount was available over an extended period, the
size of each order would not matter.
Forward buying and diversions can be avoided with stable prices.
Two terms now being used are everyday low prices (EDLP) and
everyday low costs (EDLC).
Eliminate the gaming activities that exist at times of shortage.
Firms should allocate orders on the basis of past orders. Regular
customers can continue to receive regular deliveries.

Collaborative supply chains

The supply chain is a partnership between organisations involved
in delivering a product or service to the customer. This usually
involves organisations at many levels within the supply chain. The
raw materials provider, manufacturer and retailer are but a few of
the many entities involved in processing a product before it gets to
the end customer.
A collaborative supply chain indicates that members of the supply
chain have co-ordinated their effort in some manner to achieve
their ultimate goal, which is the satisfactory supply to the end user.
This is the very essence of a collaborative supply chain.

Characteristics of a collaborative supply chain

Cox (1999) described eight defining characteristics of a
collaborative supply chain. These are:
1. Based on collaborative relationships and a win-win
situation rather than the arm’s-length scenario of the past
where it was always a win-lose situation.
2. Recognise the stakeholder status of those involved and
therefore the need for each stakeholder to create value in the
chain.
3. Operate a pull strategy (rather than a push) since the focus
is on the end customer and everything must be based on the
end customer and true demand.
4. Strive to deliver value to the end customer and, as with any
strategy, the aim is to create as much value as possible, in
this case for the benefit of the end customer.

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 C4: Operations Management

5. Eliminate waste which can be achieved by mitigating the

bullwhip effect.
6. Create lean logistics processes to ensure maximum
efficiencies in delivery and output.
7. Segment suppliers and customers since each subset of
suppliers and customers may have differing requirements
and need to be treated separately.
8. Develop a supplier network to share experiences and
learning.

Strategic view of supply chains

Supply chains work well when the rewards are fairly distributed
throughout the chain. Firms should encourage other participants in
the supply chain to improve everyone’s performance and benefits.
They should not attempt to optimise their own position. Each firm
should strive to do what is best for the supply chain rather than
what they believe is best for themselves.
Narayanan and Raman (2004) identified the need for alignment in
the supply chain by observing that when incentives were aligned it
was possible to obtain a bigger share of the profits since the costs
of the entire supply chain were reduced. This creates a win-win
situation for all participants.
Alignment is difficult when one firm has access to information
such as cost data, profit margins, capacity cushions or potential
disruptions that the other firm does not. Small and medium
enterprises are reluctant to disclose their cost structures for fear that
they will have their profit margins squeezed by larger firms.
Therefore they hold back on releasing that data and protect their
rights to it.
Incentive schemes are often poorly designed and result in the
opposite effect to what was intended. Assume that a steelmaker
offers production managers a bonus based on tonnes of output. Any
self-respecting manager would then arrange for the production
schedule to include extra tonnes of the fastest and heaviest product
to make. In reinforcing steel rods this is a 50 mm round. This
product is one of the easiest to make in a steel rolling mill and
generates more tonnes of output a day than any other. The
managers receive an excellent bonus for lifting production volumes
but what happens to the extra tonnes of output? These are
discounted to the market so the company receives fewer dollars for
their efforts. The result is that the company may lose because of
poorly designed incentives.

35
Unit 10

Triple-A supply chain approach

The whole approach to collaboration is based on speed and cost
reduction. Unfortunately, the real benefits are not realised by all
participants. Lee (2004) proposed that supply chains needed the
Triple-A approach which is based on agility, adaptability and
alignment.
Agility
The objective of agility is to respond to short-term changes in
demand or supply quickly and handle external disruptions
smoothly. Both demand and supply patterns change rapidly and
firms struggle to get a balance between demand and supply. For
commodity products with established demand patterns it should be
relatively easy to maintain supply. For new product introductions it
is virtually impossible to establish in advance the true level of
demand and thus the required level of supply.
Firms typically focus on costs, or speed of delivery and lose track
of the need to be agile. Demand shocks seem to happen more often
and with greater effect. Who would have anticipated the effects on
demand as a result of the terrorist attacks in New York in 2001? Or
the demand patterns following a natural disaster such as the
tsunami in South East Asia at the end of 2004. Demand patterns are
further disrupted when fear infiltrates our news systems and
changes consumer behaviour. Examples include the SARS (severe
acute respiratory syndrome) epidemic of 2002/3 and the threat of a
bird flu pandemic.
The reality is that demand patterns change and firms have to be
agile to respond to those changes.
Adaptability
The objective of adaptability is to adjust the design of the supply
chain to meet structural shifts in markets and modify the supply
network to changing strategies, products and technologies. Markets
do not stand still and the needs of customers are not static.
Therefore, it makes sense to have a supply chain that can adapt to
changes in market structure, the economy, demand patterns,
political and social environments, and advances in technology.
Once a firm has identified the competitive priorities that it will
emphasise, it translates these priorities into patterns of decisions.
These strategic decisions are of two types, structural and
infrastructural. The categories of structural decisions include
capacity, facilities, process technology, and vertical integration and
supplier relationships. Categories of infrastructural decisions
include human resources, quality, production planning/inventory
control, new product and service development, performance
measurement and reward, and organisation/systems.

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 C4: Operations Management

Adaptability may require changes in structural decisions as well as

infrastructural decisions.
Alignment
The objective of alignment is to create incentives for better
performance. Alignment is helped by exchanging information and
knowledge freely with suppliers and customers, discussing and
documenting roles, tasks, and responsibilities clearly for suppliers
and customers and sharing the risks, the costs and the improvement
gains equitably.

Supplier selection
In a collaborative supply chain the choice of supplier assumes an
extremely important position. It is unfortunate that the majority of
small and medium firms still pick suppliers based on price. One of
the first questions asked in negotiation is “What is your price?”
With the modern approach to collaboration each supplier should be
evaluated on the following criteria:
 Potential to develop a close long-term relationship.
 Financial strength and capability.
 Quality performance, including process capability and ability to
conform to agreed specification.
 Research, technical ability and new product development
strategy.
 Ability to deliver frequently, quickly and reliably.
 Management structures and attitudes to collaboration.
 Pricing structures and dependencies.
 Trustworthiness and ability to have timely communications on
any problems.

37
Unit summary

Activity 4.4
Work through the following questions. You may need to go back
and reread the unit to help you.
1. Explain the bullwhip effect. In particular, explain how it
Activity happens and what can be done to minimise adverse effects.
2. Describe the Triple-A supply chain approach.
3. Explain vertical integration as a means to secure more linkages
in the supply chain.
4. Evaluate the criteria for selecting a supplier.

Unit summary
This unit started by defining supply chain management from a
strategic view. This led directly to the bullwhip effect or demand
amplification. The concept of collaborative supply chains was
Summary introduced and one method for approaching collaboration, the
Triple-A approach, was introduced. The unit concluded by
discussing the strategic role of inventory in supply chains and the
criteria for supplier selection.

38
 C4: Operations Management

References
Cox, A. (1999). Power, value and supply chain management.
Supply Chain Management: An International Journal, 4 (4)
(pp. 167-175).
Gardiner, D. (2010). Operations Management for Business
Excellence (2nd ed.). North Shore, New Zealand: Pearson
Education.
Lee H. L. (2004, October). The Triple-A supply chain. Harvard
Business Review, 82 (10), October 2004 (pp 102–112).
Lee, H. L., Padmanabhan, V. & Whang, S. (1997, Spring). The
bullwhip effect in supply chains. Sloan Management
Review, 38 (3) (pp. 93-102).
Narayanan, V. G. &. Raman, A. (2004, November). Aligning
incentives in supply chains. Harvard Business Review, 82
(11) (pp. 94-102).

Readings for further study

Gardiner, D. (2010), Operations Management for Business
Excellence (2nd ed.). (pp 299-336). North Shore New
Zealand: Pearson Education.
Reading Heizer, J. & Render, B. (2010). Operations Management (10th ed.).
Upper Saddle River, New Jersey: Prentice Hall.
Lee H. L. (2004, October). The Triple-A supply chain. Harvard
Business Review, 82 (10) October 2004 (pp. 102–112).
Lee, H. L., Padmanabhan, V. & Whang, S., (1997, Spring). The
bullwhip effect in supply chains. Sloan Management
Review, 38 (3)
(pp. 93-102).
Narayanan, V. G. &. Raman, A. (2004, November). Aligning
incentives in supply chains. Harvard Business Review, 82
(11) (pp. 94-102)

39
Unit 11

Unit 11

Project management
Introduction
This unit will consider the challenges facing operations managers
in order to help them understand the difficulties and complexities
of managing projects.
This unit will treat projects as a derivative of a fixed-position
process structure and provide an operations manager with some
fundamental tools for communicating with project management.
Many process improvement tools discussed in this course will
require a project management approach for implementation. Thus
the operations manager needs an appreciation and understanding of
the requirements and issues faced by a project manager.
This unit begins by investigating the strategic nature of projects,
the project life cycle and project organisation structures. This is
followed by a description of the project manager. Project
management structures are developed. Then the concepts of the
critical chain, as proposed by Goldratt, are presented. Finally, we
examine why projects fail and what makes projects successful.

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 C4: Operations Management

Upon completion of this unit you will be able to:

 Define a project.
 Describe the nature of project management.
 Discuss the strategic nature of projects.
 Describe project organisation structures.
Outcomes  Discuss the role of the project manager.
 Discuss project management processes.
 Define a critical path.
 Discuss project risk and uncertainty.
 Discuss the critical chain method.
 Outline what makes a project successful.

Critical chain The longest route through a project network

considering both technical precedence and
resource contention constraints in completing
Terminology
the project.

Critical path Critical path is the longest path through the

project network. Activities on the critical path
determine the duration of the project.

Functional Functional organisation is a structure where a

organisation group of people perform the duties required by
their function and they report to only one
person, the functional manager.

Matrix Matrix organisation is a structure in which

organisation individuals report to a project manager as well
as their functional manager. The responsibility
for assigning priorities and directing work
activities is shared by the functional manager
and the project manager.

Progressive Progressive elaboration is a project

elaboration management technique to continuously refine
and expand activities. A project may start with
a sketchy outline and this is expanded on an
iterative basis as more information becomes
available and as the project develops.

Project Project is a temporary endeavour undertaken

to create a unique product, service or result.

Project life cycle Project life cycle is the stages on the path from
start to completion of a project.

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Unit 11

Project Project management is the application of

management knowledge, skills, tools and techniques to
project activities to meet the project
requirements.

Project scope Project scope is the work that must be

performed to deliver a product, service or
result with the specified features and
functions.

Projectised A projectised organisation is a self-contained

organisation team working full time under the control of a
project manager who has full responsibility for
assigning priorities and directing work
activities.
Terminology sourced from Gardiner (2010)
and Project Management Institute (2008).

Managing projects
The Project Management Institute (2008) defines a project as a
temporary endeavour undertaken to create a unique product or
result. There are two key words in that definition: temporary and
unique. Temporary means the project has a definite beginning and
ending. Unique means the product or service is different in some
way from all other products and services.
Construction industries, consulting services, infrastructure
development and major events management are all examples of
projects.
New product and service development is usually undertaken by a
project team. The people involved with new product and service
development would more than likely be developing on a
continuous basis, but for the duration of one particular product, it is
deemed to be one project.
Finding, or building, a new facility and equipping it with process
technology would typically be managed as a project. Software
development and a major upgrade in computing and information
technology software and hardware would typically be managed as a
project.
A project is developed using progressive elaboration, or an iterative
approach. It needs a purpose, is temporary in nature, requires
resources, needs a primary sponsor and has uncertainty (which
implies risk).

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 C4: Operations Management

A successful project requires a balance between time, scope of the

project, cost of resources and quality of the result. The most
important factor to evaluate whether or not a project has been
successful is to determine whether the customer is satisfied. A
project could easily finish on time and within the cost allocation
but the customer may not be happy with the result.
Differences in scope often occur when the project “creeps” with
function being added without allocating more time and money.
Project management is the integration of resources, such as people,
equipment and material that are employed to carry out project
processes, such as initiating, planning, executing, monitoring and
controlling, and closing, to meet the quality, cost and time
constraints of the project. Projects can be large or small. Large-
scale projects are typically expensive, one-of-a-kind endeavours
that may require months or years to complete and involve major
portions of an organisation’s resources.
Effective project management requires clearly identified project
requirements, clearly stated objectives, a simple and timely
progress reporting system and good people management practices.
Insufficient planning, an unmanaged change in the scope, a lack of
direction and lack of talent can all lead to project failure.

Strategic nature of projects

The cost of most projects suggests an organisation would not want
to repeat them if the first attempt had to be scrapped. Internal and
external failure is not an option. By definition, each project must be
successful the first time. This also means sufficient finance is
allocated and the project delivers within the scope of allocated
financial resources.
Major events such as an Olympic Games or the FIFA World Cup
have published dates for the events to start. Event management
projects must finish on time and any completion delays are
untenable.
The management skills required during project management are
essentially the same as required for general management. Financial,
purchasing, marketing, operational, supply chain, planning, health
and safety, and information and communications technology skills
are all required at some stage in most projects. All these skills may
not be found in one person, so the skill and ability of the project
manager uses available resources to provide these skills in a timely
and cost-effective manner.
Communicating, influencing, motivating, leading, resolving
conflict, negotiating and other interpersonal skills are of prime

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Unit 11

importance to a project and should be considered when selecting

project personnel.

Project life cycle

A project is made up of several phases and there is no general
agreement on how these are put together. The decision rests with
the project manager and the project team. The phases are usually
put together in some logical sequence based on the actual project.
A construction project may, for example, have a resource consent
phase, a foundations phase, a structural phase, an essential services
phase, a fitting-out phase, a commissioning phase and a closeout
phase. These overlap and intertwine in some areas.
In each phase, the cost elements start at a low level and increase at
the peak of the phase and taper off towards the end. Uncertainty is
at its highest at the start of each phase and diminishes as each phase
approaches completion. When all phases are superimposed onto the
whole project this pattern of cost and uncertainty is repeated.
One thing that separates project phases from structured new
product and service development is that project phases deliver
phase-dependent outcomes and the next phase is not dependent on
the previous, or any other phase. With structured new product and
service development, the completion of one step authorises the start
of the next.
Project phases pass through the various steps and deliver the
product at the end of the project. At that stage, the project life cycle
ceases but the product life cycle keeps going. The product life cycle
includes the development, production, operation and ongoing use
of the product until it is disposed of or destroyed. It is likely that
product management may ask for a modification to the product
and, in that case, it would start as an additional project and quite
separate from the original.
Project stakeholders include:
 the sponsor who finances the project
 the project manager who manages the project
 the customer who uses the product outcome of the project
 the project management team who perform management
activities of the project
 the project team who perform the work
 anyone affected by or able to be affected by the project.

Project organisation structures

Projects can be organised as functional organisations, matrix
organisations or projectised organisations.

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 C4: Operations Management

Functional organisation
A functional organisation uses people on a part-time basis from
within the same organisation to manage the project, which is
clearly the responsibility of one department. An existing manager
from within the department acts as the project manager and project
team members are usually not dedicated to the project. The
functional manager controls the budget and allocation of resources.
The project manager is assigned part time and has little or no
authority.
The advantages of using a functional organisation structure are:
 Team members are familiar with each other and individual
skill levels are known.
 Each team member can work on more than one project.
 Staff members can be assigned as needed and then returned
to their normal roles within the organisation.
 The lines of authority and communication are clearly
understood and conflicts are minimised.
The disadvantages of using a functional organisational structure
are:
 The project often lacks focus.
 Motivation is often weak.
 Bureaucratic procedures may slow process and decision-
making as there may be more levels of approval than
needed.
 The needs and priorities of the department are often placed
before the needs of the customer.
Matrix organisation
A matrix organisation attempts to blend the properties of functional
and projectised project structures. The project manager decides
what tasks take place and when, but functional managers control
how the tasks take place and who performs each task.
The matrix organisation can be weak, balanced or strong, with the
main differences being the role the project manager assumes. With
the weak matrix structure, the project manager is assigned part time
and has little or no authority while the functional manager controls
the budget and allocates resources. With the strong matrix, the
project manager is assigned full time, has a moderate to high level
of authority and manages the budget. The balanced matrix
organisation structure is somewhere in between.
The advantages of using a matrix organisational structure are:
 Communication is enhanced.
 It provides an efficient use of resources.

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Unit 11

 Team members are more secure in their functional role and

their participation in the project.
 Policies are set and followed.
The disadvantages of using a matrix organisational structure are:
 It generates complex command and authority relationships
when staff report to more than one manager.
 It is prone to failure with weak project management skills
and poor negotiation skills.
Projectised organisation
A projectised organisation structure involves a team or a task force
being put together to accomplish the goals of the project. With this
type of structure all project team members report directly to the
project manager only for the duration of the project. When a team
member’s role has finished, the person is reassigned to another
project. Smaller projects may have a flat structure where the project
manager is directly responsible for all members of the project.
Larger projects may have a project management team and the
project manager manages the team.
In a projectised organisation structure, the project manager is full
time, has full budget control and can allocate and assign resources.
Project team members are also full time on the project.
The advantages of using a projectised organisation structure are:
 The project manager has clear authority over the entire
project.
 Project communication is simplified with everyone
reporting to one manager.
 Project activities are focused.
 Team pride, motivation and commitment are maintained at
a high level.
The disadvantages of the projectised organisation structure are:
 Equipment and people are not shared across projects and
this leads to some duplication.
 While strong loyalties are developed within the project, the
uncertainty about what will happen when the project
finishes may cause disharmony within members of the
project team.

The role of the project manager

The role played by the project manager is critical to the success of
every project and it is not easy to find really good project managers
for every project. It certainly helps when the project manager has
an understanding and an appreciation of the technical aspects
associated with the project, but the project manager does not have

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 C4: Operations Management

to be an expert in the field. A project manager for a project

assembled to implement new information and communications
technology, for example, should have an appreciation of the
strategic role computers play in a business environment, but the
manager does not have to be a computer technician. The technical
knowledge, though, must be sufficient to be able to ask the right
questions and make the right decisions.
The project manager should be able to ask penetrating questions,
have credibility, sensitivity and the ability to handle stress.
Leadership and expertise in strategy are essential attributes for the
project manager. Leadership is necessary to provide direction,
motivation and facilitation to all project team members and the
strategy expertise is required to gain the overall perspective of the
business need for the project.
A defining characteristic of the project manager is communication
and people skills displayed at all times. The project manager may
have to deal with a personal issue with one individual at one time
and at another time communicate project progress to the media and
stakeholders. The project manager must be able to resolve
interpersonal conflicts. This range of skills makes this role
challenging and rewarding to the point that a good project manager
should never complain about having a boring job.
The project basics of planning, executing and controlling resources
such as people, equipment and material need to be managed to
meet the quality, cost and time constraints of the project.
Monitoring and control activities include measuring the volume of
work being completed, the quality of work being performed, the
costs compared to budget, the attitudes of those involved, including
team members and customers, the co-operation of the team and the
status of the work being performed compared to plan.
Management resource is often applied to the cost and time
constraints and trying to keep the project within budget. The reality
is that unless the project is quite similar to other projects, or
contains quantifiable work packages, the original time and cost
budget is a guess and wishful thinking. Instead of concentrating
solely on cost and time elements, a good project manager manages
change and risk.
A change of scope is allowed, but it has to be approved by the
customer and the project plan has to be updated to reflect the
change. Project danger arises from scope creep that allows changes
to creep into the project without customer approval, without an
allocation for additional resources and without adjusting the project
duration. Most projects have creep of some form or other and a
good project manager does not allow it to happen.

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Unit 11

The best way to prevent project creep is to establish a clear project

charter and an agreed scope statement before detailed execution
commences.
As for risk, the project manager should plan all risk elements,
identifying risk, performing a qualitative risk analysis, performing
a quantitative risk analysis and developing a risk response plan.
The project manager should be able to spot unstated assumptions.
These risk elements are strategic in nature. They may be boring,
but when identified risk occurs as an event the project is able to
handle it within the scope of the project. It does not arrive out of
the blue.

Project management processes

The processes required to manage projects are: initiating, planning,
executing, monitoring and control, and closing.
Initiating process
The first step in any project is to obtain a project charter. It is a
clear statement from the sponsor that the project exists and that it is
part of the strategic plan for the organisation. In other words, the
organisation needs the project to be completed and will be better
off when it has been completed. There should be a definite business
need for every project to proceed.
The scope of the project defines the limits of what should be
included within the project activities. It is a clear statement of the
eventual outcome expected from the project and specifies the
features and functions of the product or service that forms the end
result.
The project scope statement describes the major deliverables,
objectives, assumptions, constraints, and is a statement of work that
provides a documented basis for making future project decisions. It
forms the basis of common understanding. The scope statement
describes the purpose, history, deliverables and measurable success
indicators of a project and quantifies the support required from the
customer. Contingency plans for events that could throw the project
off course are identified. The scope statement can be a persuasive
document.
To prevent scope creep, the scope document has to be carefully
prepared and agreed among all parties. It should not be seen as a
binding limitation on the project outcome because, if a change in
scope is envisaged, then a scope change can be authorised by the
customer.
The project scope statement describes what will be delivered to the
customer, the assumptions made in terms of outcomes and resource
availability, the constraints identified, as well as the overall

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 C4: Operations Management

objective of the project. This statement is crucial in terms of project

success.
Planning process
The planning process involves planning and defining the scope,
developing the work breakdown structure, defining activities to be
performed, sequencing those activities, estimating the resources
required to complete each activity, estimating the duration of each
activity, developing the schedule, estimating the cost of each
activity, estimating the budget to create a cost baseline, planning
the quality, planning human resource requirements, developing the
communications plan, planning all risk elements, identifying risk,
performing a qualitative risk analysis, performing a quantitative
risk analysis, developing a risk response plan, planning purchases
and acquisitions and planning contractor requirements.
Executing process
The executing process includes directing and managing the actual
project execution, performing quality assurance, acquiring project
team members, developing the project team and distributing project
information.
Monitoring and controlling process
The monitoring and controlling processes include controlling any
changes to the scope of the project, verifying the scope, controlling
the schedule, controlling cost elements, controlling quality,
managing the project team, performing project reporting, managing
the stakeholders, managing risk and performing administration.
Closing process
The closing process closes the project and closes contracts.

Critical chain
The concept of the critical chain was introduced by Eliyahu
Goldratt (1997) in his book, Critical Chain, because of inherent
problems with project management. He identified typical problems
and behaviours, such as:
 Activity durations are inflated to make sure they can be
completed on schedule.
 Project team members procrastinate because they know
activity durations have built-in slack time.
 Safety time is wasted at the beginning of each activity
instead of completing the activity and preparing for the next
one.

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Unit 11

 Project team members multitask because they know

activities have built-in slack and they want to demonstrate
that they are busy.
 Activity schedules are based on start dates and end dates so
if an activity finishes early it is unlikely that the next
activity can start early.
 An early finish cannot compensate for lateness in another
activity.
 A late finish is passed on to subsequent activities and may
have cost implications as the project attempts to catch up.
 Resources allocated to catch-up activities cannot be used on
other scheduled activities so this problem of lateness is
compounded.
Critical chain is the longest route through a project network
considering both technical precedence and resource contention
constraints in completing the project.
The following techniques are used in critical chain scheduling:
 Resources are levelled so that contentious resources are
available for just one activity at a time. This minimises the
muddling of priorities caused by multi-tasking.
 Activity duration estimates are set at the average level to
minimise procrastination.
 The time initially cut from each activity is accumulated and
used as a project buffer placed strategically at the end of the
project. This prevents activity safety time from actually
existing and then subsequently being lost. The project
buffer is a safety time added to the end of the critical chain
to protect the project completion date.
 Resource buffers are used to ensure the availability of
resources on the critical chain. They ensure that resources
(such as rental equipment) are available to perform critical
chain activities when scheduled.
 Feeding buffers are placed on all activities leading to the
critical chain to ensure activities feeding into the critical
chain are completed on time and do not hold up critical
activities. Feeding buffers protect the critical chain from
delays.
 Project progress is measured as a percentage of critical
chain completion.

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 C4: Operations Management

Why projects fail

Projects fail when:
 The customer is not happy with the resulting product.
 The project charter is not drawn up.
 The project scope statement is not discussed and agreed
upon.
 The project creeps by adding function and features that
have not been agreed to by the customer.
 Not enough resources are available to complete the project.
 Not enough time is allowed to complete the project in a
quality fashion.
 Expectations are not clear.
 Stakeholders disagree about the expectations of the project.

Why projects are successful

The following are some good basic rules for a successful project:
 Gain consensus on project deliverables.
 State project objectives clearly.
 Build the best possible project team.
 Outline activities and sequence them correctly.
 Develop accurate time and cost estimates.
 Identify and eliminate duplicate activities.
 Develop a comprehensive schedule and keep it up to date.
 Determine the level of activities to get things done.
 Have a realistic and achievable activity schedule.
 Remember that people can and do make a difference.
 Assign system-oriented personnel for major decisions.
 Gain the full support of management and stakeholders.
 Be willing to accept change, but make it formal by
including scope changes in the scope statement and
rescheduling activities accordingly.
 Maintain excellent communications and keep people
informed of changes and progress.
 Use project management tools to monitor progress.
 Take risks and try new methods and new technologies.
 Demonstrate real leadership.
 Enjoy life and have fun!
Project management success means the project has been completed
on time and on budget (as in the scope statement). However,
project success is ultimately measured by the customer. The project
is successful when the project team delivers to the customer exactly
what the customer wants, when they want it, and how they want it.
In other words, the customer is entirely happy with the result.

51
Unit summary

Activity 4.5
Work through the following questions. You may need to go back
and reread the unit to help you.
1. What is a project?
Activity 2. What makes a project different from other business activities?
3. What is project “creep” and what should be done to prevent it?
4. Explain the critical chain method.
5. What makes a project successful?
6. As a project manager, how would you ensure that your project
is successful?

Unit summary
This unit began by investigating the strategic nature of projects, the
project life cycle and organisation structures. This was followed by
a description of the project manager and the role expected of a
Summary project manager. Project management structures were developed.
Then the concept of the critical chain was presented. Finally, we
examined why projects fail and what makes projects successful.

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 C4: Operations Management

References
Gardiner, D. (2010). Operations management for business
excellence (2nd ed.). Auckland, New Zealand: Pearson
Education.
Goldratt, E. M. (1997). Critical chain. Great Barrington, MA:
North River Press.
Project Management Institute. (2008). A guide to the project
management body of knowledge (4th ed.). Newton Square,
PA: Project Management Institute.

Readings for further study

Gardiner, D. (2010). Operations management for business
excellence (2nd ed.) (pp 337–370). Auckalnd, New Zealand:
Pearson Education.
Reading Goldratt, E. M. (1997). Critical chain. Great Barrington, MA:
North River Press.
Heizer, J. & Render, B. (2010). Operations management (10th ed.).
Upper Saddle River, NJ: Prentice Hall.
Kersner, H. (2006). Project management: A systems approach to
planning scheduling and controlling (9th ed.). Hoboken, NJ:
John Wiley & Sons.
Project Management Institute (2008). A guide to the project
management body of knowledge (4th ed.). Newton Square,
PA: Project Management Institute.
Schwalbe, K. (2009). An introduction to project management (2nd
ed.). Boston, MA: Cengage Learning.
Tuckman, B. W. (1965). Developmental sequence in small groups.
Psychological Bulletin, 63(6), 384–399.
Tuckman, B. W. & Jensen, M. A. (1977). Stages of small group
development. Group and Organizational Studies, 2(4), 419–
427.

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Unit 12

Unit 12

Performance measurement
Introduction
In public sector service organisations, stakeholders and the press
demand information to enable them to construct rankings.
Hospitals, schools, local councils and charities are among the
organisations now scrutinised on an annual basis against a set of
performance measures. With this comes the problem of
misunderstanding or misinterpretation.
With traditional accounting measures, profit, or return on
investment, is relatively easily understood. It represents one
approach to performance measurement that is based on a few
quantifiable financial measurements. The approach today requires a
proliferation of measurements and these measurements include
dimensions that are quantitative as well as qualitative.
This unit begins by investigating the need to have a balanced view
on performance measurement. The Hoshin process is described for
setting the goals and using measurement systems. The balanced
scorecard approach to performance measurement is presented. The
closed-loop management system involving developing the strategy,
translating the strategy, planning the operations, monitoring and
learning, and testing and adapting the strategy is presented.
The driving forces of performance and benchmarking are
discussed.

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Upon completion of this unit you will be able to:

 Describe measurements for business excellence.
 Describe the Hoshin process for setting goals and using
measurement systems.
 Describe the balanced scorecard approach to performance
Outcomes measurement.
 Describe how the closed-loop management system links strategy
and operations.
 Describe benchmarking.

Balanced Balanced scorecard is a set of performance

scorecard measures designed to reflect strategy and
uniquely communicate a vision to the
Terminology
organisation. Usually includes a customer
perspective, financial perspective, internal
business processes and innovation and
learning.

Benchmarking Benchmarking is the process of measuring a

company’s products, services, costs and
practices and comparing that measurement
with the best in the industry, the best-of-class
or world-class. The aim is to use that
measurement as a means to improve
performance.

Best practice Best practice is the measurement or

performance standard by which similar items
are evaluated. Approaches that produce
exceptional results are usually innovative in
terms of the use of technology or human
resources, and are recognised by customers or
industry experts.

Hoshin planning Hoshin planning is a systematic process that

looks at the organisation and defines long-
range business objectives. The methodology
provides for breakthrough objective focus to
determine the most effective actions and the
development of plans to support those actions.
Formal review processes are implemented to
measure performance and provide a
framework for learning.

Performance Performance measure, in a performance

measure measurement system, is the actual value

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measured for the criterion. The performance

criterion is the characteristic to be measured.

Developing balanced results

To enable business leaders to make effective and timely decisions,
a firm needs to develop the key set of results required to monitor
progress against the vision, mission and strategy of the
organisation.
Operations management plays a strategic role in every organisation
and the ultimate performance test is survival. If the organisation
intends to remain a viable entity and survive, then by definition, it
is successful. Executives are often worried by the survival target
saying that to just survive is an underachievement and most
organisations should be able to do better. Look at it the other way.
If the organisation does not survive, that is untenable. At the very
worst, to survive is the minimum positive achievement.
The operations function has an excellent opportunity for changing
overall performance of the organisation. In fact, the foundation
theme of operations is process improvement and product
improvement in an environment of increasing customer
expectations and requirements. Therefore, to have any chance of
success, an organisation needs to raise performance level at least as
fast as customer requirements rise.
Performance measurement provides some advice on progress and
may highlight areas of particular concern that require more
attention or more resources. Potential areas and topics are discussed
in this section.
Strategy
Strategy sets a vision of where the organisation is headed and the
philosophy underlying the vision statement. It uses broad
statements that set the direction for the organisation to take. It
specifies how to satisfy customers, how to grow the business, how
to compete in its environment, how to manage the organisation,
how to develop capabilities within the business and how to achieve
financial objectives. A high-performance organisation achieves
these objectives.
Demand management
The performance of a forecasting system is measured by most firms
using some form of accuracy measure. They typically use measures
such as mean absolute percentage error (MAPE), mean absolute
deviation (MAD) and bias. These measures do not tell what the
forecast should have been. They report past performance but do not
attempt to assist the forecasting process to perform a better job.

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Capacity management
Capacity management can be measured at the aggregate level to
improve performance.
Capacity performance measurement is usually linked with demand
performance measurement since both are calculated at the
aggregate level.
Process design
The real measures on process design relate to how well the process
can cope with the variability of customer demand. This translates
into shorter lead times and increased flexibility.
Process improvement
Process thinking is not about overhead allocation and cost
accounting, not about confusion and delay; it is a discipline that
designs outstanding performance rather than relying on luck.
Traditional company measurement systems look at history and tell
(approximately) what has happened. The missing link is telling you
what to do to make things better. That is where process thinking
develops a structure to improve performance across the whole
organisation.
Lean thinking
Often the metrics for lean thinking are aimed at technical issues or
process issues that are of little or no value to the customer. The real
metric for lean thinking should be a measure of the value being
added and that value is determined by the customer. Is the customer
willing to pay? Is the customer willing to pay a premium?
The next metric should be related to the waste inherent in the
process. Few customers are happy paying for waste and lean
thinking is all about eliminating waste.
Product design
The performance wants and excitement characteristics of new
products and services provide an excellent opportunity for an
organisation to gain competitive advantage. Knowledge about each
market segment and the changing customer requirements helps to
hit customer targets. Quality function deployment is epistemic and
allows invisible customer requirements to be visible.
Quality
Excellence is creating sustainable customer value and achieving
results that delight all the organisation's stakeholders. It requires
visionary and inspirational leadership, coupled with constancy of
purpose. The organisation is managed by processes and facts and

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by allowing employees to maximise their contribution through their

development and involvement.
Inventory and resources
Inventory measurements are based on increasing customer
satisfaction, stock availability, service levels, forecast accuracy,
supply chain confidence, honest and true communication;
increasing flexibility and throughput as products that are demanded
are stocked and supplied, and products are not sitting for extended
periods waiting for a customer.
Inventory measurements are also based on decreasing demand
uncertainty, and the number of customer complaints because
customers have the required products in the required quantities and
the products meet the expected quality standards, decreasing
conflicts as organisations satisfy all demands and do not need to
trade off one customer demand against another, decreasing delivery
quantities, safety stock, lead time uncertainty, lead times and
obsolescence as inventory flows through the system and is
consumed.
Supply chain management
A supply chain works well when the rewards are fairly distributed
throughout the chain. Firms should not endeavour to optimise their
position; rather they should encourage other participants in the
supply chain to improve everyone’s performance and benefits.
Supply chain objectives should be aligned since any misalignment
might lead to non-optimal financial performance. A collaborative
supply chain must show a propensity towards elimination of waste.
This means a desire to deliver value to the customer and requires
continuous elimination of waste in all processes.
Project management
Project management success occurs when the project team delivers
exactly what the customer wants, when and how the customer
wants it. Moreover, the customer is entirely happy with the result.
Project management failure occurs when the customer is not happy
with the result.

Hoshin planning
Any organisation wanting to exceed their customers’ expectations
and to stay competitive needs a long-range strategic plan that is
forward-looking, visionary and achievable. The best way to obtain
the desired outcome is to ensure all employees fully understand the
long-range goals and follow a co-ordinated plan to make that vision
a reality.

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Additionally, there has to be a set of fundamental process measures

which have to be monitored to ensure the continuous improvement
of the organisation's key business processes. Essentially, everyone
is heading in the same direction with the same sense of control.
This is the basic premise behind Hoshin planning.
Hoshin planning is a systematic process that looks at the
organisation and defines long-range business objectives. The
methodology provides for a breakthrough objective focus to
determine the most effective actions and the development of plans
to support those actions. Formal review processes are implemented
to measure performance and provide a framework for learning.
Breakthrough activities are aimed at achieving significant
performance improvements or making significant changes in the
way the organisation operates. Usually, critical business issues the
organisation will face in the next two to five years are identified
and plans are implemented to address these. In its broadest sense,
these business issues may relate to profitability, growth, market
share, quality problems or maybe the need for a new product or
service. It is essential to identify critical business issues facing the
organisation and to select an objective and a goal to overcome each
issue.
Supporting strategies are developed and specific goals for each
strategy are established. These require a regular review and
monitoring of progress.
Formal review processes are implemented on a monthly and annual
basis. Organisations may use balanced scorecard reporting (as
discussed below) to develop the process performance measurement
and the balanced scorecard approach may identify initiatives
required. The planning system itself may need revision.
A Hoshin review table is used for each strategy using the plan-do-
check-act cycle to measure the progress against the target that was
set at the beginning of the year (plan). Actual results are written
alongside each strategy (do) and any difference between the target
and the actual are noted (check). The impact or effect of any
difference is documented (act). This analysis is conducted for the
objectives that were successful and also for those that were not
successful or not completed.
For each objective successfully completed, an analysis is
performed to determine what went right and to determine if the
supporting strategies and performance measures were appropriate.
Any exceptional results are noted with details on how they were
obtained. This is a learning step and is vital to knowing how to do
better and to transfer that knowledge to the organisation.

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As the planning table is completed, it is passed down the hierarchy

to the next level within the organisation so that the lower level can
add their inputs and interpret the planning document as it affects
them. This is the cascading attribute of the Hoshin planning process
and is a vital step in empowering the organisation. It is all part of
the buy-in at every level and a locking-in of the plan, resulting in
total ownership of the plan.
The Hoshin planning process encourages an organisation to learn
from the problems that are solved and the business successes. This
is fundamental to building a learning organisation.
Hoshin enables an organisation to accumulate performance
information about itself from the routine day-to-day activities and
from longer-term strategic initiatives. It helps the organisation
reflect on where it is headed, the best way to get there and to do
that while in full control.

Balanced scorecard
Balanced scorecard is a balanced set of performance measures
designed to reflect strategy and uniquely communicate a vision to
the organisation. Usually includes a customer perspective, financial
perspective, internal business processes, and innovation and
learning.
The balanced scorecard was developed by Kaplan and Norton in
1992. It was introduced when most business performance
measurements were finance-based and aimed only at controlling
the business from a financial perspective.
Traditional performance measurement was compared to a set of
predetermined actions that were expected to be followed. This may
be, for example, to achieve a given sales target or keep within a
given cost budget. It was assumed the organisation was successful
when these targets were achieved. By relying on traditional
financial measures, management does not receive the necessary
feedback to stimulate continuous improvement and innovation.
The balanced scorecard approach aims at cross-functional
integration, customer-supplier partnerships, global scale,
continuous achievement, and team rather than individual
accountability. This provides a balanced view of both financial and
operational performance measures.

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The diagram above, illustrating the balanced scorecard, was

developed by Kaplan and Norton (1992).
The balanced scorecard measures business performance from four
perspectives:
1. Customer perspective
2. Internal perspective
3. Innovation and learning perspective
4. Financial perspective.
Customer perspective
The customer perspective asks, “how do customers see us?”.
Organisations may have a strategic objective to add value to
customers, satisfy customer needs, listen to customer wants, allow
customers to participate in process and product design and to act
and think from a customer’s viewpoint. This needs measuring from
a customer perspective by asking customers for their views.
Competitive capability is based on cost, quality, delivery,
flexibility and service. Customers share these concerns.
A customer view of cost considers the total cost and not just the
price. An organisation establishes prices for their products and
services, and they receive these amounts for products produced and
services delivered. The missing part is the extra that the customer
has to add to the price to arrive at the total cost to the customer.
Additional cost could be taxes, freight, storage, inspection, quality
assurance, quarantine, pilferage, deterioration and obsolescence.
This needs measuring from a customer perspective.
Quality can be measured inside the organisation using quality
control, quality assurance and process capability. Customers only

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see external quality. They value the product on their own hands and
measure aspects such as delivery in full on time and in
specification (DIFOTIS).
Delivery measurements often measure the time and date products
leave the supplier’s premises and the actual delivery performance is
up to the customer to negotiate. Customers do not see it this way.
They want products delivered to their premises when and how they
want them.
Flexibility is often demonstrated by organisations after they have
stated the rules of engagement. Flexibility is often at the supplier’s
convenience, not when it suits the customer. Delivery is often made
at a supplier-determined schedule. Passenger and freight transport
is arranged at the transport operator’s advertised schedule.
Internal perspective
The customer perspective looks at the organisation from the outside
while the internal perspective looks at the organisation from the
inside and asks, “at what aspects of business should we excel?”.
Process design and process improvement all occur internally and
the results of these initiatives affect customers.
Processes measured as part of the balanced scorecard have the most
impact on customer satisfaction. Clearly these affect lead time,
throughput time, employee skills and attitudes, flexibility,
availability, responsiveness and information systems.
Organisations decide on competitive capability as a part of strategy
and develop core competence to deliver that capability. Processes
are designed and improved to enhance core competence from a
customer perspective. These are all internal processes and can be
measured from an internal perspective.
Information and communication technology play an important part
in the internal perspective. When problems are identified by the
balanced scorecard, analysis of the relevant data is often a
responsibility of information systems. As an example, if delivery
performance is highlighted as a customer issue, the delivery data
can be analysed to determine the delivery status and possibly
identify root cause.
Innovation and learning perspective
Innovation and learning perspective asks, “can we continue to
improve and create value?”. Competitive activities are constantly
challenging every organisation’s position. All other organisations
challenge the organisation at the top of the league. Even
organisations positioned somewhere in the middle have to face
constant challenges for their position. Customer expectations are
constantly changing and these force organisations to be totally
aware of the range and scope of those changes.

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Each business requires an ability to create new products and

services and to update how those products and services are
delivered to customers. This requires innovation and learning.
Innovation provides new ideas, concepts, processes, approaches
and technologies. Existing ideas, concepts, processes, approaches
and technologies have to be updated. This requires learning.
Businesses listen to their customers and learn from comments and
reactions received. This requires understanding and judgement.
Financial perspective
The financial perspective asks, “how do shareholders see us?”. In
the end it is the bottom line that counts. Firms can have any amount
of customer satisfaction, close to perfection with internal processes,
unlimited innovation and learning and still fail on financial
measures.
The trick is to capitalise on the other perspectives and translate
gains into financial achievements.
Financial measures are often short term. Quarterly and half-yearly
reporting does not provide much opportunity for process
improvement and capital spending to generate tangible figures. The
improvements may be present but the reality is determined by
financial outcomes.
Taking a quality view, organisations should concentrate on
operational excellence and allow financial results to flow naturally
from that. Traditional financial measures do not improve customer
satisfaction, quality, throughput time and employee motivation. In
fact, some financial measures, such as a price increase, alienate
customers and force them to go elsewhere.

Linking strategy with operations

Ever since Kaplan and Norton published their balanced scorecard
approach, various authors have attacked their premise by quoting
examples that suggest the balanced scorecard was difficult to
implement and often only partially implemented. It has been widely
acknowledged (even by its authors) that the original balanced
scorecard was not a perfect tool.
In their original concept of the strategy map and the balanced
scorecard, Kaplan and Norton encouraged companies to select
initiatives independently for each objective. They came to realise,
however, that by doing so, companies would fail to benefit from
the integrated and cumulative impact of multiple, related strategic
initiatives (Kaplan & Norton, 2008).
They continued experimenting and researching, and suggested that
if firms were having trouble using the balanced scorecard they

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should try using strategy maps. They maintained that the balanced
scorecard could be implemented better by using strategy maps
(Kaplan & Norton, 2000).
While the balanced scorecard is a tool for the implementation of
strategy, it does not, in itself, ensure best strategy is implemented.
Successfully implementing a money-losing or disastrous strategy
will result in successfully losing money or disaster. The tool is not
to blame.

Closed-loop management system

An organisation’s underperformance is caused largely by a
breakdown in the organisation’s management system which
includes the integrated set of processes and tools an organisation
uses to develop its strategy, translate it into operational actions, and
monitor and improve the effectiveness of both. This can be avoided
by using a closed-loop management system comprising the
following stages:
 Develop the strategy
 Translate the strategy
 Plan the operations
 Monitor and learn
 Test and adapt the strategy.
Develop the strategy
Developing the strategy starts with defining the mission, vision and
values of the organisation. Essentially this answers the question,
“what business we are in and why”. A strategic analysis follows to
answer the question, “what are the key issues we face as a
business?”. This should look at external as well as internal
situations and challenges, before stating clearly how the business is
going to achieve the vision.
Translate the strategy
Now that the strategy has been formulated, the organisation needs
to translate it into objectives and measurements that can be clearly
and succinctly communicated to all employees and in a language
they can understand. The strategy map provides a powerful tool for
visualising the strategy as a chain of cause-and-effect relationships
between strategic objectives. Start with the organisation’s long-
term financial objectives and link these to objectives for customer
loyalty and the value proposition. Continue to link to goals related
to critical processes and eventually to the people, technology and
organisational climate and culture required for successful strategy
execution.

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Plan the operations

The organisation next develops an operational plan that lays out the
actions that will accomplish the strategic objectives. This stage
starts with setting priorities for process improvement projects,
followed by preparing a detailed sales plan, a resource capacity
plan, and operating and capital budgets.
Monitor and learn
The execution of business processes takes place between the
previous step and this step. The performance of operating
departments and business functions should be reviewed to address
any problems that have arisen or remain. Strategy management
meetings that review balanced scorecard performance indicators
are convened to assess progress and identify barriers to strategy
execution.
Test and adapt the strategy
In this step, the performance of the strategy itself is assessed and
changed if necessary. From time to time managers may discover
some assumptions underlying their strategy are flawed, or are no
longer applicable, or relevant. When that happens, managers need
to rigorously re-examine their strategy and change it by deciding
whether incremental improvements will be sufficient or whether a
new, transformational, strategy is required. This step closes the
loop of the management system.

Benchmarking
Benchmarking is the process of measuring a company’s products,
services, costs and practices and comparing that measurement with
the best in the industry, the best-of-class or world-class. The aim is
to use that measurement as a means to improve performance.
Best practice is the measurement or performance standard by which
similar items are evaluated. Approaches that produce exceptional
results are usually innovative in terms of the use of technology or
human resources, and are recognised by customers or industry
experts.
A benchmark is a standard or point of reference by which
something can be measured or judged and competitive
benchmarking involves analysing the performance and practices of
best-of-class companies. The best practice is demonstrated by the
best-of-class and their performance becomes a benchmark to which
a firm can compare its own performance. Once a comparison has
been made, the firm can improve its processes.

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Unit summary

Activity 4.6
Work through the following questions. You may need to go back
and reread the unit to help you.
1. Describe the balanced scorecard approach.
Activity 2. Evaluate Hoshin planning as a strategic planning system.
3. Evaluate Hoshin planning as a performance measuring system.
4. What are some financial measurements for an organisation?
5. What are some operational measurements for an organisation?
6. How can innovation and learning be measured?
7. What is an appropriate measurement for internal processes?
8. What performance measurements are suitable for a call centre?
9. How does benchmarking benefit an organisation?

Unit summary
In this unit you learned descriptive measurements for business
excellence. You learned about the Hoshin process for setting the
goals and using measurement systems. The balanced scorecard
Summary approach to performance measurement was introduced and
discussed. The closed-loop management system linking strategy
and operations was described and finally, benchmarking was
discussed.

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References
Gardiner, D. (2010). Operations management for business
excellence (2nd ed.). Auckland, New Zealand: Pearson
Education.
Kaplan, R. S. & Norton, D. P. (1992, January–February). The
balanced scorecard: Measures that drive performance.
Harvard Business Review, 72.
Kaplan, R. S. & Norton, D. P. (2000, September–October). Having
trouble with your strategy? Then map it. Harvard Business
Review, 167–176.
Kaplan, R. S. & Norton, D. P. (2004). Strategy maps: Converting
intangible assets into tangible outcomes. Boston, MA:
Harvard Business School Press.
Kaplan, R. S. & Norton, D. P. (2008, January–February). Mastering
the management system. Harvard Business Review, 68.

Readings for further study

Angel, R. & Rampersad, H. (2005). Do scorecards add up? CA
Magazine.
Barad, M. & Dror, S. (2008). Strategy maps as improvement paths
Reading of enterprises. International Journal of Production
Research, 46(23).
Gardiner, D. (2010). Operations management for business
excellence (2nd ed.) (pp. 183–218). Auckland, New
Zealand: Pearson Education.
Hendricks, K. B., Menor, L., & Wiedman, C. (2004). The balanced
scorecard: To adopt or not to adopt? Ivey Business Journal.
Hopp, W. J. & Spearman, M. L. (2008). Factory physics 3e. New
York, NY: McGraw-Hill.
Hoque, Z. & James, W. (2000). Linking balanced scorecard
measures to size and market factors: Impact on
organizational performance. Journal of Management
Accounting Research, 12(1).
Kaplan, R. S. & Norton, D. P. (1996). The balanced scorecard.
Boston, MA: Harvard Business School Press.
Kaplan, R. S. & Norton, D. P. (1996, January–February). Using the

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Readings for further study

balanced scorecard as a strategic management system.

Harvard Business Review, 75–85.
Kaplan, R. S. & Norton, D. P. (2000, September–October). Having
trouble with your strategy? Then map it. Harvard Business
Review, 167–176.
Kaplan, R. S. & Norton, D. P. (2004). Strategy maps: Converting
intangible assets into tangible outcomes. Boston, MA:
Harvard Business School Press.
Kaplan, R. S. & Norton, D. P. (2008, January–February). Mastering
the management system. Harvard Business Review, 62–77.

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Activity feedback
Activity 4.1
Inventory costs money so when an organisation obtains more
inventory it costs it more money. If it obtains a lot more inventory
it costs it a lot more money. That money is now tied up with the
inventory investment and cannot be used for any other purpose.
While inventory is being held it may appreciate in value but, more
than likely, it will depreciate in value. Appreciation arises in times
of rising prices and currency fluctuations. Depreciation is more
common as customers are not prepared to pay full price for
something that is not brand new or fresh.
Inventory hides problems and compensates for poor delivery
performance, high levels of scrap and rework, poorly maintained
equipment, incorrect quantities used and supplied, and poor buying
decisions. Inventory, in this sense, encourages ineffective
behaviour and poor performance.
Inventory requires storage places. Warehouses, storage sheds, retail
shelves, containers and transport systems are built to hold and
manage inventory. This is a real concern when the items held are
large, bulky and carry little value. Foam used in packaging and
upholstery is an example of a product made almost entirely of air
that is relatively cheap to make but expensive to store.
Inventory slows the speed of production as batches of product
move through production systems. When more inventories are
used, transport systems are bigger, slower, clumsier and less able to
cope with changing customer demands.
Inventory encourages obsolescence or may even become obsolete.
The use-by date on supermarket items encourages households to
buy in smaller quantities and hold smaller quantities in their homes
to prevent the goods expiring.
Inventory requires special handling conditions and may be
hazardous to store. Dangerous chemicals and inflammable liquids
need specially constructed storage areas and staff need specialist
training when handling and using these items.
Inventory is counted, administered, managed and may also be
insured against loss. These actions take up time and money for the
people involved.

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Activity feedback

Activity 4.2
Material requirements planning (MRP) is a set of techniques that
uses the master production schedule, bills of material and inventory
data to calculate the requirements of component materials.
MRP uses the master production schedule which is the list of
products, quantities and dates for the next few months. It starts with
each specific item and quantity listed, and calculates the quantities
of all components and materials required to make those items and
the date those items must be available for use.
To calculate the quantities of all components and materials
required, it uses the bill of materials indicating the quantities of
components to be used to make each product. Bills of materials are
also called formulas, recipes, formulations or ingredient lists.
MRP explodes the bill of material, adjusts for inventory quantities
on hand or already on order, and calculates net requirements that
are offset by the lead time.
The inventory data needed for a basic MRP system includes lead
time required to obtain or manufacture all products and materials,
the quantity to order or the batch size and the quantity on-hand or
the current inventory balance.
The master production schedule entries are translated into gross
requirements for all materials by time period.
The gross requirement is the total requirement of an item generated
from the master production schedule and subsequent levels in the
bill of material. The gross requirement is balanced with inventory
on hand, scheduled receipts and safety stock to calculate net
requirements.
The net requirement is the result of applying a gross requirement
against inventory on hand, allocations, scheduled receipts and
safety stock. The net requirement is then lot-sized and offset for
lead time and becomes a planned order.
MRP calculates the net requirements by subtracting current stocks
and current on order quantities from the overall gross requirement.
The explosion process is controlled by the bills of material. If net
requirements are greater than zero, order receipts must be planned.
The order release is offset from the required order receipt date by
the lead time.
MRP outputs include planned orders, order release notices, changes
in open orders due to rescheduling, and inventory status data. The
resulting planned order releases which become the detailed
production schedules are examined for availability of resources for
each time period. If the capacity is inadequate to meet the schedule,
the MPS is modified and the MRP programme run again. The

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procedure is repeated until the MPS and available capacity have a

reasonable match.

Activities 4.3–4.6
All answers are in the learning material.

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