Powerpoint managing quality

1. How would you identify categories about which to collect information from your customers. For example, specify, categories that describe possible causes or types of defects?

2. How will you gather data and calculate the frequency of observations in each category for an appropriate time period?

3. How will you sort your categories in descending order based on your percentages?

4. Present your data graphically and identify the vital few categories that account for most of the variation.

5. 8 – 10 slides excluding cover and reference page

6. Two outside sources

7. MLA format – examples and sources to use. 

Attached: example pptx, sources(chapter 6-7). 

MANAGING QUALITY

Pareto Analysis

➢ Pareto Analysis is a decision-making tool to help compare and fix
problems strategically.

➢ It uses the Pareto Principle which is the 80/

2

0 rule.

➢ Named after Italian economist Vilfredo Pareto

Identify
List Of
Problems

Some ways I could collect information from my
customers would be:

-Anonymous Complaints

-Feedback Forms

-Customers Surveys

-Employee organizational recommendations

Why Did This
Problem Occur?

To understand why these problems in the
company occurred you would need to think
to the root of the problem.

Scoring

➢ You could assign a number to each problem based on its negative
impact, in a descending order. Defects should be organized from
highest to lowest priority. The defects with the highest priority are
resolved first.

Sorting

➢ You would sort all similar
problems together and
calculate a collective score.
Once you have gotten a total
the highest score will be
resolved first to provide a
higher return.

Restaurant Example:

Ex: Restaurant Customers reason to leave

Bad Service 40

Horrible Food 35

To Expensive 15

Long waits to be seated 57

Long waits for food 29

Total 176

Pareto Diagram Example

Results

➢ From the above graphs show what 80% of
the problem is bad service and long
seating waits, and the horrible food. So
those to problems should be the first to be
fixed.

Extra Information

The Pareto Analysis has multiple benefits depending on the kind of project.

It helps to identify problems to help complete a task.

Be careful not to look over small hurdles that could multiply over time.

This analysis also does not factor the seriousness of the problem only the
quantity

References

https://corporatefinanceinstitute.com/resources/knowledge/strate
gy/pareto-analysis/

1

https://www.geeksforgeeks.org/advantages-and-disadvantages-of-
pareto-chart/

2

https://corporatefinanceinstitute.com/resources/knowledge/strategy/pareto-analysis/

https://www.geeksforgeeks.org/advantages-and-disadvantages-of-pareto-chart/

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Chapter 6

Managing Quality

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Learning Objectives

6-1 Explain what the concepts of product quality
and quality management entail.

6-2 Explain the roles that operations and other
functional managers play in determining product
quality.

6-3 Apply the core values and typical practices
associated with quality management.

6-4 Perform a cost of quality analysis.

6-5 Apply the Six Sigma DMAIC approach to quality
improvement.

6-6 Compare and contrast various quality standards
and certification programs.

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Learning Objective 6-1

Brand Turnaround at Hyundai—What
Hyundai Did

1. Increased the number of workers on the quality control
team from 100 to more than 850.

2. Instituted mandatory seminars for all workers on the
importance of quality.

3. Invoked the direct involvement of its CEO in twice-
monthly meetings comparing Hyundai quality with that of
its rivals.

4. Made capital investments in problem areas, including $30
million invested in a computer center to test electronic
systems.

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Learning Objective 6-1

Brand Turnaround at Hyundai—Results of
Changes

1. Brand loyalty for Hyundai surpassed that of Honda
and Toyota to take the No. 1 spot.

2. Five Hyundai cars among Cars.com’s “Best Bets” for
safety, reliability, and fuel efficiency.

3. Sonata and Genesis models made Hyundai a strong
competitor in the luxury market, where excellent
quality is imperative.

4. In 2018 Hyundai and its sister company Kia averaged
122 and 124 problems per 100 vehicles, which
placed them in the top 10 for car quality.

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Learning Objective 6-1

Quality Definitions

• Product Quality: fitness for consumption in
meeting customers’ needs and desires

• Design Quality: match between designed
features and customer requirements

• Conformance Quality: meeting design
specifications

• Quality Management: organizationwide quality
focus

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Learning Objective 6-1

Dimensions of Quality for Goods and
Services

•

Quality

– Performance

– Features

– Reliability

– Durability

– Conformance

– Aesthetics

– Support/responsiveness

– Perceived quality

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Learning Objective 6-2

Functional Influences on Product Quality
(1 of 3)

Table 6-2 Functional Influences on Product Quality

Functional Personnel
Decisions and Activities with Potential Impact on Product

Quality

Marketing managers

Choices of market to pursue and product features to offer

Design of advertising and other programs that communicate
product attribute to customers

Development of new product testing programs

Sales managers

Setting of sales targets

Interactions with customers

Interpretations of customers’ needs and desires

Product engineers

Design of product specifications, service elements, dimensional
tolerances, etc.

Design of product prototyping procedures

Process engineers

Design of manufacturing and service processes

Choices of technology and associated capabilities and capacity
limits

Design of quality assurance tests and procedures

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Learning Objective 6-2

Functional Influences on Product Quality
(2 of 3)

Table 6-2 Functional Influences on Product Quality

Functional Personnel
Decisions and Activities with Potential Impact on Product

Quality

Finance and accounting
managers

Setting of restrictions for equipment purchases

Establishing goals for utilization of facilities and working capital

Design of measures used to assess efficiency and productivity

Human resources
managers

Design of hiring criteria and training and development programs

Setting of compensation schemes and incentives

Manufacturing and service
operations managers

Design and execution of processing procedures

Design of work policies

Interactions with customers

Management of facilities and equipment

Scheduling of work

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Learning Objective 6-2

Functional Influences on Product Quality
(3 of 3)

Table 6-2 Functional Influences on Product Quality

Functional Personnel
Decisions and Activities with Potential Impact on

Product Quality

Supply managers

Description of purchase requirements

Selection of suppliers

Establishment of contracts and associated incentives and
penalties

Management of and interactions with suppliers

Logistics managers

Selection of transportation providers

Development of tracking and other information systems

Design of packaging, storage, and material handling
processes

Management of and interaction with transportation providers

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Learning Objective 6-2

Student Activity (1 of 3)

Ask a marketing professor, a supply chain
operations professor, a finance professor, and
an engineering professor to give you their
definitions of product quality. Compare and
contrast the definitions you receive.

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Learning Objective 6-3

Quality Thought Leaders (1 of 2)

• Deming

– Holistic view of responsibility for quality

– Variability as source of most problems

– Importance of customer

• Juran

– Broadened definition of quality

– Focus on change management

– Cost of quality analysis

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Learning Objective 6-3

Quality Thought Leaders (2 of 2)

• Crosby

– Quality is free

– Zero defects

– Focus on incremental change

• Imai

– Kaizen system of continuous improvement

– Intense process-oriented view

– Heavy dependence on frontline worker insights

– Emphasis on worker training and development

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TQM: A “Total” View of Quality

Total Quality Management (TQM): an integrated
business management strategy aimed at embedding
awareness of quality. The word total has important
connotations:

1. A product’s quality is determined by customer’s
acceptance and use

2. Quality management is a total, organizationwide
activity, rather than a technical task

3. Quality improvement requires a total commitment
from all employees

Learning Objective 6-3

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Learning Objective 6-4

Cost of Quality (COQ)

• Prevention Costs

– Costs associated with preventing defects and limiting failure
and appraisal costs (e.g., training, improvement projects,
data gathering, analysis)

• Appraisal Costs

– Costs associated with inspection to assess quality levels (e.g.,
staff, tools, training, etc.)

• Internal Failure Costs

– Costs from defects found before delivery to the customer
(e.g., rework, scrap, etc.)

• External Failure Costs

– Costs associated with defects found after delivery to customer
(e.g., warranty, recall, etc.)

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Learning Objective 6-4

Inverted View of Management

Figure 6-1 Traditional versus Quality Management View of
Organizational Structure

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Learning Objective 6-4

TQM Values and Success Factors

Table 6-4 TQM Values and Success Factors

Values that Characterize TQM Factors Affecting the Success of TQM

Holistic view of product quality
and its impacts Strong, charismatic leadership

Emphasis on customer
requirements

Trust between labor and management

Extended process view of
operations

Crisis situation or compelling reason for change

Emphasis on prevention rather
than inspection

Adequate resourcing of training and improvement projects

Disdain for variability Clear, well communicated, uncomplicated change process

Data-based decision making (not
opinion-based)

Unquestionable success of early efforts

Employee empowerment

Top management support

Supplier involvement

Continuous improvement

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Quality Goes Digital

• Walmart is using the Internet of Things and
blockchain to provide visibility of food quality

• Digital developments are changing the cost of
quality by raising the cost of external failures

• Using social media, one can post experiences to
be read by many viewers

Learning Objective 6-4

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Student Activity (2 of 3)

Search various social media sites and see if
you can find posts that address the four
different costs included in the cost of quality
framework. What is interesting about these
postings? How would these postings affect
you as a potential customer?

Learning Objective 6-4

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Learning Objective 6-5

Guiding Methodologies: PDCA

Figure 6-2 PDCA in Action

Plan: identify problem and actions for improvement

Do: implement formulated plan

Check: monitor results

Act: take corrective action and institutionalize changes

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Learning Objective 6-5

Guiding Methodologies: Six Sigma (1 of 3)

• Six Sigma: quality improvement through
elimination of defects and variation

• Standard Deviation: statistical measure of
variation

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Learning Objective 6-5

Guiding Methodologies: Six Sigma (2 of 3)

Table 6-5 How Quality Relates to Sigma

Sigma Level
Defects per Million

Units

2σ 308,770

3σ 66,810

4σ 6,209

5σ 233

6σ 3.4

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Learning Objective 6-5

Guiding Methodologies: Six Sigma (3 of 3)

Figure 6-3 The DMAIC Process
Source: Copyright © 2009 Dynamic Diagrams.

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Student Activity (3 of 3)

For a candy such as M&Ms, identify the
important critical-to-quality characteristics.
How would you measure these
characteristics objectively? Which of these
measures pertain to the physical product
itself? Which of these measures relate to the
packaging or the services surrounding the
good?

Learning Objective 6-5

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Learning Objective 6-5

Guiding Methodologies: DMAIC

DMAIC example: See the cough drop production DMAIC
example in your text

• Define: determine critical-to-quality (CTQ) characteristics
from customer’s perspective

• Measure: gather data on CTQ processes

• Analyze: determine cause of defects

• Improve: modify processes

• Control: ensure improvements are maintained

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Learning Objective 6-6

Guiding Methodologies: ISO 9000

• ISO 9000: internationally accepted standards for
business quality management systems

• ISO 9000 requires:

– fulfilling the customer’s quality requirements, and

– meeting applicable regulatory requirements, while

– enhancing customer satisfaction, and

– achieving continuous improvement of its
performance in pursuit of these objectives

http://www.iso.org

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Learning Objective 6-6

The ISO 9001: 2015 Certification Structure (1 of 3)

Table 6-6 The ISO 9001: 2015 Certification Structure

Section Focus/Description

4 Context of the organization

4.1 Understanding the organization and its context.

4.2
Understanding the needs and expectations of interested
parties.

4.3 Determining the scope of the quality management system.

4.4 Quality management system and its processes.

5 Leadership

5.1 Leadership and commitment.

5.2 Policy.

5.3 Organizational roles, responsibilities, and opportunities.

6 Planning

6.1 Actions to address risks and opportunities.

6.2 Quality objectives and planning to achieve them.

6.3 Planning of changes.

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Learning Objective 6-6

The ISO 9001: 2015 Certification Structure (2 of 3)

Table 6-6 The ISO 9001: 2015 Certification Structure

Section Focus/Description

7 Support

7.1 Resources.

7.2 Competence.

7.3 Awareness.

7.4 Communication.

7.5 Documented information.

8 Operation

8.1 Operational planning and control.

8.2 Requirements for products and services.

8.3 Design and development of products and services.

8.4
Control of externally provided processes, products, and
services.

8.5 Production and service provision.

8.6 Release of products and services.

8.7 Control nonconforming outputs.

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Learning Objective 6-6

The ISO 9001: 2015 Certification Structure (3 of 3)

Table 6-6 The ISO 9001: 2015 Certification Structure

Section Focus/Description

9 Performance evaluation

9.1 Monitoring, measurement analysis, and evaluation.

9.2 Internal audit.

9.3 Management review.

10 Improvement

10.1 General

10.2 Nonconformity and corrective action.

10.3 Continual improvement.

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Managing Quality Summary

1. Quality management strives to achieve superior
quality.

2. It is important to integrate quality management into
the firm’s strategic activities.

3. Formal certifications confirm that a firm’s major
processes have been documented and followed.

4. Many firms use award guidelines to assess the
performance of their quality management systems.

5. Service quality management must take into
consideration the interpersonal interactions of service
providers and customers.

6. Core TQM values are the critical aspects to make
quality improvement a success.

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Chapter 7

Managing Inventories

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2

Learning Objectives

7-1 Define the different types and roles of inventory in the supply
chain.

7-2 Explain the financial impact of inventory on firm performance.

7-3 Explain and compute asset productivity and customer
service–related measures of inventory performance.

7-4 Calculate inventory policy parameters to minimize total
acquisition cost in continuous review, periodic review, and
single period models.

7-5 Determine the cost of a company’s service level policy.

7-6 Explain the advantages and disadvantages of different
inventory location strategies.

7-7 Describe practical techniques for inventory planning and
management.

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Learning Objective 7-1

Inventory at PolyCor

p

Inventory:

• When do I order?

• How much do I order?

• Where do I deploy the inventory?

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Learning Objective 7-

1

Types of Inventory

• Raw materials and component parts: items that are
bought from suppliers to use in the production of a produc

t

• Work in process inventory: inventory that is in the
production process

• Finished goods inventory: items that are ready for sale to
customers

• MRO inventory: maintenance, repair, and operating
supplies

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Learning Objective 7-1

Roles of Inventory

• Balancing supply and demand: decouples differences in
supply and demand requirements

• Buffers against uncertainties: variation in supply and
demand are managed with buffer (safety) stock

• Enabling economies of buying: price discounts or reduced
shipping costs

• Enabling geographic specialization: supply and demand
locations vary

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Types of Stock

• Cycle Stocks: inventory repeatedly produced/ordered and
used to fill deman

d

• Seasonal Stocks: additional inventories produced in
advance of seasonal peak demands or held after seasonal
peak supplies

• Buffer (or Safety) Stock: extra inventory held to guard
against uncertainty in demand or supply

• Speculative Stock: stock purchased or produced to hedge
against future price increases or shortages

Learning Objective 7-1

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Learning Objective 7-1

Student Activity (1 of 6)

Each of the uses of inventory described has a
particular cause. For example, safety stock is needed
because managers are uncertain about demand or
supply. For each inventory type, list the cause(s) and
how each cause could be reduced or eliminated,
thereby reducing the need for inventory.

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Learning Objective 7-2

Financial Impact of Inventory

Carrying (Holding) Costs
Ordering and Setup

Costs
Stockout Costs

• Opportunity cost (including
cost of capital)

• Storage and warehouse
management

• Taxes and insuranc

e

• Obsolescence, spoilage, and

shrinkage
• Materials handling, tracking,

and management

• Purchased items:
placing and receiving
orders

• Made items: change-
over between items

• Lost sales or
customer loyalty

• Expediting
• Schedule disruption

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Learning Objective 7-2

Student Activity (2 of 6)

Using your library’s electronic databases or a Web
browser, find three articles that describe specific
companies and their efforts to reduce inventory.
Summarize the different reasons given for the desire
to reduce inventory.

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0

Measures of Inventory Performance:
Inventory Turnover (1 of 2)

Inventory Turnover: ratio between average
inventory on hand and level of sales

= Cost of goods sold/Average inventory at cost

= Net sales/Average inventory at selling price

= Unit sales/Average inventory in units

Learning Objective 7-3

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Learning Objective 7-3

Measures of Inventory Performance:
Inventory Turnover (2 of 2)

Advantages of high turnover:

• “Fresh” inventory from high sales

• Reduced risk of obsolescence or need to mark down

• Reduced total carrying costs

• Lower asset investment and higher productivity

Dangers of high turnover:

• Stockouts may mean lower sales

• Increased costs from missing quantity requirements

• Increased purchasing, ordering, and receiving time,
effort, and cost

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Learning Objective 7-3

Measures of Inventory Performance:
Inventory Turnover—Example 7-2

Suppose a firm has an annual cost of goods sold of $500
million and its average inventory level during the year is
$80 million at cost. What is the firm’s inventory turnover?

Inventory turnover

=

= Cost of goods sold/Average inventory level

= $500/$80

= 6.25 turns

Or, in terms of days

= 365 days/6.25 times

= 58.4 days

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Learning Objective 7-3

Measures of Inventory Performance: Days of
Supply, Service Level, Stockouts

• Days of Supply: length of time operations can be
supported with inventory on hand

• Service Level: ability to meet customer demand
without a stockout

• Stockout: no inventory is available

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Measures of Inventory Performance: Days of
Supply—Example 7-3

Suppose there are currently 2,000,000 finished
automobiles sitting in dealer or manufacturing
facility lots. If expected sales of automobiles are
25,000 units per day, how many days of supply are
there?

= Current inventory/Expected daily sales

= 2,000,000/2

5,000

= 80 days

Learning Objective 7-3

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Student Activity (3 of 6)

Choose three companies that are competitors in an
industry of interest to you. Find their most recent
annual reports and compute and compare their
inventory turnover ratios. Explain the financial and
marketing implications of the differences in
inventory turnover rates for each of the three
companies.

Learning Objective 7-3

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Learning Objective 7-4

Inventory Management Systems (1 of 2)

• Independent Demand: demand for an item is
beyond control of the organizatio

n

• Dependent Demand: demand for an item is
driven by demand for another item

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Learning Objective 7-4

Inventory Management Systems (2 of 2)

• Continuous Review Model: inventory is
constantly monitored to decide when a
replenishment order needs to be placed

• Periodic Review Model: management system
built around checking and ordering inventory at
some regular interval

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Total Acquisition Costs (1 of 2)

• Total Acquisition Cost: sum of all relevant annual
inventory costs

– Holding Costs: associated with storing and assuming
risk of having inventory

– Ordering Costs: associated with placing orders and
receiving supply

Learning Objective 7-4

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Total Acquisition Costs (2 of 2)

TAC = annual ordering cost + annual carrying cost

TAC = Co (D/Q) + UCi * Q/2

N = D/

Q

I = Q/2

Where:

N = orders per year I = average inventory level

D = annual demand Co= order cost

Q = order quantity U = unit cost

Ci = % carrying cost per year

Learning Objective 7-4

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Total Acquisition Costs—Example 7.4

If we need 3,000 units per year at a unit price of $20 and
we order 500 each time, at a cost of $500 per order, with
a carrying cost of 20 percent, what is the TAC?

N = D/Q = 3000/500 = 6 orders per year

I = Q/2 = 500/2 = 250 average inventory

TAC = ordering cost + carrying cost

= Co (D/Q) + (UCi )(Q/2)

= $50 (3000/500) + ($20 × 20%) × (500/2)

= $1,300

Where:

N = D/Q Q = 500 I = Q/2

U = $20 D = 3,000 Co = $50 Ci = 20%

Learning Objective 7-4

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Total Acquisition Costs—Example 7.5

If we need 3,000 units per year at a unit price of $20 and
we order 200 each time, at a cost of $500 per order, with
a carrying cost of 20 percent, what is the TAC?

N = D/Q = 3000/200 = 15 orders per year

I = Q/2 = 200/2 = 100 average inventory

TAC = ordering cost + carrying cost

= Co(D/Q) + (UCi)(Q/2)

= $50(3000/200) + ($20 × 20%) × (200/2)

= $1,150

Where:

N = D/Q Q = 200 I = Q/2

U = $20 D = 3,000 Co = $50 Ci = 20%

Learning Objective 7-4

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Total Acquisition Costs Comparison

Figure 7-1 Trexoid Inventory Saw-Tooth Diagram: Order
Quantity 500

Figure 7-2 Trexoid Inventory Saw-Tooth Diagram: Order
Quantity 200

Learning Objective 7-4

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Learning Objective 7-4

Economic Order Quantity (EOQ) (1 of 4)

• Economic Order Quantity (EOQ): minimizes
total acquisition costs; points at which ordering
costs and carrying costs are equal

EOQ

=
2DC

0

UC

i

D = Annual Demand

C
0

= Ordering cost

U =Unit cost

C
i
=Holding cost

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Learning Objective 7-4

Economic Order Quantity (EOQ) (2 of 4)

Example 7-6

If we need 3,000 units per year at a unit price of $20, at a
cost of $50 per order with a carrying cost of 20 percent,
what is lowest TAC order quantity?

EOQ =
2DC

0

UC
i

=
2´3000´50

20´20%

=273.86 =

274

D = 3,000

C
0

= $50

U = $20

C
i
= 20%

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Learning Objective 7-4

Economic Order Quantity (EOQ) (3 of 4)

Example 7-6

If we need 3,000 units per year at a unit price of $20, at a
cost of $50 per order with a carrying cost of 20 percent,
what is lowest TAC order quantity?

3000/274 = 10.948, rounded to 11.
Average inventory will be 137 units.

TAC = Order cost + Inventory carrying cost = 11($50)
+ 137($20)(.2) = $550 + $548 = $1,098

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Learning Objective 7-4

Economic Order Quantity (EOQ) (4 of 4)

Figure 7-3 EOQ Cost Trade-Offs

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Learning Objective 7-4

Reorder Point (1 of 2)

• Reorder Point: minimum level of inventory that
triggers a replenishment

• When to order:

ROP = d( ) t
d = average demand per time period

t = average supplier lead time

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Reorder Point (2 of 2)

Example 7-7
If you use 10 units per day, and the lead time for
resupply is 9 days, how low can your inventory get
before placing a new order?

ROP = d( ) t
= 9´10

= 90

d =10

t = 9

Learning Objective 7-4

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EOQ Extensions

Assumptions underlying EOQ:

• No quantity discounts

• No lot size restrictions

• No partial deliveries

• No variability

• No product interactions

Learning Objective 7-4

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Quantity Discounts

Determining best price break quantity:

• Identify price breaks/lot size restrictions

• Calculate EOQ for each price/lot size

• Evaluate viability of each option

• Calculate TAC for each option

• Select best TAC option

Learning Objective 7-4

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Learning Objective 7-4

Total Acquisition Costs

TAC+C
0

D

Q

æ

è
ç

ö

ø
÷+UC

i

Q

2

æ

è
ç

ö

ø
÷+UD

C
0

= Ordering cost

D = Annual demand

Q = Order quantity

U =Unit cost

C
i
=Holding cost

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Total Acquisition Costs—Without Price
Discount

Example 7-8

If we need 3,000 units per year at a unit price of $20, at a cost
of $50 per order with a carrying cost of 20 percent, what is TAC
with a Q=1,000?

Where:

C
0

= $50 D = 3,000 Q =

1,000

U = $20 C
i
= 20%

TAC =

C
o

D

Q

æ

è
ç

ö

ø
÷+UC

i

Q

2

æ

è
ç

ö

ø
÷+UD

= $50
3,000

274

æ

è
ç

ö

ø
÷+$20´ 20%

274

2

æ

è
ç

ö

ø
÷+$20´3,000

= $61,095.45

Learning Objective 7-4

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Learning Objective 7-4

Total Acquisition Costs—With Price
Discount

Example 7-8

If we need 3,000 units per year at a unit price of $19, at a cost
of $50 per order with a carrying cost of 20 percent, what is TAC
with a Q=1,000?

Where: C
0

= $50 D = 3,000 Q =1,000

U = $19 C
i
= 20%

TAC =C
o

D

Q

æ

è
ç

ö

ø
÷+UC

i

Q

2

æ

è
ç

ö

ø
÷+UD

= $50
3,000

1,000

æ

è
ç

ö

ø
÷+$19´ 20%

1,000

2

æ

è
ç

ö

ø
÷+$19´3,000

= $59,050

TAC at unit cost $20= $61,095.45, new price saves

$2,045.45

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Student Activity (4 of 6)

Think about several instances where you have
bought a larger quantity of an item than you would
normally buy. What factors influenced you to do so?
Explain how those factors relate to the discussion of
EOQ and TAC.

Learning Objective 7-4

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Learning Objective 7-4

Production Order Quantity (1 of 2)

Production Order Quantity: most economical order
quantity when units become available at rate produced









−

=

p

d
UC

DC
Q

i

p

1

2 0

D = Annual demand

C
o

= Ordering cost

C
i
=Holding cost

U =Unit cost

d = daily rate of demand

p = daily rate of production

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Learning Objective 7-4

Production Order Quantity (2 of 2)

Example 7-9

Q
p

= EOQ

D = 500,000

C
0

= $2,000

C
i
= 25%

U = $10

d = 2,000

p = 5,000

Economic Production Size:

Q
p

=
2DC

0

C
i
U 1-

d

p

æ

è
ç

ö

ø
÷

=
2´500,000´$2,000

25%´$10 1-
2,000

5,000

æ

è
ç

ö

ø
÷

= 36,514.84

= 36,515

Length of Production Days:

=Q p

= 36,515 5,000 =7.3 days

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Production Order Quantity—Example 7-9

Consider the manufacturer of the Trexoid video games you have been
ordering for your store. The manufacturer expects annual demand from
all retailers to be 500,000 units of Trexoid games. It receives orders from
retailers for, on average, 2,000 units per day (250 days per year). To
change from production of another game to production of Trexoid requires
a setup cost of $2,000. Once production of Trexoid units begins, it can
produce 5,000 units per day. The cost to produce a unit of Trexoid is $10.
Finally, the manufacturer has determined that its inventory carrying cost
is 25 percent annually. The fundamental question to answer is how many
units of Trexoid should be ordered in each production run? It is also useful
to know the length of the production run in days.

Qp= production order quantity (the same concept as EOQ)

D = annual demand = 500,000

Co= setup cost (the same concept as ordering cost in EOQ) = $2,000

Ci = annual inventory carrying cost percentage = 25%

U = unit cost = $10

d = daily rate of customer demand = 2,000

p = daily rate of production = 5,000

Learning Objective 7-4

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Student Activity (5 of 6)

Verify the difference between the Qp quantity and
the EOQ. You can do that by using the standard EOQ
formula and assuming that all items produced arrive
simultaneously.

Learning Objective 7-4

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Standard Deviation of Demand During Lead
Time (1 of 2)

Variation can occur in both demand rates and lead
times

s
ddlt

= ts
2

d
+ d 2s

2

1

s
ddlt

= standard deviation of demand during lead time

t = average lead time

s
d

= standard deviation of demand

d = average demand

s
t
= standard deviation of lead time

Learning Objective 7-4

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Standard Deviation of Demand During Lead
Time (2 of 2)

Example 7-10
Average demand is 10 units per day with standard
deviation of 1.5, and lead time of 10 days with
standard deviation of 2.5 days.

days 2.5

dayper 10

units 1.5

days 10

=

=

=

=

t

d

d

t





( )

( )

units 25.4=

+=

+=

222

2

5.2105.19

1

22
 d

d
tddlt

Learning Objective 7-4

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Determining Service Levels (1 of 2)

Service Level Policy: determining the acceptable
stockout risk level

SS =s
ddlt

SS = safety stock

z = standard deviations needed for service level

s
ddlt

= standard deviation of demand during lead time

Learning Objective 7-5

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Learning Objective 7-5

Determining Service Levels (2 of 2)

Example 7-11
Standard deviation of demand during lead time is
25.4 units, and acceptable stockout level is 5
percent (95 percent service level). From the z table
= 1.65

SS = zs
ddlt

=1.65´ 25.4

= 42 units

Safety stock carrying cost:

$19´42 units´20%=$159.60 year

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Learning Objective 7-5

Standard Deviations and Probabilities

Table 7-2 Standard Deviations and Probabilities

Number of Deviations
Required

Probability of Being in
Stock

Probability of
Stockout

1 84.13% 15.77%

1.04 85 15

1.28 90 10

1.65 95 5

1.96 97.5 2.5

2.0 97.72 2.28

2.33 99 1

3.0 99.86 0.14

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Learning Objective 7-5

Cost Related to Service Levels

Table 7-3 Cost Related to Trexoid Service Levels

Std. Deviations
of Safety Stock

Probability of
in Stock

Probability of
Stockout

Safety Stock
Required

Safety Stock
Inventory
Carrying

Cost

1 84.13% 15.77% 25 $ 95.0

1.04 85 15 26 98.8

1.28 90 10 33 125.4

1.65 95 5 42 159.6

1.96 97.5 2.5 50 190.0

2.0 97.72 2.28 51 193.8

2.33 99 1 59 224.2

3.0 99.86 0.14 76 288.8

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Learning Objective 7-5

Relationship between Inventory
Investment and Product Availability

Figure 7-4 Relationship between Inventory Investment and Product Availability

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Learning Objective 7-5

Revisiting ROP and Average Inventory

Example 7-12
Considering uncertainty

ROP = reorder point

d = average lead time

t = average demand

SS = safety stock

Q = order quantity

ROP = d ´ t( ) +

SS

average inventory =
Q

2
+ SS

ROP = 10´9( ) +42 =132 units

average inventory =

1000

2

æ

è
ç

ö

ø
÷+42=542

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Periodic Review Model (1 of 3)

Order Interval: fixed time between inventory review; on-hand
level is unknown during this uncertainty period

UP =Uncertainty period

OI = Order interval

t = lead time

d = average daily demand

z = standard deviations of safety stock desired

s
ddup

= standard deviation of demand during

the uncertainty period

A= inventory on hand

UP =OI + t

Q = d UP( ) + zs
ddup

– A

Learning Objective 7-5

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Learning Objective 7-5

Periodic Review Model (2 of 3)

Example 7-13
Orders are placed every 30 days and average lead
time is 9 days. Standard deviation of demand is 1.5
units.

UP =Uncertainty period

OI =30 days

t = 9 days

s
d

=1.5 units

UP =OI + t

= 30+9 =39 days

s
ddup

= UP( )s d

2

= 39( ) 1.52( ) = 9.37

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Learning Objective 7-5

Periodic Review Model (3 of 3)

Example 7-14
There are currently 105 units in stock.

UP =39 days

OI =30 days

t = 9 days

d =10 units

z = 95%=1.65

s
ddup

= 9.37

A =105

( )

( ) ( )

units 301=

−+=

−+=

−+=

10516390

10537.965.13910

AzUPdQ ddup

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Learning Objective 7-5

Single Period Inventory Model (1 of 2)

Single Period Inventory Model: items are ordered once,
and have little leftover value (newsvendor problem)

Target Service Level: probability of meeting all demand
for an item

C
stockout

=Unit selling price -Unit cost

C
overstock

=Unit cost +Disposal cost -Salvage value

1- TSL( ) Cstockout( ) = TSL C
overstock( )

TSL =
C
stockout

C
stockout

+C
overstock

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Learning Objective 7-5

Single Period Inventory Model (2 of 2)

Example 7-15

Units cost $10 and sell for $30, unsold units have no
value, and there is no disposal or salvage value.

C
stockout

=Unit selling price -Unit cost

C
overstock

=Unit cost +Disposal cost -Salvage value

TSL =
C
stockout

C
stockout

+C
overstock

C
so

= $30-$10 = $20

C
os

= $10+0-0 = $10

TSL =
$20

$20+$10
= .667

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Impact of Location on Inventory Requirements
(1 of 2)

Square Root Rule: estimate of impact of changing
the number of locations on quantity of inventory
held

SS
n

=

N

n

N
e

´ SS
e

SS
n

= system safety stock for the new number of locations

N
n

= total number of new locations

N
e
=number of existing locations

SS
e
= system safety stock for the number of existing locations

Learning Objective 7-6

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Impact of Location on Inventory Requirements
(2 of 2)

Example 7-16
A single warehouse currently has 1,000 units of safety stock.
How much is needed if a second warehouse is added?

410,1

1000
1

2

1000

1

2

=

=

=

=

=

=

=

e

e

n

n

e

e

n

n

SS
N

N
SS

SS

N

N

SS

locations ofnumber

new the ofstock safety

Learning Objective 7-6

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Inventory Related to Number of Locations

Figure 7-5 Inventory Related to Number of Locations

Learning Objective 7-6

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Learning Objective 7-6

Managing Inventory

• Managing Cycle Stock: reducing lot sizes

• Managing Safety Stock: using ABC analysis and
reducing lead time

• Managing Locations: balance inventory, lead time,
and service levels

• Implementing Inventory Models: matching
management system to specific items

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Managing Inventory: ABC Analysis

• ABC Analysis: ranking inventory by importance

• Pareto’s Law: small percentage of items have a large impact
on sales, profit, or importance to a company

Figure 7-6
ABC
Classification
of Inventory

Learning Objective 7-6

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Learning Objective 7-7

Inventory Information Systems and
Accuracy

• Inventory Record Accuracy

– Cycle Counting: inventory is physically counted on

a routine schedule

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Managing Inventory Across the Supply
Chain (1 of 2)

Bullwhip Effect: variation increases upstream in the
supply chain (from consumer to manufacturers)

Figure 7-7 The Bullwhip Effect: An Example

Learning Objective 7-7

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Managing Inventory Across the Supply
Chain (2 of 2)

• Supplier-Managed Inventory (SMI): the
vendor is responsible for managing inventory for
the customer

– Vendor monitors and replenishes inventory balances

– Customer saves holding costs

– Vendor has higher visibility of inventory usage

• Collaborative Planning, Forecasting, and
Replenishment (CPFR): supply chain partners
sharing information

Learning Objective 7-7

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Blockchain

• Blockchain: a decentralized, distributed, and
public digital ledger used to record transactions
across many computers

– Provides visibility and prevents distortion of data

Learning Objective 7-7

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Student Activity (6 of 6)

Find a YouTube video (there are many) that
describes blockchain and gives an example of its
use.

Learning Objective 7-7

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Managing Inventories Summary

1. There are multiple types of inventory.

2. Inventory fulfills multiple roles.

3. Inventory is an asset, and has multiple costs.

4. An inventory policy determines how much and when to order.

5. Continuous systems monitor on-hand inventory levels.

6. Safety stock levels are linked with service levels.

7. Periodic review systems count inventory at specific intervals.

8. Number of storage locations impacts inventory levels.

9. Managers should work to reduce inventory requirements.

10. Each item must have a unique identification and accuracy.

11. Bullwhip effect occurs when a small change in demand results in a
large change up the supply chain.

12. Vendor-managed inventory may reduce bullwhip effect and overall
inventory levels.