OPERATION & QUALITY MANAGEMENT 2

MBALN-670 Operations Management

Title of the topic 4 Inventory Management – inclusive of Lean Systems (JIT) and Forecast and Demand

Planning.

Topic’s learning objectives

1. Identify and critique the strategic frameworks of operations and quality

management within a global business environment. 2. Comprehensive knowledge of the main concept and methods related to

designing and managing operations and supply chains. 3. Systematic application of a range of fundamental operational improvement

concepts. 4. Critically evaluate the role of operations within different business models /

functions.

Introduction

This week we will study how organisations use inventory management concepts as

part of their operational strategy. The material is broken down into 3 parts.

Part 1 - Lean Systems / Just in Time is the simplest form means getting the right

quantity of goods at the right place and at the right time. The goods arrive just-in-

time, which is where the term JIT comes from. JIT considers reducing waste.

We will look at how JIT is connected to the Total Quality Management strategies of

the business.

Part 2 - We will identify principles of forecasting and demand planning and

observing the steps involved in the forecasting process and the different types of

forecasting methods.

Part 3 – Effective Inventory Management is a crucial aspect of a successful

business practice. We will explore key business practises and principles to carefully

balance and manage inventory (goods, raw materials and finished products)

Learning Material Part 1 - Lean Systems / JIT Systems

The philosophy of JIT originated in Japan. After World War II, the Japanese set

themselves the goal of strengthening their industrial base, which included full

employment and a healthy trade balance. Just-in-time (JIT) developed out of the

nation's need to survive after the devastation caused by the war. Although many

authors say that the origins of JIT can be traced back to the early 1900s, no one can

argue that the philosophy gained worldwide prominence in the 1970s. It was

developed at the Toyota Motor Company, and the person most often credited with its

development is Taiichi Ohno, a vice president of the company. JIT helped propel

Toyota into a leadership position in the areas of quality and delivery. Since then, JIT

has been widely adopted in all types of industries and has been credited with

impressive benefits, including significant reductions in operating costs, improved

quality, and increased customer responsiveness. Companies such as Honda, GE,

Ford, Boeing, Lockheed Martin, Hewlett-Packard, and IBM are among those that

have made JIT part of their operations. Even the retailer Zara relies on JIT.

The central belief of the JIT philosophy is elimination of waste, but there are other

beliefs that help define JIT philosophy. These include a broad view of operations,

simplicity, continuous improvement, visibility, and flexibility. Next we look more

closely at each of these beliefs.

Eliminate Waste

The underlying premise of JIT is that all waste must be eliminated. Many think that

the roots of the philosophy can be traced to the Japanese environment, which lacks

space and natural resources. As a result, the Japanese have been forced to learn to

use all their resources very efficiently, and waste of any kind is not tolerated. In JIT

waste is anything that does not add value. Types of waste can include material, such

as excess inventory to protect against uncertain deliveries by suppliers or poor

quality. Waste can be equipment that is used as a backup because regular

equipment is not maintained properly. Other types of waste include time, energy,

space, or human activity that does not contribute to the value of the product or

service being produced.

The concept of waste addresses every aspect of the organization and has a far-

reaching impact. For example, waste can be found in the production process itself,

and JIT requires perfect synchronization in order to eliminate waiting and excess

stock. Waste is also found in improper layout that necessitates the transportation of

goods from one part of the facility to another. JIT requires a streamlined layout

design so that resources are in close proximity to one another and material handling

is kept to a minimum. Also, JIT requires compact layouts and increased visibility so

that everyone can see what everyone else is doing. Waste can also take the form of

poor quality, because scrap and rework cost money and add no value. Total quality

management (TQM) programs thus are an integral part of JIT. Waste is also found in

unnecessary motion, and JIT requires studying processes to eliminate unnecessary

steps.

A Broad View of Operations

Part of the philosophy of JIT is that everyone in the organization should have a broad

view of the organization and work toward the same goal, which is serving the

customer. In traditional organizations, it is very easy for employees to focus

exclusively on their own jobs and have a narrow view of the organization that

includes only their assigned tasks. Companies whose employees have a narrow

view become production-oriented, forgetting that individual tasks and procedures are

important only if they meet the overall goals of the company. One example is an

employee who will not help a customer with a problem, saying, “It's not my job.” This

might occur at a grocery store when a customer asks for the location of an item from

an employee who is “only responsible for stocking shelves.” A broad view of

operations involves understanding that all employees are ultimately responsible for

serving the customer.

Simplicity

JIT is built on simplicity—the simpler the better. JIT encourages employees to think

about problems and come up with simple solutions. Although this may seem easy

and crude, it is actually quite difficult. It is often tempting to solve an organizational

problem using a complex and perhaps expensive method. It is far more difficult to

think of a simple solution that goes directly to the root of the problem. The value of

simple solutions is demonstrated by a company whose delivery truck was lodged in a

passageway because it was too high to pass through. Many costly and complex

solutions were being considered, such as getting a smaller truck or expanding the

height of the doorway. After a bit of thought, an employee came up with a simple

solution: reduce the air in the tires to bring down the height of the truck. The solution

worked.

Continuous Improvement

A major aspect of the JIT philosophy is an emphasis on quality. Continuous

improvement, called kaizen by the Japanese, in every aspect of the operation is a

cornerstone of this philosophy. Continuous improvement applies to everything from

reducing costs to improving quality to eliminating waste.

Food for Thought

To understand the full impact of continuous improvement, try answering this

question: When has JIT been implemented fully? The answer: Never. The reason is

that an organization is never perfect and can always be improved in some way.

A number of companies are utilizing a powerful JIT approach called the “kaizen

blitz.” This is an improvement tool that utilizes cross-functional teams to plan and

deliver improvements to specific processes during two- or three-day marathon

sessions. This process allows a small group of people to concentrate on a bite-size

chunk of the problem for a short period of time. Companies find that a kaizen blitz

can quickly deliver dramatic and low-cost improvements to processes.

Visibility

Part of the JIT philosophy is to make all waste visible. Waste can be eliminated only

when it is seen and identified. Also, if we see waste we can come up with simple

solutions to eliminate it. When waste is hidden we forget about it, which creates

problems.

Think about the closets in your home. Because the closet doors are closed, we often

forget the clutter and junk we have inside. Now imagine that the closet doors were

open and the inside was visible to us and everyone else. Certainly it would remind us

that we need to eliminate the clutter.

JIT facilities are open and clean, with plenty of floor space. There is no clutter, and

everyone can see what everyone else is doing. No one can hide extra inventory in a

corner of his or her office or take a short nap in the afternoon. Also, part of the JIT

philosophy is that a cluttered environment creates confusion and disrespect toward

the workplace. By contrast, a clean and orderly environment creates calm and clear

thoughts. Just because space is available, it should not automatically be filled.

Visibility allows us to readily see waste. We can then eliminate it.

Flexibility

JIT was based on the need for survival, and survival means being flexible in order to

adapt to changes in the environment. A company can be flexible in many ways. First,

flexibility can mean being able to make changes in the volume of a product

produced. JIT accomplishes this by keeping the costs of facilities, equipment, and

operations at such a low level that breaking even typically is not a problem.

A second way in which a company can be flexible is by being able to produce a wide

variety of products. Although this is difficult to achieve, JIT systems are designed

with the ability to produce different product models with different features through a

manufacturing process that can easily switch from one product type to another by

flexible workers who can perform many different tasks. Part of the JIT philosophy is

to design operations that are highly efficient but flexible in order to accommodate

changing customer demands.

Figure 7-1 elements of JIT (WileyPlus)

JIT within the Organisation and Across other Functions

Accounting is strongly affected by JIT. Traditional accounting systems generally

allocate overhead on the basis of direct labour hours. The problem with this method

is that it does not accurately describe the actual use of overhead by different jobs.

For example, jobs that are labour intensive in nature may be assigned a

disproportionately high share of overhead. These numbers may lead management to

make inappropriate decisions. JIT relies on activity-based costing to allocate

overhead. In activity-based costing, specific costs are identified and then assigned to

various types of activities, such as inspection, movement of goods, and machine

processing. Overhead costs are then assigned to jobs depending on how many

activities a particular job takes up.

Marketing plays a large role in JIT, as the interface with customers becomes more

important. JIT focuses on customer-driven quality, not quality as defined by the

producer. Marketing managers must understand customer needs and ensure that

this information is passed on to operations managers for proper design, production,

and delivery of the product or service.

Finance is responsible for approving and evaluating financial investments. Switching

to a JIT system proves financially beneficial in the long run but generally requires an

investment in resources. Included are hiring consultants, training workers,

purchasing or modifying equipment, more record keeping, and rearrangement of

facilities. Finance must evaluate these investments and measure their performance,

which requires an understanding of JIT.

Engineering plays a major role in JIT. As we have seen in this chapter, reduction of

setup time is critical to the success of JIT. It is up to engineering to design machines

so as to reduce setup time and to design poka-yoke, or foolproof devices that

prevent defects from occurring. Engineering is largely responsible for designing the

mechanisms that enable JIT to function as desired. Without engineering, true JIT

could not exist.

Information systems (IS) create the network of information necessary for JIT to

function. JIT is based on the assumption that information about quality, inventory

levels, order status, and product returns is available to everyone in the organization.

This type of information needs to be readily available and up-to-date. Otherwise, a

JIT system would come to a halt. Communication with suppliers is another

prerequisite of JIT that requires a high-level information system. JIT cannot function

without the ongoing involvement of IS. In turn, IS needs to understand JIT

functioning and information requirements.

The Supply Chain Link

The concept of JIT naturally extends itself to the entire supply chain. The philosophy of JIT teaches us that waste anywhere in the system hinders efficiency, doesn't provide value to the customer, and ultimately increases cost. Every organization is just one element of an entire supply chain system. As such, waste anywhere in the supply chain is ultimately passed down to other members of the chain and the final customer. Also recall that JIT views a company's suppliers as the external factory, focuses on building long-term relationships with suppliers, and promotes sharing data along the supply chain. In fact, a company's pull system cannot work properly unless its suppliers are also using it. Otherwise, the JIT system of the company would not be able to function properly, as there would be no guarantee of stable deliveries. Therefore, the principles of JIT need to be adopted by all members of a supply chain in order to have a full impact. This is often referred to as a lean supply chain.

Dell provides a good example of the impact JIT can have when it is implemented along the supply chain. The company has a build-to-order model that produces computers only when there is actual customer demand. Dell has implemented a JIT system throughout its supply chain and shares demand information with its suppliers. As a result, Dell is able to introduce new technologies in its computers much quicker than competitors because they are seamlessly available in the supply chain. Dell also works closely with its suppliers to reduce inventories, align processes, and eliminate waste across the supply chain. The result has been high responsiveness at a competitive price.

Discussion question 3 - JIT

Explain how you think JIT techniques can be used by the Food and Beverage

Operations to meet guest needs for a variety of fresh foods in just the right quantity

at just the right time.

Case Study Mcdonalds uses JIT to reduce waste and keep costs low. Please read the blog on

the page below. Otherwise, this can be found on the VLE.

Please contribute your views to this article as part of Discussion 4 – McDonalds

http://www.inventorymanagementreview.org/2005/11/mcdonalds_a_gui.html

Part 2 - Principles of Forecasting

There are many types of forecasting models. They differ in their degree of complexity, the amount of data they use, and the way they generate the forecast. However, some features are common to all forecasting models. They include the following:

1. Forecasts are rarely perfect. Forecasting the future involves uncertainty.

Therefore, it is almost impossible to make a perfect prediction. Forecasters know that they have to live with a certain amount of error, which is the difference between what is forecast and what actually happens. The goal of forecasting is to generate good forecasts on the average over time and to keep forecast errors as low as possible.

2. Forecasts are more accurate for groups or families of items rather than for individual items. When items are grouped together, their individual high and low values can cancel each other out. The data for a group of items can be stable even when individual items in the group are very unstable. Consequently, one can obtain a higher degree of accuracy when forecasting for a group of items rather than for individual items. For example, you cannot expect the same degree of accuracy if you are forecasting sales of long-sleeved hunter green polo shirts that you can expect when forecasting sales of all polo shirts.

3. Forecasts are more accurate for shorter than longer time horizons. The shorter the time horizon of the forecast, the lower the degree of uncertainty. Data do not change very much in the short run. As the time horizon increases, however, there is a much greater likelihood that changes in established patterns and relationships will occur. Because of that, forecasters cannot expect the same degree of forecast accuracy for a long-range forecast as for a short-range forecast. For example, it is much harder to predict sales of a product two years from now than to predict sales two weeks from now.

Steps in Forecasting Process

Regardless of what forecasting method is used, there are some basic steps that should be followed when making a forecast:

1. Decide what to forecast. Remember that forecasts are made in order to plan for the future. To do so, we have to decide what forecasts are actually needed. This is not as simple as it sounds. For example, do we need to forecast sales or demand? These are two different things, and sales do not necessarily equal the total amount of demand for the product. Both pieces of information are usually valuable. An important part of this decision is the level of detail required for the forecast (e.g., by product or product group), the units of the forecast (e.g., product units, boxes, or dollars), and the time horizon (e.g., monthly or quarterly).

2. Evaluate and analyze appropriate data. This step involves identifying what data are needed and what data are available. This will have a big impact on the selection of a forecasting model. For example, if you are predicting sales for a new product, you may not have historical sales information, which would limit your use of forecasting models that require quantitative data.

3. Select and test the forecasting model. Once the data have been evaluated, the next step is to select an appropriate forecasting model. As we will see, there are many models to choose from. Usually we consider factors like cost and ease of use in selecting a model. Another very important factor is accuracy. A common procedure is to narrow the choices to two or three different models and then test them on historical data to see which one is most accurate.

4. Generate the forecast. Once we have selected a model, we use it to generate the forecast. But we are not finished, as you will see in the next step.

5. Monitor forecast accuracy. Forecasting is an ongoing process. After we have made a forecast, we should record what actually happened. We can then use that information to monitor our forecast accuracy. This process should be carried out continuously because environments and conditions often change. What was a good forecasting model in the past might not provide good results for the future. We have to constantly be prepared to revise our forecasting model as our data change.

Forecasting methods

Now turn to your ebook, review the time series and casual methods of

forecasting. The diagrams are useful to demonstrate how this is done.

Part 3 - Inventory Management

Finally we explore Inventory Management.

Inventory comes in many shapes and sizes. Most manufacturing firms have the

following types of inventory. Raw materials are the purchased items or extracted

materials that are transformed into components or products. For example, gold is a

raw material that is transformed into jewellery. Components are parts or

subassemblies used in building the final product. For example, a transformer is a

component in an electronic product. Work-in-process (WIP) refers to all items in

process throughout the plant. Since products are not manufactured instantaneously,

there is always some WIP inventory flowing through the plant. After the product is

completed, it becomes finished goods—the bicycles, stereos, CDs, and automobiles

that the company sells to its customers. Distribution inventory consists of finished

goods and spare parts at various points in the distribution system—for example,

stored in warehouses or in transit between warehouses and consumers.

Maintenance, repair, and operational (MRO) inventory are supplies that are used in

manufacturing but do not become part of the finished product. Examples of MRO are

hand tools, lubricants, and cleaning supplies.

How Companies use Inventory Management

1. Anticipation or seasonal inventory

2. Fluctuation Inventory or Safety stock: buffer demand fluctuations

3. Lot-size or cycle stock: take advantage of quantity discounts or purchasing

efficiencies

4. Transportation or Pipeline inventory

5. Speculative or hedge inventory protects against some future event, e.g. labor

strike

6. Maintenance, repair, and operating (MRO) inventories

Objectives of Inventory Management

Provide desired customer service level

o Customer service is the ability to satisfy customer requirements

o Percentage of orders shipped on schedule

o Percentage of line items shipped on schedule

o Percentage of $ volume shipped on schedule

o Idle time due to material and component shortages

Provide for cost-efficient operations:

o Buffer stock for smooth production flow

o Maintain a level work force

o Allowing longer production runs & quantity discounts

Minimum inventory investments:

o Inventory turnover

o Weeks, days, or hours of supply

Customer service level examples

Percentage of Orders Shipped on Schedule

o Good measure if orders have similar value. Does not capture value.

o If one company represents 50% of your business but only 5% of your

orders, 95% on schedule could represent only 50% of value

Percentage of Line Items Shipped on Schedule

o Recognizes that not all orders are equal, but does not capture $ value of

orders. More expensive to measure. Ok for finished goods.

o A 90% service level might mean shipping 225 items out of the total 250

line items totaled from 20 orders scheduled

Percentage Of Dollar Volume Shipped on Schedule

o Recognizes the differences in orders in terms of both line items and $

value

Follow the “Solved Demo Problem” within the Wileyplus ebook. This will

demonstrate how the formulas are used for determining order quantities.

Video 6 Eagle Ridge Spa Inventory Management

http://www.youtube.com/watch?v=rCrR3kckyvA

Also within Wiley Plus book

Article to Read

Further Reading o Just in Time Inventory Management

http://accounting4management.com/just_in_time.htm

Think Theory 5

There will be no think theory exercises this week as I would like you to focus on working

through the problems and formula I have guided you to within your ebook.

o Companies that use JIT management

o Harley Davidson

o Toyota Motor Company

o General Motors

o Ford Motor Company –

Review their websites to understand how they use JIT today.

o Read more at

http://accounting4management.com/just_in_time.htm#OdLquAmS2AB6GCP

m.99

o What is Inventory Management -

http://merchantos.com/articles/inventory/what-is-inventory-management/

Topic’s summary

JIT is a philosophy that was developed by the Toyota Motor Company in the mid-

1970s. It has since become the standard of operation for many industries. It focuses

on simplicity, eliminating waste, taking a broad view of operations, visibility, and

flexibility. Three key elements of this philosophy are JIT manufacturing, total quality

management, and respect for people.

JIT views waste as anything that does not add value, such as unnecessary space,

energy, time, or motion.

Traditional manufacturing systems use “push” production, whereas JIT uses “pull”

production. Push systems anticipate future demand and produce in advance in order

to have products in place when demand occurs. This system usually results in

excess inventory. Pull systems work backwards. The last workstation in the

production line (or the customer) requests the precise amounts of materials required.

JIT manufacturing is a coordinated production system that enables the right

quantities of parts to arrive when they are needed precisely where they are needed.

Key elements of JIT manufacturing are the pull system and kanban production, small

lot sizes and quick setups, uniform plant loading, flexible resources, and streamlined

layout.

JIT considers people to be the organization's most important resource. All

employees are highly valued members of the organization. Workers are empowered

to make decisions and are rewarded for their efforts. Team efforts make possible

cross-functional and multilayer coordination.

JIT is equally applicable in service organizations, particularly with the push toward

time-based competition and the need to cut costs.

JIT success is dependent on interfunctional coordination and effort. Marketing must

work closely with customers to define customer-driven quality. IS must design a

powerful information system. Engineering must develop equipment with low setup

time and design jobs with foolproof devices. Finance must monitor financial

improvements with realistic expectations. Accounting must develop appropriate

costing mechanisms.

Forecasting

Three basic principles of forecasting are: forecasts are rarely perfect; forecasts are

more accurate for groups or families of items rather than for individual items; and

forecasts are more accurate for shorter than longer time horizons.

The forecasting process involves five steps: decide what to forecast; evaluate and

analyze appropriate data; select and test a forecasting model; generate the forecast;

and monitor forecast accuracy.

Forecasting methods can be classified into two groups: qualitative and quantitative.

Qualitative forecasting methods generate a forecast based on the subjective opinion

of the forecaster. Some examples of qualitative methods include executive opinion,

market research, and the Delphi method. Quantitative forecasting methods are

based on mathematical modelling. They can be divided into two categories: time

series models and causal models.

Time series models are based on the assumption that all the information needed for

forecasting is contained in the time series of data. Causal models assume that the

variable being forecast is related to other variables in the environment.

There are four basic patterns of data: level or horizontal, trend, seasonality, and

cycles. In addition, data usually contain random variation. Some forecasting models

that can be used to forecast the level of a time series are naïve, simple mean, simple

moving average, weighted moving average, and exponential smoothing. Separate

models are used to forecast trend, such as trend-adjusted exponential smoothing.

Forecasting seasonality requires a procedure in which we compute a seasonal

index, the percentage by which each season is above or below the mean.

A simple causal model is linear regression, in which a straight-line relationship is

modelled between the variable we are forecasting and another variable in the

environment. The correlation coefficient is used to measure the strength of the linear

relationship between these two variables.

Three useful measures of forecast accuracy are mean absolute deviation (MAD),

mean square error (MSE), and a tracking signal.

There are four factors to consider when selecting a forecasting model: the amount

and type of data available, the degree of accuracy required, the length of forecast

horizon, and patterns present in the data.

Inventory Management

Raw materials, purchased components, work-in-process (WIP), finished goods,

distribution inventory and maintenance, repair and operating supplies are all types of

inventory. Inventories have several uses: anticipation inventory is built before it is

needed; fluctuation stock provides a cushion against uncertain demand; cycle stock

is a result of the company's ordering quantity; transportation inventory includes items

in transit; speculative inventory is a build-up to protect against some future event;

and MRO inventory supports daily operations.

The objectives of inventory management are to provide the desired level of customer

service, to allow cost-efficient operations, and to minimize inventory investment.

Customer service can be measured in several ways, including as a percentage of

orders shipped on schedule, a percentage of line items shipped on schedule, a

percentage of dollar volume shipped on schedule, or idle time due to material and

component shortages. Cost-efficient operations are achieved by using inventory as

buffer stocks, allowing a stable year-round workforce, and spreading the setup cost

over a larger number of units.

Inventory investment is measured in inventory turnover and/or level of supply.

Inventory performance is calculated as inventory turnover or weeks, days, or hours

of supply.

Relevant inventory costs include item costs, holding costs, ordering costs, and

shortage costs. Holding costs include capital costs, storage costs, and risk costs.

Ordering costs are fixed costs for placing an order or performing a setup. Shortage

costs include costs related to additional paperwork, additional shipping expense, and

the intangible cost of lost customer goodwill.

The ABC classification system allows a company to assign the appropriate level of

control and frequency of review of an item based on its annual dollar volume.

Cycle counting is a method for maintaining accurate inventory records. Determining

what and when to count are the major decisions.

Retailers, wholesalers, and food service organizations use tangible inventory even

though they are service organizations. Proper inventory control and management for

these organizations often is the difference between a profit and loss. Since the items

are often desirable, organizations must strive to reduce the amount of theft by

customers and employees. Magnetic strips, security devices, and surveillance

systems are all means of reducing inventory loss.

Lot-for-lot, fixed-order quantity, min-max systems, order n periods, periodic review

systems, EOQ models, quantity discount models, and single-period models can be

used to determine order quantities.

Ordering decisions can be improved by analyzing total costs of an inventory policy.

Total costs include ordering cost, holding cost, and material cost.

Practical considerations can cause a company to not use the optimal order quantity,

that is, minimum order requirements.

Smaller lot sizes give company flexibility and shorter response times. The key to

reducing order quantities is to reduce ordering or setup costs.

Calculating the appropriate safety stock policy enables companies to satisfy their

customer service objectives at minimum cost. The desired customer service level

determines the appropriate z value.

Inventory decisions about perishable products (like newspapers) can be made using

the single-period inventory model. The expected payoff is calculated to assist the

quantity decision.