OPERATIONS RESEARCH

1. Introduction
The subject of operations Research or Operational researches (OR) was developed in military
context during World War II. At that time, the tools under OR were developed and used to
effectively utilize the scarce military resources. The OR techniques were successful in their
purpose and were taken up by the industry to improve profits or to reduce costs. OR in the most
general sense can be characterized with the appl9ication of scientific methods, techniques and
tools to problems involving operation of a system so as to provide those in control of the system
with optimum solutions to the problems.

Different characteristics constituting nature of OR are;

(a) OR an attempt to optimize a well-defined function subject to given constraints and as such is
concerned with the optimization theory.
(b) OR emphasizes on the overall approach to the system. This is referred to as “system
orientation”. In OR, all the significant effects are taken into consideration and evaluated as a
whole while making decisions.
(c) OR tries to reduce the complexity of business operations and does help the managers in
correcting troublesome function and to consider innovations which are too costly &
complicated to experiment with the actual practice.
(d) OR adopts a planned approach to solve the problems.

2. Phases of OR Application:
The application of OR to solve problems and making decisions can be split into following
phases, each of which is composed of specific tasks.

1. The judgement phase – It includes

a) Determination of the problem
b) Establishment of the objectives and values related to the problem
c) The determination of suitable measures of effectiveness.
2. The research phase – it is composed of
a) observations and data collection for better understanding of problem.
b) formulation of hypothesis and models.
c) observation and experimentation to test the hypothesis on basis of additional data.
d) predictions of various results from the hypothesis, generalization of results and
consideration of alternative methods.

In general, an OR model is formulated from following steps-

1. Formulating the problem
2. Constructing the model
3. Deriving the solution
4. Testing the validity
5. Controlling the solution
6. Implementing the results

3. Classification of problems in OR:

Broadly speaking, problems in OR can be put into one of the following categories:
1. Allocation Allocating limited resources to optimize effectiveness
2. Replacement deciding optimal time to replace equipment or part of equipment for one
reason or other
3. Routing Determining optimal route from an origin to a destination when a number of
alternative routes are available.
4. Sequencing deciding upon order or sequence of objects performed by some source
5. Inventory deciding upon optimal number of facilities to provide service to customers.
6. Queuing deciding upon optimal number of facilities to provide service to customers
7. Competitive these include situations where two or more persons are competing for a
certain resource.

4. Role of OR:
The role of OR can be will understood under following heads
1. OR provides a tool for scientific analysis. OR replaces intuitive and subject approach of
decision making by analytical, objective approach.
2. OR provides solutions for various business problems.
3. OR enables proper deployment of resources to minimize the cost or maximize revenue.
4. OR helps in minimizing waiting & servicing cost.
5. OR enables the management to decide when to buy and how much to buy?
6. OR assists in choosing an optimum strategy in competitive situations.
7. OR renders help in resource allocation.
8. OR facilitates the process of decision making.

5. Typical mathematical OR model :

A typical OR model is of the form :
Z = f (x1, x2,….., xn)
Subject to c1, c2, ….., cn
Where,
Z = objective function
x1, x2,….., xn = System variables that are subject to control.
c1, c2, ….., cn = constraint in system due to variables that are not subject to control.

6. Limitations of OR :
OR has several limitations, being a perfect mathematical technique:
1) The inherent limitations concerning mathematical expression. It may be difficult or
impossible to express the system in form of a mathematical expression.
2) High costs are involved in the use of OR techniques
3) OR does not take into consideration the intangible factors like human relations, political
environment. Many times the decision making is very much affected by these non-
tangible factors.
4) OR is only a tool of analysis and not the complete decision making process. IT must be
remembered that OR is simply a tool and its use or misuse is in the hands of the user.
 LINEAR PROGRAMMING

1. INTRODUCTION
Programming problems in general are concerned with the use or allocation of scarce resources-
labor, materials, machines, and capital-in the “best” possible manner so that costs are
minimized or profits are maximized. In using the term “best”, it is implied that some choice or a
set of alternative courses of actions is available for making the decision. In general, the best
decision is found by solving a mathematical problem. The term linear programming merely
defines a particular class of programming problems that meet the following conditions:

1. The decision variables involved in the problem are nonnegative (i.e. positive or zero).

2. The criterion for selecting the “best” values of the decision variables can be described by a
linear function of these variables, that is, a mathematical function involving only the first
powers of the variables with no cross products. The criterion function is normally referred to
as the objective function.

3. The operating rules governing the process (e.g., scarcity of resources) can be expressed as a
set of linear equations or linear inequalities. This set is referred to as the constraint set.

2. FORMULATION OF LINEAR PROGRAMMING MODELS

The three basic steps in constructing a linear programming model are as follows:

Step I. Identify the unknown variables to be determined (decision variables) and represent them
in terms of algebraic symbols.

Step II. Identify all the restrictions or constraints in the problem and express them as linear
equations or inequalities which are linear functions of the unknown variables.
Step III. Identify the objective or criterion and represent it as a linear function of the decision
variables, which is to be maximized or minimized.

EXAMPLE 1: PRODUCT-MIX PROBLEM

The Handy-Dandy Company wishes to schedule the production of a kitchen appliance that
requires two resources-labor and material. The company is considering three different models
and its production engineering department has furnished the following data:

Model
A B C
Labor (hours per unit) 7 3 6
Material (pounds per unit) 4 4 5
Profit ($ per unit) 4 2 3

The supply of raw material is restricted to 200 pounds per day. The daily availability of labor is
150 hours. Formulate a linear programming model to determine the daily production rate of the
various models in order to maximize the total profit.

Formulation
Step I. Identify the Decision Variables. The unknown activities to be determined are the daily
rate of production for the three models. Representing them by algebraic symbols,
xA - Daily production of model A
xB - Daily production of model B
xC - Daily production of model C

Step II. Identify the Constraints. In this problem the constraints are the limited availability of
the two resources-labor and material. Model A requires 7 hours of labor for each unit,
and its production quantity is x4. Hence, the labor requirement for model A alone
will be 7xA hours (assuming a linear relationship). Similarly, models B and c will
require 3xB and 6xC hours, respectively. Thus, the total requirement of labor will be
 7xA + 3xB + 6xC, which should not exceed the available 150 hours. So, the labor
constraint becomes,

7xA + 3xB + 6xC 150

Similarly, the raw material requirements will be 4xA pounds for model A, 4xB
pounds for model B, and 5xC pound for model C. Thus, the raw material constraint
is given by

4xA + 4xB + 5xC 200

In addition, we restrict the variable xA, xB, xC to have only nonnegative values. This
is called the nonnegativity constraint, which the variables must satisfy. Most
practical linear programming problems will have this nonnegative restriction on the
decision variables. However, the general framework of linear programming is not
restricted to nonnegative values, and methods for handling variables without sign
restrictions will be discussed later.

Step III. Identify the Objective. The objective is to maximize the total profit from sales.
Assuming that a perfect market exists for the product such that all that is produced
can be sold, the total profit from sales becomes

Z = 4xA + 2xB + 3xC

Thus, the linear programming model for our product mix problem becomes:

maximize Z = 4xA + 2xB + 3xC

Subject to the constraints

 7xA + 3xB + 6xC 150
4xA + 4xB + 5xC 200
xA 0, xB 0, xC 0.

3. GRAPHICAL SOLUTION OF LINEAR PROGRAMS IN TWO VARIABLES

EXAMPLE 2 :- Solve :

Minimize: Z = 40x1 + 36x2

Subject to: x1 8
x2 10
5x1 + 3x2 45
x1 0, x2 0

In this problem, we are interested in determining the values of the variable x 1 and x2 that will
satisfy all the restrictions and give the least value for the objective function. As a first step in
solving this problem, we want to identify all possible values of x1 and x2 that are nonnegative and
satisfy the constraints. For example, a solution x1 = 8, x2 =10 is positive and satisfies all the
constraints. Such a solution is called a feasible solution. The set of all feasible solutions is
called the feasible region. Solution of a linear program is merely finding the best feasible
solution in the feasible region. The best feasible solution is called an optimal solution is a
feasible solution which minimizes the objective function 40x1 + 36x2. The value of the objective
function corresponding to an optimal solution is called the optimal value of the linear program.

To represent the feasible region in graph, every constraint is plotted, and all values of x 1, x2 that
will satisfy these constraints are identified. The nonnegativity constraints imply that all feasible
values of the tow variables will lie in the first quadrant. The constraint 5x1 +3x2 45 requires
that any feasible solution (x1, x2) to the problem should be on one side of the straight-line 5x1
+3x2 = 45. The proper side is found by testing whether the origin satisfies the constraint or not.
The line 5x1 +3x2 = 45 is first plotted by taking two convenient points (e.g., x1 = 0, x2 = 15, and
x1 = 9, x2 = 0).
 Fig 1 Solution of Example 1

The proper side is indicated by an arrow directed above the line since the origin does not satisfy
the constraint. Similarly, the constraint x1 8, x2 10are plotted. The shaded region ABC as
shown in Fig. 1 gives the feasible region. Obviously there is an infinite number of feasible
points in this region. Our objective is to identify the feasible point with the lowest value of
Z. Observe that the objective function, given by Z = 40x 1+36x2, represents a straight line if the
value of Z is fixed a priori. Changing the value of Z essentially translates the entire line to
another straight line parallel to itself. In order to determine an optimal solution, the objective
function line is drawn for a convenient value of Z such that it passes through one or more points
in the feasible region. Initially Z is chosen as 600. By moving this line closer to the origin the
value of Z is further decreased (see Fig. 1). The only limitation on this decrease is that the
straight line 40x1+36x2 = Z contains at least one point in the feasible region ABC. This clearly
5
occurs at the corner point A given by x1 = 8, x2 = . This is the best feasible point giving the
3
5
lowest value of Z as 380. Hence, x1 = 8, x2 = is an optimal solution, and Z = 380 is the
3
optimal value for the linear program.

Unique Optimal Solution

5
In Example 2, the solution x1 = 8, x2 = is the only feasible point with the lowest values of Z.
3
In other words, the values of Z corresponding to the other feasible solutions in Fig. 1 exceed the
5
optimal value of 380. Hence for this problem, the solution x 1 = 8, x2 = is the unique optimal
3
solution.

Alternative Optimal Solutions

In some linear programming problems, there may exist more than one feasible solution such that
their objective function values are equal to the optimal value of the linear program. In such
cases, all of these feasible solutions are optimal solutions, and the linear program is said to have
alternative or multiple optimal solutions.

Unbounded Solution
Some linear programming problems may not have an optimal solution. In other words, it is
possible to find better feasible solutions continuously improving the objective function values.
When there exists no finite optimum, the linear program is said to have an unbounded solution.
It is found that if there exists an optimal solution to a LP problem, then at least one of the corner
points of the feasible region will always qualify to be an optimal solution.

4. Some definitions in Linear Programming

A variable x1 is said to be a basic variable in a given equation if it is appears with a unit
coefficient in that equation and zeros in all other equations. Those variables, which are not
basic, are called nonbasic variables. By applying the elementary row operations, a given
variable can be made a basic variable. This is called a pivot operation.

Pivot Operation
A Pivot operation is a sequence of elementary operations that reduces a given system to an
equivalent system in which a specified variable has a unit coefficient

Basic Feasible Solution

A basic feasible solution is a basic solution in which the values of the basic variables are
nonnegative. With m constraints and n variables, the maximum number of basic solutions to the
standard linear program is finite and is given by
n n!
=
m m! n m !

By definition, every basic feasible solution is also a basic solution. Hence, the maximum
number of basic feasible solutions is also limited by the above expression. A naïve approach to
solve a linear program (which has an optimal solution) would be to generate all possible basic
feasible solutions through canonical reduction, and determine which basic feasible solution gives
the best objective function value. But, the simplex method for solving linear programs does this
in a more efficient manner by examining only a fraction of the total number of basic feasible
solutions!

5. Sensitivity analysis in linear programming

In all LP models the coefficients of the objective function and the constraints are supplied as
input data or as parameters to the model. The optimal solution obtained by the simplex method
is based on the values of these coefficients. In practice the values of these coefficients are seldom
known with absolute certainty, because many of them are functions of some uncontrollable
parameters. For instance, future demands, the cost of raw materials, or the cost of energy
resources cannot be predicted with complete accuracy before the problem is solved. Hence the
solution of a practical problem is not complete with the mere determination of the optimal
solution.
Each variation in the values of the data coefficient changes the LP problem, which may in turn
affect the optimal solution, found earlier. In order to develop an overall strategy to meet the
various contingencies, one has to study how the optimal solutions will changes in the input (data)
coefficients. This is known as sensitivity analysis or post-optimality analysis.

Other reasons for performing a sensitivity analysis are:

1. Some data coefficients or parameters of the linear program may be controllable; for example,
availability of capital, raw material, or machine capacities. Sensitivity analysis enables us to
study the effect of changes in these parameters on the optimal solution. If it turns out that the
optimal value (profit/cost) changes (in our favor) by a considerable amount for a small change
in the given parameters, then it may be worthwhile to implement some of these changes. For
example, if increasing the availability of labor by allowing overtime contributes to a greater
increase in the maximum return, as compared to the increased cost of overtime labor, then we
might want to allow overtime production.

2. In many cases, the values of the data coefficients are obtained by carrying out statistical
estimation procedures on past figures, as in the case of sales forecasts, price estimates, and
cost data. These estimates, in general, may not be very accurate. If we can identify which of
the parameters affect the objective value most, then we can obtain better estimates of these
parameters. This will increase the reliability of our model and the solution.
 TRANSPORTATION MODEL

1. Introduction
The transportation model is a special class of the linear programming problem. It deals with the
situation in which a commodity is shipped from sources (eg. Factories) to destinations (eg.
Warehouses). The objective is to determine the amounts shipped from each source to each
destination that minimize the total shipping cost while satisfying both the supply limits and the
demand requirements. The model assumes that the shipping cost on a given route is directly
proportional to the number of units shipped from the rout. In general, the transportation model
can be extended to the areas other than the direct transportation of a commodity including,
among other, inventory control, employment scheduling and personnel assignment. Typically a
transportation problem can be expressed as a linear programming problem. However, a special
structure of the constraints allows us to solve the problem more conveniently using the
“transportation tableau” as explained in the example. When the total supply does not equal the
total demand, the transportation model is said to be unbalanced (if supply equals demand, it is
referred to as the standard model). We will illustrate the transportation model and it’s solution
with following example.

2. The Transportation Algorithm

The steps of the transportation algorithm are exact parallels of the simplex algorithm namely, the
following:
Step 1: Determine a starting basic feasible solution, and go to step 2
Step 2: Use the optimality condition to determine the entering variable from among all the non-
basic variables. If the optimality condition is satisfied, Stop. Otherwise go to step 3.
Step 3: Use the feasibility condition of the simplex method to determine the leaving variable
from among all the current basic variables, and find the new basic variable. Return to
Step 2.

Following sections would discuss these steps using an example.

EXAMPLE 1:
Sun Ray Transport Company ships truckloads of grain from three silos to four mills. The supply
(in truckloads) and the demand (in truckloads) together with the unit transportation costs per
truckload on different routes are summarized in the transportation model given below. The unit
transportation costs Cij (shown in the northeast corner of each box) are in hundreds of Indian
Rupees.

Mill Supply

1 2 3 4
10 2 20 11
1 X11 X12 X13 X14 15
12 7 9 20
Silo 2 X21 X22 X23 X24 25
4 14 16 18
3 X31 X32 X33 X34 10
Demand 5 15 15 15 50

3. Determination of the starting solution:

The special structure of the transportation problem allows securing nonartificial Starting basic
solution using one of the three methods:

1. Northwest corner method

2. Least-lost method
3. Vegel approximation method (vam)

The Northwest corner method involves least computations and is used have to find basic starting
solution. (At end of topic the VAM method is also given to find basic starting solution).
The Northwest corner method is as follows:
Step 1: Allocate as much as possible to the Northwest cell (or selected cell, after 1st iteration) and
adjust the associated amounts of supply $ demand by subtracting the allocated amount.
Step 2: Cross out the row or column with zero supply or demand to indicate that no further
assignment can be made in that row or column. If both the row and column net to zero
simultaneously, cross out one only, and leave a zero supply (demand) in the uncrossed-
out row (column).
Step 3: If exactly one row or column has just been crossed out or to the right if a column has just
been crossed out or to the one below if a row has been crossed out. Go to step 1. In our
example, Example 1, the starting basic solution is as follows:

The associated cost of the schedule is Z = 5 10+10 2+5 7+15 9+5 20+10 18
= Rs. 520

4. Determination of entering variable

This is done by using the “method of multipliers.” The process is as follows:
Step 1: Associate the multipliers ui and vj with row i and column j of Transportation tableau. For
each current basic variable xij, following condition is satisfied
uj+ vj = cij , for each basic xij.
Step 2: Calculate values of ui and vj and (ui + vj- cij) for all basic xij
Step 3: Choose the basic xij with mix. Value of (ui + vj- cij).

In our example, the steps would be as follows;

1. Calculation of ui & vj we have 7 variables & 6 equations. Hence arbitrate equate to ui zero.
To summarize, we have : u1 = 0, u2 = 5, u3 = 3, v1 = 10, v2 = 2, v3 = 4, v4 = 15

The results of computation of (ui + vj - cij) is as follows;

Non basic variable ui + vj - cij
x13 u1+ v3 – c13 = 0 + 4 – 20 = -16
x14 u1+ v4- c14 = 0 + 15 – 11 = 4
x21 u2+ v1- c21 = 5 + 10 – 12 = 3
x31 u3+ v1 – c31 = 3 + 10 – 4 = 9
x32 u3+ v2- c32 = 3 + 2 – 14 = -9
x33 u3+ v3- c33 = 3 + 4 – 16 = -9

The max. value for (ui + vj - cij) = 9 for x31. x31 is the entering variable.
These computations can also be done in the tableau as shown;

5. Determination of leaving variable

Step 1: From the cell with entering variable, construct a closed loop such that
a) each corner of the loop must be as basic variable (obtained in basic starting solution)
b) the loop would consist of horizontal & vertical segments only (no diagonals allowed)
Step 2: Allocation of amount .
a) Allocate an amount to the entering variable.
b) For the supply & demand conditions to remain satisfied, alternate between subtracting
and adding an amount at the successive corners of the loop.

The steps for our example are as follows:

Step 3: Find maximum possible value of , such that no negative shipments are allowed through
any of the routes.

In our example, would be calculated as:

x13 = 5 - 0

x13 = 5 - 0

x13 = 10 - 0

Max. Value of to satisfy above condition is = 5.

Step 4: Choose the basic variable at which maximum value of occurs this is the leaving
variable. In our example, x11 and x22 both can be leaving variables. We arbitrarily chose
x11.

Step 5: Adjust the values of basic variables & the loop with new entering and leaving variables.
Step 6: Recalculate values of ui, vj and (ui + vj - cij). If any of the (ui + vj - cij) values are
positive, repeat step 5, else stop. If all nonbasic xij are negative, the solution is optimal.

In our example, the steps are as follows.

Recalculating ui, vj and cij ;

As all (ui + vj - cij) values are –ve, the solution is optimal.

The following table summarizes the optimum solution:

From Silo To Mill No. of truckloads

1 2 5
1 4 10
2 2 10
2 3 15
3 1 5
3 4 5
Optimal cost = Rs. 435
 INVENTORY MANAGEMENT

1. INTRODUCTION
Any materials that are held for future use can be considered inventories. There are at least four
reasons to hold inventories: (1) to increase operating efficiency, (2) to provide a quick response
to customers, (3) to provide safety against normal business uncertainties, and (4) to take
advantage of unusual price opportunities or to protect against irregular business risks.

1.1. Why maintain inventories?

a) Inventories can improve operating efficiency in several ways.

(a) Spreading the Fixed Costs of Procurement or Setups.

Some costs of acquiring materials, such as processing and transmitting orders and possibly
shipping, are fixed and independent of the order quantity. Therefore, the larger the quantity
purchased per order, the smaller the fixed cost per unit. Quantities purchased above immediate
needs, however, must be held in inventory and incur holding costs. The same idea can apply to
outputs. If there is a fixed setup cost to produce a product, then the more units produced per
production urn (the larger the produced above those needed for immediate shipment must be held
in inventory and incur a holding cost.

(b) Decoupling of Production

Most goods pass through a series of production stages (work stations, cells, or departments)
during the manufacturing process. If production is halted or slowed at one stage due to product
changeovers, machine adjustments, personnel training, or machine failure, subsequent stages will
soon have to stop operation unless they have in-process inventories available to process. In-
process inventories make it possible to decouple one production stage from another, allowing
greater scheduling and staffing flexibility.
(c) Smoothing and Stabilizing Production
If demand for a product is seasonal, it is often less expensive to maintain a constant level of
production and employment throughout the year than to alter production and employment levels
to match demand. During periods of low demand, production exceeds demand and inventories
of the product increase; then, during periods of high demand, these inventories are depleted.

b) Stocks of raw materials or finished goods lead to quicker customer response (due to
availability of material/goods in form of inventories.

c) Inventories help organizations to reduce the risks of uncertainties (like breakdown of

machines, unexpected surges in demand, etc.)

1.2. Types of Inventories:

Inventories of the same product may look the same physically, but they may be held for different
reasons. Inventories held primarily to achieve economic efficiency normally increase and
decrease in a planned cycle and are called cycling inventories (not to be confused with cycle
counting of inventories, which is discussed later). In contrast, inventories that are held to protect
the organization against normal business uncertainties and risks are called safety stocks. Firms
try to maintain a set level of safety stock, which they use only when random variations in
demand, lead-time, or production require it. A final type of inventories is speculative
inventories. These inventories, do not grow or shrink in a regular fashion, not are they held
perpetually for protection; rather, they are held for short periods on an irregular basis to take
advantage of special opportunities or to protect against unusual risk, like strikes, festival seasons,
etc.

1.3 Inventory-related costs

(a) Holding Costs
The holding cost is the cost of actually keeping items in inventory. The primary components of
this cost are (1) the opportunity cost of capital, (2) taxes and insurance, (3) breakage, spoilage,
pilferage, and obsolescence, and (4) handling and storing.

The opportunity cost of capital is usually the largest component of holding cost. Money invested
in inventories could instead be used for some other productive purpose, such as purchasing
equipment or reducing debt. The cost of this foregone return from other uses is typically about
10-25% of the inventory’s value. Taxes and insurance are also a direct function of the monetary
value of inventories, as are the costs of deterioration, pilferage, and obsolescence. The cost of
handling and storage is the only cost that is usually not directly proportional to the monetary
value of the item, but we can allocate such costs on a proportional basis without seriously
distorting the total holding cost.

Per unit holding costs are usually computed using a company-wide holding cost rate, i (this
generally assumes that the handling, storage, deterioration, and pilferage rates are either
relatively small or similar for most products). The rate i represent the holding cost per unit time
as a fraction of the item’s value. For example, suppose i = 0.24 per year (or 24% per year). The
holding cost per unit for a item that was purchased at the price p = Rs. 20 (the value of the
inventory) would then be
Ch = p i = Rs.20/unit 0.24/year = Rs.4.80/unit/year

(b) Ordering or Setup Costs

For many items the cost of purchasing or making Q units of an item, C(Q), has the form C(Q) =
co +pQ

Where co is the fixed cost to execute an order or to start a production run and p is per unit price
of purchase or variable cost of production. The larger the order size or production lot size, the
lower the fixed ordering or setup cost per unit because the fixed cost is spread over a larger
number of units.

(c) Shortage or Stock-out Costs

When customers wish to buy a product and it is not available, the supplier incurs a cost, which
might include not only lost profit but also lost future profits if the customer changes suppliers.
These costs are called stock-out or shortage costs.
(d) Hidden Costs
The three previous costs are the ones most commonly associated with inventory management,
and they are frequently included explicitly in inventory decision making. However, inventories
also carry many hidden costs. Companies keep extra raw materials on hand to protect
themselves against unreliable deliveries by suppliers. They maintain substantial in-process
inventories to keep some activities operating when machines break or workers fail to show up for
work. They overproduce products in the expectation that some will be defective. And
substantial final product inventories are maintained because of long production lead times and
poor demand forecasting. In each of these cases, inventories are used to compensate for and
effectively hide the real problems. All the extra costs incurred by not identifying and solving the
underlying production problems are inventory-induced costs, but they are not easy to measure.

2. INVENTORY MANAGEMENT POLICIES

Different companies manage inventory according to their needs. They can use many different
policies for managing the inventory. Following are the important methodologies that can be used
to manage the inventories.

(a) Fixed Period (P) System:

In this system the reordering for material is done after a fixed period, say every 2 weeks. The
inventory profile for P system can be shown as in figure 1.

Fig. 1: P System
As can be seen from fig.1, the reordering is done every two weeks. The reorder quantity is equal
to the EOQ explained later. The advantage of this system is easy control, as reordering has to be
done after a fixed period. The disadvantage is that the inventory may go negative if the
consumption of inventory is faster than expected. This would lead to material shortages.

(b) Fixed Quantity (Q) System:

Q system was designed to remove the error found in P system. In Q system, reordering is
done after a specific level of inventory is reached. This is independent of period or duration
between two recorder points. The inventory profile is shown in figure 2. As it can be seen from
fig. 2, the reordering is need based. The inventory consumption in week 3 was very fast, hence
quick reordering was required.

Fig. 2

The advantage of this system is that material shortages never occur, as some quantity (R in Fig.
2) is always present. This quantity is referred to as Safety stock and it is equal to the amount of
inventory required for the time gap between ordering the material and receiving it.

The reordering quantity is again equal to EOQ.

The disadvantage of the system is holding cost for inventory R is always charged on system.

3. EOQ (ECONOMIC ORDER QUANTITY) MODEL:

Two of the most important decisions related to controlling the inventories of raw materials or
supplies is when to place an order and how much to order. In 1913 F. W. Harris developed a rule
for determining the optimal number of units of an item to purchase if several fundamental
assumptions are satisfied. This model is referred to as the basic economic order quantity
(EOQ) model.

3.1. Assumptions: The assumptions of the basic EOQ model are as follows:
1. The demand for or usage of the item is relatively constant over time at a rate of D units per
unit time.
2. The item’s cost (price), p, is independent of the quantity ordered, Q.
3. There is a fixed cost, co for executing an order that is independent of the quantity
ordered, Q.
4. The holding cost for inventories is proportional to the quantity stored; that is, the holding cost
per unit per time, ch, is independent of the inventory level.
5. No shortages are allowed; all demand must be satisfied when requested.
6. The lead-time (LT) for deliveries, which is the time from when an order is placed until it is
delivered, is known with certainty and is constant.
7. All items ordered are delivered at the same time; there are no split deliveries.

3.2. Calculation of EOQ:

EOQ is that order quantity that leads to minimum total cost (per unit) of inventories.

Total cost = setup cost (ordering cost) + Holding cost of inventories.

If Co = Ordering cost/order (Rs.) D = Annual demand

Ch = Holding cost /item-year (Rs.) Q = EOQ

Setup cost (ordering cost) = no. of setups (orders) setup (or ordering) cost

= (D ) Co
Q
The cost vs. quantity chart is as shown in Fig. 3.

Fig. 3: Holding, Ordering and Total Inventory cost

Holding cost = Average quantity held holding cost/item

= (Q ) Cn
2
D Q
Total cost = Co. + Cn.
Q 2
This cost would be minimized, if

2C o D
Q = EOQ =
Cn

(Calculated by differentiating equation (1) and equating to zero to obtain minima).

3.3 Validity of the assumptions and model Robustness.

1. Assumptions, such as fixed demand and constant holding cost per unit are impractical but
do not substantially affect the EOQ. The other assumptions like no quantity discounts, no
uncertainty in demand or lead times have been dropped in advanced model to get more
accurate results.

2. An especially important characteristic of the EOQ model is that the total stocking cost
function is relatively flat around the optimal order quantity (see Figure 3).
 This is important because estimates for Co and Ch are not always extremely accurate, so
the value computed for EOQ may not equal the true optimum value. However, because
of the flatness of the TSC function, even if the computed EOQ is 20-30% different from
the true optimum, the cost penalty is relatively small.

3. Field studies indicate that it is common for organizations to use order quantities that are
100% or more in error. There are many reasons for this, but two common ones are that
(1) organizations use the same simple rules of thumb to purchase all products (e.g., buy
once per month) and (2) ordering rules that were initially established based on certain
data have not been updated even though the environment has changed.

4. ABC CLASSIFICATION OF ITEMS AND THE PARETO PRINCIPLE

The Pareto principle states that a few large problems or issues an organization encounters have
a large effect on its performance, whereas a large number of small problems or issues have a
small impact. Therefore, managers should categorize problem areas so that they spend most of
their time working on the important few problems and only minimal time on the unimportant
many. With respect to inventory management, we should focus on those items that have the
largest impact on total inventory-related costs; normally, these are the ones on which we spend
the most money annually. The data in Table 1 and Figure 4 can be used to classify items using
an ABC classification system. Items are divided into three categories according to their impact
on the organization, as illustrated in Figure 4. Items in category A account for a small number of
the item types but have a large cumulative monetary impact. Normally, category A items account
for 10-20% of the item types and 60-80% of the total value of all items used. Category C items
are those that have a small impact on the firm’s material costs. Normally, these account for 50-
60% of the material costs. The remaining items are classified as type B items, which constitute
20-40% of the items and 15-30% of the total cost.
 TABLE 1 ANNUAL $ USAGE OF ITEMS FOR A TYPICAL FIRM
Item No. Used/ Rs. Rs. Usage/ Rs. Cum.
Name r
Cost/Unit r
Usage/Total Usage/Total usage

A 500,000 20.00 10,000,000 .413 .413

B 40,000 150.00 6,000,000 .248 .661
C 120,000 30.00 3,600,000 .149 .810
D 50,000 50.00 2,500,000 .103 .913
E 70,000 15.00 1,050,000 .043 .956
F 20,000 25.00 500,000 .021 .977
G 40,000 7.50 300,000 .012 .989
H 5,000 35.00 175,000 .007 .996
I 6,000 12.00 72,000 .003 .999
J 2,000 9.00 18,000 .001 1.000
K 200 60.00 12,000 .000 1.000
Total 24,227,000 1.000

A items B items C items

Cumulative % of item types
Fig. 4 ABC classification of inventory items
It is usually most cost effective to devote our initial effort and our greatest attention to the few
items in category A; a small percentage reduction in their inventory costs has a large impact on
the organization. Inventory management systems for category A items may include a demand
forecasting module, a real-time inventory tracking module, and sophisticated ordering rules. In
contrast, we often use simpler, lower-cost methods (such as the two-bin system discussed below)
to control the inventories of category C items because even substantial reductions in inventory
costs for these items will produce only small overall savings. Categories B items receive an
intermediate amount of attention once the inventories of type A items are under control.
 Sample Objective Questions

1. ABC analysis is used in :

(a) CPM & PERT (b) Sensitivity analysis

(c) Plant layout design (d) Inventory control

2. The constraints in a given situation are found to be as follows:

3x + 6y 66 ; 0 x 12 ; 0 y 9
The objective function to be maximized is:
The values of x, y are:
(a) (1, 6) (b) (6, 1) (c) (5, 12) (d) (12, 5)

3. In ABC analysis, which class of items is large in number?

(a) A (b) B (c) C (d) depends on situation

4. Which of the following is not a method to find basic feasible solution for transportation
models?
(a) Northwest corner Rule (b) Vogel’s Approximation method
(c) Stepping stone method (d) Least-cost method

5. The LP model: maximize Z = 5x1 + 4x2

Subject to 6x1 + 4x2 24
x1 + 2x2 6
x1, x2 0
has following feasible solutions:
(a) (3, 1) (b) (1, 1), (1, 2), (2, 1), (2, 2), (3, 1)
(c) (1, 3), (3, 1), (2, 1), (2, 2) (d) (1, 3), (3, 1)

6. When is LP solution referred to as digerati?

 (a) When on or more basic variable becomes zero in interaction process
(b) Alternate optimum solutions are obtained.
(c) Values of variable may be increasing indefinitely without violating any constraints
(d) None of the above

7. In work study, which of the following is used in man analysis?

(a) Man & machine analysis chart (b) Man & machine operation time chart
(c) Man & machine process time chart (d) all of the above

8. A manufacturing process consists of two processes A and B. Process A is performed on

machines M1 and M2, while B is performed on machines M3, M4 and M5. The costs of
shifting units from M1 and M2 to M3, M4 and M5 are different. Which of the following
models would you not use to determine number of units to be transferred from M1 and
M2 to M3, M4 & M5?
(a) Transportation (b) Simplex method (c) Waiting line (d) none of these

9. In which of the following situations linear programming can be applied?

(a) Maximizing Insulation (b) procurement problems
(c) Scheduling production to meet sales forecast (d) all of the above

10. In work study which of the following is used in product analysis?

(a) Process chart (b) Workplace layout
(c) Man-operation chart (d) Multi-man process chart
 Answers and Solutions

1. (d)

ABC analysis finds the distribution of no. of items (stored in inventory) to the cost of
storing inventory. It is used in inventory control.

2. (d)
3x + 6y = 66 x + 2y = 22
If x =12 : y = 15 and p = 5(12) + 4(5) = 80
17 17
If x = 5 : y = and p = 5(5) + 4( ) = 59
2 2
If x =6 : y = 8 and p = 5(6) + 4(8) = 62

If x =11 : y = 11 and p = 5(11) + 4( 11 ) = 77

2 2
Hence, (d)

3. (c)
The premise of ABC classification/analysis is that the C class items represents most of
the items but contribute to least problems.

4. (c)
Stepping stoma method to used to optimize the solution already obtained from other
methods.

5. (b)
Feasible solution is any solution that satisfies all constraints of the model.

6. (a)
Degenerate solution represents a redundant constraint. Hence, the value of one or more
basic variable can become zero in an iteration of Simplex method.
7. (d)
All the charts are used to analyze the work content and utilization of manpower within
the plant.

8. (c)
The situation is a typical “movement” scenario/transportation scenario with 2 sources and
3 destinations. Hence, simples’ method & transportation model can only be used.

9. (d)
Linear programming can be done wherever linear equations can be constructed to model
a system and complete data regarding constraints is available. Hence, all the situations
can be modeled with linear programs.

10. (a)
Process chart describes the sequence of different processes required to produce one
product, hence it helps in product analysis