Copyright : Lal Prasad Aryal

Unit 2:Product and Service Design

2.1 Concept of Product Design

Product refers to one of the 4Ps of marketing. Effective selling or marketing demands a proper
understanding of the word "Product". Product is a bundle of benefits or satisfaction offered to a customer.
Design has a tremendous impact on the quality of a product or service. Poor designs may not meet
customer needs or may be so difficult to make that quality suffers. Costly designs can result in over-priced
products that lose market share. If the design process is too lengthy, a competitor may capture the market
by being the first to introduce new products, services, or features. However, rushing to be first to the
market can result in design flaws and poor performance, which totally negate first-mover advantages.
(Russell & Taylor, 2009).
A new product design does not always mean a new conceptual product based on new research,
modification of existing product and featuring additional also taken as new product design.
Figure 2.1 New Product Design
Modification of Existing Product
[Adding some additional features]
What ?
Totally New Concept Product
[Innovative product]

Pure Research (Concept Building)

Product Design
- Experts from inside and outside
- Marketing Personnel
- Consultants
- Research Groups
- Students from various universities
How ?
Applied Research (Implementation)
- Manpower
- Machinery and equipments
- Schedule
- Management
- Information

Product design defines the appearance of the product, sets standards for performance, specifies which
materials are to be used, and determines dimensions and tolerances. Design may be an art, but the design
process must be managed effectively. An effective design process are:
 Matches product or service characteristics with customer requirements.
 Ensure that customer requirements are met in the simplest and least costly manner.
 Reduces the time required to design a new product or service.
 Minimizes the revisions necessary to make a design workable.
Product development translates the needs of customers given by marketing into technical specifications
and designing the various features into the product to meet the product specifications. Manufacturing has
the responsibility of selecting the process by which the product can be manufactured. Product design and
development provides a link between marketing, customer needs and expectations and the activities
required to manufacture the product. The manufacturing process should be able to meet the local
preferences in a global market place.
The essence of any organization is the product or service it offers. There is an obvious link between
product design and the success of the organization. Those organizations which have well-designed
products are more likely to realize their goals than those with poorly designed products. Hence
organizations have a vital stake in achieving good product design.

Product design is concerned with the designing of three issues as form, process and function of a
production.
1. Form Design
It is concerned with the appearance, and aesthetic considerations and also the size, volume and
weight of the product which are secondary to the performance of the product.
2. Process Design
It is concerned with the overall sequences of operations required to achieve the design specifications
of the product. It specifies the type of work stations that are to be used, the machines and
equipments necessary to carry out the processes to produce the product.

3. Function Design
It is concerned with the first and foremost requirement of a good product i.e., the product should
effectively perform the function for which it is developed. For example, for a television set, the
picture quality and the sound quality is more important than the appearance of the cabinet in which
the picture tube is fixed. (Joshi, P.R., Fago., G. and Aryal, L.P., 2012)

2,2 Objectives of New Product Design

Every business organization has to design, develop and introduce new products as a survival and growth
strategy. The purpose of any organization is to provide products or services to its customers. An organization
can gain a competitive advantage through designs that bring new ideas to the market. The design of the
product is required for the organizations for the following reasons or Objectives:
 To be in business on a continuous basis, believing a fact that business is a long lasting institution.
 To gain profit in the long run.
 To satisfy unfulfilled needs of the customers.
 To achieve the desired product quality.
 To reduce the development time and cost to the minimum.
 To reduce the cost of the product.
 To enter into new prospective business through related or unrelated diversification.
 To fierce competition in the existing product line.

Lifecycles / Product Life Cycle

Product life cycle is predictable pattern of demand and continuous process but period or time of
product life cycle cannot be predicted or estimated. Life cycle may vary from product to product and
industry to industry. Operational rules, regulations, policies, strategies and conversion process,
system and technology vary in each stage due to change in volume of product, variety of product,
industry structure and level of competition. Production and operation manager is always concerned
with dealing following issues:
 When various stages of product life cycle occur for our product?
  What management facilities and resources are needed on various stages of the product life
cycle?
 What should be done with existing facilities and conversion process when product is in
various stages?
 What and when new product should be introduced to sustain the existing process or
conversion system?
Life cycle of any product have four distinct stages which are:
 Introduction phase or start-up phase
 Growth Stage
 Maturity stage
 Decline stage

Figure: Simple Product Life Cycle

Maturity stage
Sales Revenue

Decline stage Maturity

Sales
Start up Rapid Decline
Growth stage Rapid Revenue curve
stage Growth

Start up New product curve

Time

Table Characteristics of Product at Various Stages of Product Life Cycle.

Steps 1. Start-up 2. Growth 3. Maturity 4. Decline
Product variety Great varieties Increasing standardization Emergence of dominant High standardization
design with ‘commodity’ characteristic
Product volume Low volume Increasing volume High volume High volume
Industry structure Small competitors Fall out and consolidation Few large companies Survivors
Form of competition Product varieties Product quality and availability Dependability and Price Price
Many new products and services go through a life cycle in terms of demand. When an item is introduced,
it may be treated as a curiously. Demand is generally low because potential buyers are not yet familiar
with the item. Many potential buyers recognize that all of the bugs have probably not been worked out
and that the price may drop after the introductory period. Capacity and processing are designed for low
volume. With the passage of time, design improvements usually create a more reliable and less costl y
output. Demand then grows for these reasons and because of increasing awareness of the product or
service. Higher volume will involve different methods and contribute to lower costs. At the next stage of a
life cycle, the product or service reaches maturity: there are few, if any, design changes, and demand levels
off. Eventually, the market becomes saturated, which leads to a decline in demand. In the last stage of a life
cycle, some firms adopt a defensive research posture whereby they attempt to prolong the useful life of a
product or service by improving its reliability, reducing costs of producing it (and, hence, the price),
redesigning it, or changing the packaging. In some instances, firms may seek alternative uses of their
products (e.g., baking soda, duct tape). Forward-thinking firms begin searching for replacement products
during the maturity stage.
Some products do not exhibit life cycles: wooden pencils, paper clips, nails knives, forks, and spoons,
drinking glasses and similar items. However, most new products do.
Standardization
An important issue that often arises in both product/service design and process design is the degree
of standardization. Standardization refers to the extent to which there is absence of variety in a
product, service, or process. Standardized products are made in large quantities of identical items;
calculators, computers, and milk are some examples. Standardized service implies that every
customer or item processed receives essentially the same service. An automatic car wash is a good
example; each car, regardless of how clean or dirty it is, receives the same service, standardized
processes deliver standardized service or produce standardized goods.
It refers to design activity that reduces variety among a group of products or parts. This will result in
higher volume for each product or part model which can lead to lower production costs, higher
production quality and lower inventory and higher ease of automation.

Mass Customization
Companies like standardization because it enables them to produce high volumes of relatively low-cost
products, albeit products with little variety. Customers, on the other hand, typically prefer more variety,
although they like the low cost. The question for producers is how to resolve these issues without (1)
losing the benefits of standardization and (2) incurring a host of problems that are often linked to
variety. These include increasing the resources needed to achieve design variety; increasing variety in
the production process, which would add to the skills necessary to produce products, causing a
decrease in productivity; creating an additional inventory burden during and after production, by
having to carry replacement parts for the increased variety of parts; and adding to the difficulty of
diagnosing and repairing product failures. The answer, at least for some companies, is mass
customization, a strategy of producing standardized goods or services, but incorporating some degree
of customization in the final product or services. Several tactics make this possible. One is delayed
differentiation, and another is modular design.

Reliability
Reliability is a measure of the ability of a product, part or system to perform its intended function
under a prescribed set of conditions. It is the probability that an item will function as planned over a
given time period. Reliability is always specified with respect to normal operating conditions which
are taken into considerations while designing the product for reliability. Reliability of a product can
be improved by improving the reliability of the components used in the product, by reducing the
number of components used and using backups in case certain components fail in operation.
The importance of reliability is underscored by its use by prospective buyers in comparing
alternatives and by sellers as one determinant of price. Reliability also can have an impact on repeat
sales, reflect on the product’s image, and, if it is too low, create legal implications.
Potential Ways to Improve Reliability
1. Improve component design.
2. Improve production and/or assembly techniques.
3. Improve testing.
4. Use backups.
5. Improve preventive maintenance procedures.
6. Improve user education.
7. Improve system design.
 A fundamental question concerning improving reliability is: How much reliability is needed?
Obviously, the reliability needed for a household light bulb isn’t in the same category as the reliability
needed for an airplane. So the answer to the question depends on the potential benefits of
improvements and on the cost of those improvements. Generally speaking, reliability improvements
become increasingly costly. Thus, although benefits initially may increase at a much faster rate than
costs, the opposite eventually becomes true. The optimal level of reliability is the point where the
incremental benefits received equals the incremental cost of obtaining it. In the short term, this trade-
off is made in the context of relatively fixed parameters (e.g., costs). However, in the longer term,
efforts to improve reliability and reduce costs can lead to higher optimal levels of reliability.

Modular Design
Modular design is a form of standardization. Modules represent groupings of component parts into
subassemblies, usually to the point where the individual parts lose their separate identity. One
familiar example of modular design is computers, which have modular parts that can be replaced if
they become defective. By arranging modules in different configurations, different computer
capabilities can be obtained. It is the creation of products from some combination of basic, pre-
existing subsystems known as modules. In this approach, products are designed in easily segmented
components or modules. This design offers flexibility to both production (manufacture and assembly)
and marketing. The modular design concept gives consumers a range of product options and offers
considerable advantages in manufacturing and product design.
One advantage of modular design of equipment compared with non-modular design is that failures
are often easier to diagnose and remedy because there are fewer pieces to investigate. Similar
advantages are found in ease of repair and replacement; the faulty module is conveniently removed
and replaced with a good one. The manufacture and assembly of modules generally involve
simplifications: fewer parts involved, so purchasing and inventory control become more routine,
fabrication and assembly operations become more standardized, and training costs often are
relatively low.

Designing for Manufacturing

Design needs to clearly understand the capabilities of production (e.g., equipment, skills, types of
materials, schedules, technologies, special abilities). This helps in choosing designs that match capabilities.
When opportunities and capabilities do not match, management must consider the potential for
expanding or changing capabilities to take advantage of those opportunities.
The term Design for Manufacturing (DFM) is used to indicate the designing of products that are
compatible with an organization’s capabilities. A related concept in manufacturing is Design for
Assembly (DFA). A good design must take into account not only how a product will be fabricated, but
also how it will be assembled. Design for Assembly focuses on reducing the number of parts in an
assembly, as well as on the assembly methods and sequence that will be employed. Another, more
general term, manufacturability, is sometimes used when referring to the ease with which products can
be fabricated and/or assembled.
DFMA is the process of designing a product so that it can be produced easily and economically.
Designing for manufacture includes the following guidelines:
 Designing for minimum number of parts.
 Developing modular design.
 Designing for minimum part variations and
 Designing parts for ease of fabrication.
Concurrent Engineering
Concurrent engineering means bringing design and manufacturing people together early in the
design phase to simultaneously develop the product and processes for manufacturing the product.
Concurrent engineering helps to improve the quality of early design decisions and thereby reduces
the length and cost of design process. Recently this concept has been enlarged to include
manufacturing personnel, design personnel, marketing and purchasing personnel in loosely
integrated cross-function teams. In addition, the views of suppliers and customers are also sought
frequently. This will result in product designs that will reflect customer wants as well as
manufacturing capabilities in the design stage itself.
In other words, to achieve a smoother transition from product design to production, and to decrease
product development time, many companies are using simultaneous development, or concurrent
engineering.

Phases in Product Design and Development

Product design deals with converting of ideas into reality. Developing a new product is really a complex job.
A new product design has the following development processes (as shown in figure 3.6).
Figure 3.6: Product Development Process

Need Feasibility Study/ Product

Advance Design
Identification Planning

Product Evaluation Production Process Detailed Engineering

and Improvement Design and Development Design

Product Use and

Support

1. Need Identification
The design process begins with understanding the customer and actively identifying customer needs.
Ideas for new products or improvements to existing products can be generated from many sources,
including a company's own R & D department, customer complaints or suggestions, marketing research,
suppliers, and salespersons in the field, factory workers, and new technological developments.
Competitors are also a source of ideas for new products or services. Pure research and applied research is
also used for identification of customer needs.
2. Feasibility Study /Product Planning
The feasibility study includes several types of analyses, beginning with a market analysis. The market
analysis assesses whether there's enough demand for the proposed product to invest in developing it
further. If the demand potential exists, then there's an economic analysis that looks at estimate of
production and development costs and compares them to estimated sales volume. Finally, there are
technical and strategic analyses that answer such questions as:
 Does the new product require new technology?
 Is the risk or capital investment excessive?
  Does the company have sufficient labour and management skills to support the required technology?
 Is sufficient capacity available for production?
 Does the new product provide a competitive advantage for the company?
 Does it draw on corporate strengths?
 Is it compatible with the core business of the firm?
Performance specifications are written for product concepts that pass the feasibility study and are
approved for development. They describe the function of the product-that is, what the product should do
to satisfy customer needs (Russell & Taylor, 2009).
3. Advance Design
Basic and applied researchers investigate technical feasibility and identify in greater detail the tradeoffs in
product design. Promising design alternatives are evaluated according to critical parameters to determine
whether design support such as analytical testing, experimentation, physical modeling, and prototype
testing will be required (Everett, E. et al 1992).
Rapid prototyping creates preliminary design models that are quickly tested and either discarded or
further refined. Designers take general performance specifications and translate them into a physical
product or service with technical design specifications. The process involves building a prototype,
testing the prototype, revising the design, retesting, until a viable design is determined. It involves
form, functional and production design.
Form Design: Form design refers to the physical appearance of a product - its shape, colour, size, and
style. Aesthetics such as image, market appeal, and personal identification are also part of form design.
Functional Design: Functional design is concerned with how the product performs. It seeks to meet the
performance specifications of fitness for use by the customer.
Production Design: Production design is concerned with how the product will be made. During the
design stage itself the manufacturing aspects should be considered.
4. Detailed Engineering Design
In this stage, a series of engineering activities to develop a detailed definition of the product, including its
subsystems and components, materials, sizes, shapes, and so on. Design engineers now design the
components that will constitute the product so that it has the required features and gives the desired
benefits. Technical expertise of the company comes to the fore during this stage of the product
development process.
In this stage, operations managers should provide design engineers with information about the
producibility of the components being designed. Operations managers should be included in decisions
about equipment design, since they know more about equipment than do design engineers. If the product
requires a new material that has special properties, materials managers and suppliers should be
consulted. Design engineers must be keenly aware that the product must be designed for followings:
a. Design for Functionality: The product should serve the customer needs for which it is being designed.
b. Design for Reliability: The product should function adequately over a defined period of time.
c. Design for Maintainability: Maintenance processes should not be cumbersome, time consuming, and
expensive.
d. Design for Producibility: The product should be easy to manufacture.
5. Production Process Design and Development
Working with the detailed product design, engineers and manufacturing specialists prepare plans for
materials acquisitions, production, warehousing, transportation, and distribution. Activities here,
however, go beyond just hardware considerations: This stage involves planning, too, for production and
 control systems, computer information systems, and human resource systems (Everette E., et. al. 1992).
6. Product Evaluation and Improvement
Customers’ feedback is tracked, and failure data are analyzed. Formal research is conducted to
understand customers’ experience of the product. The company keeps itself updated on product’s
underlying technologies and process technologies. Product is redesigned if customer’s feedback is
persistently negative or if new technological breakthroughs enable design and production of a better
product.
In other words, most products are continually reevaluated for improvement possibilities throughout their
lives. Field performance and failure data, technical breakthroughs in materials and equipment, and formal
research al are used to monitor, analyze, and redesign the product.
7. Product Use and Support
Customers are trained to use the product. It is important that customers use all the feature of the product
and get all the benefits that the product is capable of providing. Customers will not rate the product
highly if they do no use all the benefits that the product is capable of providing. For example, less tech-
savvy customers use their smarts phones just to make calls and send messages.
Similarly, an important stage of product development considers support for the consumer who uses the
product. Support systems might
 Educate users on specific application of the product.
 Provide warranty and repair service,
 Distribute replacement parts or
 Upgrade the product with design improvements.

Computer Aided Design (CAD)

Computers are increasingly used for product design. CAD uses computer graphics for product
design. The designers can modify an existing design or create a new design on a computer monitor
screen by means of a keyboard or a joy stick. The printed version of the completed design can be
taken and also the design can be stored electronically. A number of products such as printed circuit
boards, transformers, automobile parts, air craft parts etc. can be designed using CAD.
A major benefit of CAD is the increased productivity of designers. No longer is it necessary to
laboriously prepare mechanical drawing of products or parts and revise them repeatedly to correct
errors or incorporate revisions. A rough estimate is that CAD increases the productivity of designers
from 3 to 10 times. A second major benefit of CAD is the creation of a database for manufacturing that
can supply needed information on product geometry and dimensions, tolerances, material
specifications, and so on. It should be noted, however, that CAD needs this database to function and
that this entails a considerable amount of effort.
Some CAD, systems allow the designer to perform engineering and cost analyses on proposed
designs. For instance, the computer can determine the weight and volume of a part and of stress
analysis as well. When there are a number of alternative designs, the computer can quickly go
through the possibilities and identify the best one, given the designer’s criteria.
Service Design
There are many similarities between product and service design. However, there are some important
differences as well, owing to the nature of services. One major difference is that unlike manufacturing,
where production and delivery are usually separated in time, services are usually created and delivered
simultaneously. Let’s begin with some key definitions.
Service refers to an act, something that is done to or for a customer (client, patient, etc.). It is provided by a
service delivery system, which includes the facilities, processes, and skills needed to provide the service.
The ability to create and deliver reliable customer-oriented service is often a key competitive differentiator.
Service design begins with the choice of a service strategy, which determines the nature and focus of the
service, and the target market. This requires an assessment by top management of the potential market
and profitability (or need, in the case of a nonprofit organization) of a particular service, and an
assessment of the organization’s ability to provide the service. Once decisions on the focus of the service
and the target market have been made, the customer requirements and expectations of the target market
must be determined.

Figure: .Doctor's Service as a Production System

Inputs:
 Patients Transformation or Conversion Process
 Nurses Outputs:
 Doctors History Medical Exam Tests Prescription  Cared
 Test Equipments Patient
 Drugs

Two key issues in service design are the degree of variation in service requirements and the degree of
customer contact and customer involvement in the delivery system. These have an impact on the degree to
which service can be standardized or must be customized. The lower the degree of customer contact and
service requirement variability, the more standardized the service can be. Service design with no contact
and little or no processing variability is very much like product design. Conversely, high variability and
high customer contact generally mean the service must be highly customized. A related consideration in
service design is the opportunity for selling: The greater the degree of customer contact, the greater the
opportunities for selling.
An effective and efficient manager must try to identify optimum size of the service in a competitive
situation for his/her organization; otherwise organization may lose valuable customers. The concept of
optimum size of the service can be illustrated with the help of following figure:
Figure: Optimum Size of the Service in a Competitive Market

If High Quality Possibility in

High Cost of High Charge for
Service is Losing
Service Service
Designed Customers

Optimum
BALANCED SIZE OF SERVICE
Size of the
Service
If Low Quality Possibility in
Low Cost of Low Charge for
Service is Losing
Service Service
Designed, Customers
 Differences between Product and Service Design
Service operations managers must contend with issues that may be insignificant or nonexistent for
managers in a production setting. These include the following:
1. Products are generally tangible; services are generally intangible. Consequently, service design often
focuses more on intangible factors (e.g., peace of mind, ambiance) than does product design.
2. In many instances services are created and delivered at the same time (e.g., a haircut, a car wash). In such
instances there is less latitude in finding and correcting errors before the customer has chance to discover
them. Consequently, training, process design, and customer relations are particularly important.
3. Services cannot be inventoried. This poses restriction on flexibility and makes capacity issues very
important.
4. Services are highly visible to consumers and must be designed with that in mind; this adds an extra
dimension to process design, one that usually is not present in product design.
5. Some services have low barriers to entry and exit. This places additional pressures on service design to be
innovative and cost-effective.
6. Location is often important to service design, with convenience as a major factor. Hence, design of
services and choice of location are often closely linked.
7. Service systems range from those with little or no customer contact to those that have a very high degree
of customer contact. Here are some examples of those different types:
a. Insulated technical core; little or no customer contact (e.g., software development).
b. Production line; little or no customer contact (e.g., automatic car wash).
c. Personalized service (e.g., haircut, medical service).
d. Consumer participation (e.g., diet program, dance lessons).
e. Self-service (e.g., supermarket).
f. If there is little or no customer contact, service system design is like product system design.
8. Demand variability alternately creates waiting lines or idle service resources.
Unit 3 Capacity Planning

3,1 Defining Capacity planning

Capacity refers to the ability to receive, hold, store or accommodate in a period of time. It is the rate of
productive capability of a facility. It is a maximum productive capability of a facility and usually expressed
as volume of output per period of time. Similarly, capacity can be called as the maximum rate of output
from a process. The capacity often determines capital requirements and therefore a large portion of fixed
cost. Capacity also determines if demand will be satisfied or if facilities will be idle. If the facility is too
large, portions of it will sit idle and add cost to existing production. If the facility is too small, customers
and perhaps entire markets are lost. So, determining facility size, with an objective of achieving high levels
of utilization and a high return on investment, is critical or difficult.
Figure 3.1 Basic Components of Capacity Planning

Financial Position (Investment Capability)

Target Customers (Age wise, Sex wise etc)
Components of
Production Units (Including Quality)
Capacity Planning
Ability to Receive, Store and Delivery
Particular Point of Time (Time Factor)

Capacity refers to an upper limit or ceiling on the load that an operating unit can handle. The load might
be in terms of the number of physical units produced (e.g., bicycles assembled per hour) or the number of
services performed (e.g., computer upgraded per hour). The operating unit might be a plant, department,
machine, store, or worker. Capacity needs include equipment, space, and employee skills.
Some basic questions in capacity planning are the following:
1. What kind of capacity is needed?
2. How much is needed?
3. When is it needed?
The question of what kind of capacity is needed depends on the products and services that management
intends to produce or provide. Hence, in a very real sense, capacity planning is governed by those choices.
Forecast are key inputs used to answer the questions of how much capacity is needed and when is needed.
Capacity planning is a long-term strategic decision (also referred to as strategic capacity planning) that
establishes a firm’s overall level of resources. Capacity may be defined as the amount of resource inputs
available relative to output requirements over particular period of time.
The objective of strategic capacity planning is to provide an approach for determining the overall level of
capital intensive resources-facilities, machinery, equipment and overall size of labour force-that best
support the firm’s long-range competitive strategy. The level of capacity selected has a critical impact on
the firm’s ability to respond to customer demand (i.e., response rate), its cost structure, its inventory
policies and its management and staff support requirements. Capacity decisions affect product lead time,
customer responsiveness, operating costs and a firm’s ability to compete. Inadequate capacity can result in
loss of customers and limited growth. On the other hand excess capacity can result in under utilization of
machines, equipment and labour, excess inventory, higher costs and lesser profits.
The goal of capacity planning is to achieve a match between the long-term supply capabilities of an
organization and the predicted level of long-term demand. Organizations become involved in capacity
planning for various reasons. Among the chief reasons are changes in demand, changes in technology,
changes in the environment, and perceived threats or opportunities. A gap between current and desired
capacity will result in capacity that is out of balance. Overcapacity causes operating costs that are too high,
while under-capacity causes strained resources and possible loss of customers.

Defining and Different Measures of Capacity

Capacity is measured as the rate of the output per unit of time. Mathematically,
Output
Capacity = Time

Capacity often refers to an upper limit on the rate of output. Even though this seems simple enough, there
are subtle difficulties in actually measuring capacity in certain cases. These difficulties arise because of
different interpretations of the term capacity and problems with identifying suitable measures for a
specific situation.
In manufacturing oriented organization, capacity can be expressed on the basis of output whereas in
service oriented organization, capacity can be expressed on the basis of input. It is simple to measure
capacity while there are similar natures of products. When diverse natures of products are produced
capacity measurement becomes complex.
In selecting a measure of capacity, it is important to choose one that does not require updating. No single
measure of capacity will be appropriate in every situation. Rather, the measure of capacity must be
tailored to the situation. Table below provides some examples of commonly used measures of capacity.
Table Capacity Measurement in Different Organizations
Types of organization On the basis of output Capacity measures
Steel producer Tons of steel/shift
Automobile manufacturer Number of autos
Brewery Barrels of beer
Cannery Tons of food
Power company Megawatts of electricity
Sugar factory Tons of sugar/shift
Oil refineries Gallons of oil refined/day
On the basis of input
Hospital Number of beds
Tax office Number of accountants
Warehouse Square/cubic feet of storage space
Job shop Number of labour or machine hours
Airlines Number of seats
Movie theater Number of seats
Restaurant Number of seats or tables
University Number of students and or faculty
Merchandising Square feet of display or sales area
Source: Taken and restructured from Stevenson, W. J. (2009). “Operations Management”
However, capacity can be measured in different ways and has different meaning to different people at
different level of management. The top level of management is concerned with aggregate capacity of all
plants of the firm and financial resources required supporting these plants. Plant manager is concerned
with planning of capacity of individual plant under his control. The capacity planning is the process of
determining the capacity requirement for future to meet the production plan.

Determinants of Effective Capacity

The efficiency of operations manager depends on the expertise to determine effective capacity of the
company. Efficiency is the percentage of effective capacity actually achieved. Effective capacity decision is
the strategic decision. There are various factors to be evaluated and incorporated in the decision making
process for the determination of effective capacity. The factors determining effective capacity are as
follows:
 Facilities
The design of facilities, including size and provision for expansion, is key. Location factors, such as
transportation costs, distance to market, labor supply, energy sources, and room for expansion, are
also important. Likewise, layout of the work area often determines how smoothly work can be
performed, and environmental factors such as heating, lighting, and ventilation also play a significant
role in determining whether personnel can perform effectively or whether they must struggle to
overcome poor design characteristics.
 Product and Service Factors
Product or service design can have a tremendous influence on capacity. For example, when items are
similar, the ability of the system to produce those items is generally much greater than when successive
items differ. Thus, a restaurant that offers a limited menu can usually prepare and serve meals at a faster
rate than a restaurant with an extensive menu. Generally speaking, the more uniform the output, the more
opportunities there are for standardization of methods and materials, which leads to greater capacity. The
particular mix of products or service rendered also must be considered since different items will have
different rates of output.
3. Process Factors
The quality capability of a process is an obvious determinant of capacity. A more subtle determinant
is the influence of output quality. For instance, if quality of output does not meet standards, the rate of
output will be slowed by the need for inspection and rework activities. Productivity also affects
capacity. Process improvements that increase quality and productivity can result in increased
capacity.
4. Human Factors
The tasks that make up a job, the variety of activities involved, and the training, skill, and experience
required to perform a job all have an impact on the potential and actual output. In addition, employee
motivation has a very basic relationship to capacity, as do absenteeism and labor turnover.
5. Operational Factors
Differences in capabilities of alternatives equipments and differences in job requirements may create
scheduling problems. Other factors such as inventory decisions, late deliveries by suppliers, quality of
purchased materials and parts, inspection and quality control procedures may also have an impact on
effective capacity.
Table Determinants of Effective Capacity
Facilities Process Product/Service
Design Quantity capabilities Design
Location Quality capabilities Product or service mix
Layout
Environment

Policy Operational Human factors Supply Chain/External factors

Scheduling Job content Product standards
Materials management Job design Safety regulations
Quality assurance Training and experience Unions
Maintenance policies Motivation Pollution control standards
Equipment breakdowns Compensation
Learning rates
Absenteeism
6. Supply Chain and External Factors
Supply chain factors must be taken into account in capacity planning if substantial capacities changes
are involved. Key questions include: What impact will the changes have on suppliers, warehousing,
transportation, and distribution? If capacity will be increased, will these elements of the supply chain
be able to handle the increase?
Product standards, especially minimum quality and performance standards can restrict
management’s options for increasing and using capacity. Thus, pollution standards on products and
equipment often reduce effective capacity, as does paperwork required by government regulatory
agencies by engaging employees in non-productive activities. A similar effect occurs when a union
contract limits the number of hours and type of work an employee may do.

Unit 4: Process Selection and Facility Layout

Types of Manufacturing Processes

Manufacturing firms use different inputs (raw material, human resource, parts and components) and
convert it into finished goods (product and services) using the machines and equipments (processing).
There are different types of manufacturing process technologies and among them one appropriate
technology should be selected based on product nature, flexibility of manipulation, time required in
production process, cost of production, the change of by-product production, skill and knowledge
required in human resource for completing the production, size and capacity of production, mass a
intermittent production etc. The manufacturing process technology can be divided into following types:
Figure: Types of Manufacturing Process Technology

Project Process Technology

Job-shop Process Technology
Manufacturing Process
Technology Batch Process Technology
Assembly Line Process Technology
Continuous Flow Process Technology

1. Project Process Technology

Project process technology is generally used for the company producing the similar products but
having the unique character. Some of the examples are bridge, big houses, hydro-power, roads, etc. In
such technology, customer generally becomes the one time customer since once they have the product
that is going to fulfill their requirement for whole life. Project manufacturing businesses require
specialized technology but the product demand is infrequent and low in volume. It needs to prove the
tendered solutions in advance, prior to delivery to customers, and speed up time to profit of their
customers. Project manufacturing businesses are being driven by their customers to provide solutions
which improve time to profit.
2. Job-shop Process Technology
Job shops are generally small manufacturing operations which handle specialized manufacturing
processes such as small customer orders or small batch jobs. Job shops move on to different jobs when
each job is completed with specialized skills and processes. In this technology, it is difficult to predict
the materials requirement because all the goods are produced to meet the orders of the customers
 rather than sales forecast and stock. There is no standardization of raw materials, process, products
and other facilities in job shop so, it is difficult to make planning of resources in an organization. A
good example of job production is the work carried out by the construction companies such as offices.
Examples from the service industries include tailoring shop, hair cutting shop, printing shop,
furniture shop, etc.
3. Batch Process Technology
Batch process technology is carried on when the output variety is large or when heavy investment is
required. In this technology, products are produced in a specific number of quantities based on
customer order or demand with use of highly sophisticated technologies, different inputs, different
operations, and the time taken up by each of output also varies. Batch production is a method used to
produce or process any product in groups or batches. An example would be when a bakery produces
different types of bread separately and each object is not produced continuously. It is used in many
different ways and is most suited to when there is a need for a quality/quantity balance. Some
examples of batch processing technology are heavy equipments like dozers, special computers,
special equipments like robots and electronic devices, etc.
4. Assembly Line Process Technology
Assembly line technology is used when there is need of higher volumes of more standardized goods
or services. This type of process has specialized equipment, skilled manpower and management
system to produce limited range and high volume of products with similar types. This type of process
is suitable to "manufacture-to-stock" strategy with standard products held in finished goods
inventory. Assembly line process is less flexible in comparison to job process and batch process
technology. The products produced in assembly line process technology include automobiles, home
appliances, television sets, radio, computers, toys, motorbike, VCR, VCD, etc.
5. Continuous Process Technology
Continuous flow process technology is used when the products are highly specialized/standardized and
large volumes of products are produced for stocks. In continuous process, industries manufacture
highly extensive long range resource requirement and they are more capital intensive. This
production process is concerned with transforming a range of inputs into those outputs that are
required by the market. It uses standard raw materials; rigid management technique. It has inflexible
production system. Some examples of goods manufactured by continuous process are noodles,
biscuits, soap, newspapers, soft drinks, etc.

Manufacturing process technology begins from job shop process technology at the start up phase and
move towards a continuous process technology. The volume and standardization are low at the
startup phase and high during the maturation and decline. Unit manufacturing cost at the startup is
lower than maturation and decline stage.

Flexible Manufacturing System (FMS)

A flexible manufacturing system (FMS) is a group of machines that include supervisory computer control,
automatic material handling, and robots or other automated processing equipment. Reprogrammable
controllers enable these systems to produce a variety of similar products. In other words, flexible
manufacturing is computer controlled process technology suitable for production of variety products. In
other words, it is a computer-controlled system. It contains several workstations, each geared to different
operations.
Under this system, machines are designed to handle intermittent processing requirements with some of
the benefits of automation and some of the flexibility of individual, or stand-alone, machines. For this
system, automated equipments are used to move materials, parts and components to appropriate work
stations, and then into the programmed machines that select, position, and activate specific tools to each
job. If one of the jobs is finished, computer signals for next quantity or batch and then automatically
repositions, and retools accordingly. Flexible manufacturing systems offer reduced labor costs and more
consistent quality compared with more traditional manufacturing methods, lower capital investment and
higher flexibility than “hard” automation, and relatively quick change over time. Flexible manufacturing
systems often appeal to managers who hope to achieve both the flexibility of job shop processing and the
productivity of repetitive processing systems.
Advantages of Flexible Manufacturing System
1. Greater Flexibility
2. Reduction in direct labor
3. Reduced Capital Investment
4. Shorter Response Time
5. Consistent Quality
6. Better control of work
Disadvantages of Flexible Manufacturing Management
1. It can only produce intermediate variety of items at intermediate volumes.
2. All facilities cannot make flexible. Therefore some parts and components should be standardized to
minimize use of tools and equipments.
3. It requires high investment.
4. It requires a long planning cycle and development cycle to ensure its success.

Facilities Layout
Layout is the physical arrangement of plant or industrial facility in selected location either in existing or in
new one. It is related to a number of aspects of production and operations management. Layout is
considered as disposition of various parts, components and space of plants, equipment and other physical
properties. It is a method of allocating machineries and equipment to the various production place or
processes.
Layout is a method of allocation of department upon a site, workgroup and equipment within department,
workstations, machines and stock-holding points within production facilities. Therefore, it is concerned
with configuration of department, work centers and equipment in the conversion process.
According to Moore, "Plant layout is a plan of an optimum arrangement of facilities including personnel,
operating equipment, storage space, material handling equipment and all the supporting services along
with the design of best structure to contain all these facilities."

Types of Layout
Layouts cannot be appropriate for a specific organization. It depends upon the nature of product and
production plant. Layouts are classified under the following categories:
1. Process Layout (Functional Layout)
 Process layout is also known as functional layout. It arranges facilities and equipments in groups
according to the functions they perform. All machines performing similar type of operations is grouped at
one location in the process layout e.g. all lathes, milling machines etc. are grouped in the shop will be
clustered in like groups. Process layout can be used to provide highly customized product-service
bundles because it is flexible.
A process layout is characteristic of intermittent operations, service shops, job shops, or batch production,
which serve different customers with different needs. The volume of each customer’s order is low and the
sequence of operations required to complete a customer's order can vary considerably. The equipment in
a process layout is of general purpose, and the workers are skilled at operating the equipment in their
particular department. In this layout, all job-shop types of production, work areas are grouped together as
shown in figure 4.4 and 4.5. Hospital, university, distribution warehouses, office building, tailor shop,
work shop, printing press etc. use such type of layout.
Figure 4.4: Process Layout for a Medical Center

Emergency Pharmacy Patient out

Pediatrics

Obstetrics/ Operation Theater

Outdoor Patient Gynecology
Department (OPD)
Neurology
Pharmacy
Patient in

ECG

USG

X-Ray Patient out

Patient out

Pathology

Figure 4.5: Process Layout of an Automobile Service Station

Office Spare-Parts Oil Replacement Wheel

Store alignment
Entrance

Car Washing Dent Repairs Interiors Door Electrical

and Cleaning Repairs etc. Repairs

Under Body
Paint Booth Engine Repairs Repairs Final Inspection

Exit

Source: Aryal, L. P. (2011). “Production and Operations Management”

Advantages
 Flexibility of equipment and personnel.
 Lower investment on account of comparatively less number of machines and lower cost of general
purpose machines.
 Higher utilization of production facilities.
 Greater flexibility with regards to work distribution of machineries and workers.
  Variety of job makes the job challenging and interesting.
 Supervisors will become highly knowledgeable about the functions under their department.
Disadvantages
 Back tracking and long movement may occur in handling of materials.
 Material handling cannot be mechanized which adds to cost.
 Process time is longer which reduce the inventory turnover and increases the investment in
inventories.
 Production planning and control is difficult.
 More space is required.
 Lowered productivity due to number of set ups.

2. Repetitive Product/ Product Layout (Line Layout)

Product layout is an arrangement of facilities and equipment in the same sequence, as the order of the
operations needed to complete each unit of the product, or the service offered. In a product layout,
machines and equipments of equal capacities are ideally arranged in a line and are employed in each
workstation in order to achieve balanced capacity. Such layouts are characteristics of mass continuous
production. It is suitable for continuous process where small varieties of large volume of standardized
products are produced. They are found in such industries as cement manufacturing, oil refining,
machining of engine cylinder blocks, domestic appliances, automobile assembly, automatic car washes,
beverage bottlers, automobile makers, textiles, paper mills and mass production of hard discrete items.
Figure 4.6: Product Layout

Turning Milling Drilling

Assembly
operation operation operation

Packing Welding Inspection Testing

Shipping

Advantages
 Less space for same volume of product in comparison to process layout.
 It reduces the wastage due to continuous production.
 Product completes in lesser time, less inventory in process.
 Better co-ordination, easy production planning.
 Low labour requirement and so does the supervision.
 Less skill labour can also operate normal plants.
Disadvantages
 Once one machine is out of duty, all product process is interrupted.
 It needs heavy initial investment and even a small technical adjustment can lead to higher cost, larger
time.
 Supervisors should be expert which may raise cost.
 One mechanism can produce single type of product once.
 Only in mass production cost efficiency can be achieved.
Product layout is further classified into different layouts. They are:
1. Straight Line Product Layout: It is fixed as a thread and machines are arranged in a straight line as
shown below:
Figure 4.7: Straight Line Product Layout

Input M1 M2 M3 Finished Product

2. U-shaped Product Layout: The same straight line layout can be turned into "U" shape according to the need
of production management. Here, machines are placed in U-shape as shown below:

Figure 4.8: U-shaped Product Layout

Input Finished Product

M1 M5

M2 M3 M4

3. L-shaped Product Layout: In L-shaped product layout, the machines are arranged in "L" shape as
shown in figure 4.9.
Figure 4.9: L-shaped Product Layout

Input

M1

M2 M3 M4 Finished Products

4. Serpentine Product Layout: The layout having the shape of a snake is known as serpentine layout. Beer and
cold drinks factory usually use this type of layout. The layout is as shown below:
 Figure 4.10: Serpentine Production Layout
Input M1 M2 M3

M6 M5 M4

M7 Finished Products

3. Fixed Position Layout

Fixed position layout is an arrangement of facilities and equipment, which facilities the flow of resources
needed such as workers, equipment, materials, etc. to the term under production, or the item which is being
serviced. The fixed position layout is characteristic of jobs like assembling large steam turbines, ship building,
bus body building, air craft’s making, building construction, dam construction, etc. In this case, both people
and the machines along with tools have to be brought to the product being made. So, it is also known as
stationary layout and is a unique type as compare with others as the activities formed in this layout are just
opposite to others.
Figure 4.11: Fixed Position Layout
INDEX

Labour 1 Labour 2 Labour

Equipment A Equipment C Equipment
(fixed) Material

Work Area

Position
Equipment B Material Equipment D

Facilities

Advantages
 People can be assigned from starting to end of process.
 It involves very longer movement of materials.
 It ensures maximum flexibility of adjustments.
 A number of projects can be undertaken from same type of layout.
Disadvantages
 It needs huge investments and very hard to co-ordinate people and machines.
 It involves high equipment handling cost.
 It may not have easy maintenance service on spot (site)
 It needs complete system for control purpose.
4. Combination Layout
Combination layout is also called the hybrid or mixed type of layout because it is combined with process
layout and product layout. In this layout, production area is laid out by process, whereas another area is
laid out by product and sometimes fixed position layout. Therefore, it is a combination of process,
product and fixed layout. A very common example of combination layout is the manufacture of the
electronic company to produce refrigerator, radio, computer, television, etc. To produce various parts and
sub components, the firm use process layout whereas for metal stamping, heat-treating and welding
process the firm use fixed position layout and finally assembly is done for finished goods by using
product layout.
Figure 4.12: Combination Layout
Advantages
 It is flexible type of layout.
 It is useful when you need various processes and you need to produces different component goods.
 Advantage and efficiencies of different layout can be achieved.
 Disadvantages of a single layout can be overcome by such layout.
Disadvantages
 Needs huge investment, harder in control and co-ordination.
 Useful for only firm producing different goods.
 Combination layout requires combination of skills supervision, technology and physical components.
5. Cellular Layout / Group Technology Layout
Cellular layout assigns dissimilar machines or activities are grouped into work centers to work on
products that have similar shapes and processing requirements. Based on the concept of group
technology, dissimilar machines or activities are grouped into work centers, called cells, to process
families of parts or customers with similar requirements. The cells are arranged in relation to each other
so that material movement is minimized.
The application of group technology involves two basic steps. The first step is the determination of
component families or groups. The second step in applying GT is to arrange the plant's equipment into
cells, each containing the equipment used to process a particular family of components. Cellular layouts
can be much more flexible than product layouts and much more efficient than process layouts. Depending
on the way they are run, they can deliver a mixture of the advantage and disadvantages of process and
product layouts.
Advantages
 Reduced material handling and transit time.
 Reduced setup time.
 Reduced work-in-process inventory.
 Better use of human resources.
 Easier to automate.
Disadvantages
 Inadequate part families
 Poorly balanced cells
 Expanded training and scheduling of works.
 Increased capital investment.
 Comparison between Product Layout Vs Process
Layout
The differences between product layout and process layout are as follows:
Table Different between Product and Process Layout
Basic Product Layout Process Layout
Description Sequential arrangement of activities Functional grouping of activities
Type of process Continuous, mass production, mainly assembly Intermittent, job shop, batch production, mainly fabrication
Product Standardized, made to stock Varied, made to order
Demand Stable Fluctuating
Volume High Low
Equipment Special purpose General purpose
Workers Limited skills Varied skills
Inventory Low-in-process, high finished High-in-process, low finished goods
Storage space Small Large
Material handling Fixed path (conveyor) Variable path (forklift)
Aisles Narrow Wide
Scheduling Part of balancing Dynamic
Layout decision Line balancing Machine Location
Goal Equalize work at each station Minimize material handling cost
Advantage Efficiency Flexibility
Source: Russell & Taylor, (2009). “Operations Management: Along the Supply Chain”

Unit 5: Facility Location

5.1 Concept of Location Decision

Facility location is the process of determining geographic sites for a firm's operations. Location choices can be
critically important for firms, and have a profound impact on a firm's value chain. For example, they can
affect the supplier relationship process: the expanding global economy gives firms greater access to suppliers
around the world, many of whom can offer lower input costs or better-quality services and products.
(Karajewski, Ritzman, Malhotra, 2009).
Location of facilities for operations is, thus, a long term capacity decision which involves a long-term
commitment about the geographically static factors that affect a business organization. Some changes and
adjustments in capacity at the location are always possible; however in most of the cases, it is not easy to change
the location of the operations base once such a base has been established.
Location decisions are usually made more frequent for service operations than manufacturing facilities.
Facilities for service related businesses tend to be smaller and less costly, although a hospital, or hotel can
require a huge investment and be very large. Services depend on a certain degree of market saturation; the
location is actually part of their product. Where to locate a manufacturing facility is also important, but for
different reasons, not the least of which is the very high expense of building a plant or factory. Although
the primary location criteria for a service related business is usually in access to customers, a different set
of criteria is important for a manufacturing facility. These include the nature of the labour force, and
labour costs, proximity to suppliers and markets, distribution and transportation costs, energy availability
and cost, the community infrastructure of roads, sewers, and utilities, quality of life in a community, and
government regulations and taxes. (Russell and Taylor, 2009). The location selection process is one of
gradually and methodically narrowing down the pool of alternatives until the final location is determined.
 Need and Importance of Location Decision
The location decision often depends on the type of business. For industrial location decisions, the strategy
is usually minimizing costs, although innovation and creativity may also be critical. For retail and
professional service organizations, the strategy focuses on maximizing revenue. Warehouse location
strategy, however, may be driven by a combination of cost and speed of delivery. The objective of location
strategy is to maximize the benefit of location to the firm. Facility location planning is more important for
new enterprises.
Existing organizations may need to make location decisions for a variety of reasons. Firms such as banks,
fast-food chains, supermarkets, and retail stores view locations as part of marketing strategy, and they
look for locations that will help them to expand their markets. Basically, the location decisions in those
cases reflect the addition of new location to an existing system. A similar situation occurs when an
organization experiences a growth in demand for its products or services that cannot be satisfied by
expansion at an existing location. The addition of a new location to complement an existing system is often
a realistic alternative.
Location decisions are also strategically important for other reasons as well. One is that they retail a long-
term commitment, which makes mistakes that are difficult to overcome. Another is that location decisions
often have an impact in investment requirements, operating costs and revenues, and operations. A poor
choice of location might result in excessive transportation costs, a shortage of qualified labor, loss of
competitive advantage, inadequate suppliers of raw materials, or some similar condition that is detrimental
to operations. For services, a poor location could result in lack of customers and/or high operating costs. For
both manufacturing and services, location decisions can have a significant impact on competitive advantage.
And another reason for the importance of location decisions is their strategic importance to supply chains.
The success of organization also depends on the location decision. Wrong location decision may doom the
business and its existence forever. However, it is very difficult to find ideal and perfect location for any
business. An established organization needs a good location planning decision for the following re asons:
 The availability and cost of resources like labour, raw materials and other supporting resources may
change.
 The geography of demand may shift. It may be desirable to change facility location to provide
before service to the customer.
 As the new market is opened, the added capacity should be located so that the market is served
effectively.
 Development of new technologies.
 Socio-political situations, economic conditions or government policy may change.

Factors Affecting Location Selection

Managers of both service and manufacturing organizations must weight many factors when
assessing the desirability of particular locations, including their proximity to customers and
suppliers, labour costs, and transportation costs. Managers can divide location factors into
dominant and secondary factors.
 Dominant factors are derived from competitive priorities (cost, quality, time and flexibility)
and have a particularly strong impact on sales or costs.
Secondary factors also are important, but management may downplay or even ignore some of
these secondary factors if other factors are more important.
Many factors influence location decision. However, it often happens that one or a few factors
are so important that they dominate the decision. For example, in manufacturing, the
potentially dominating factors usually include availability of an abundant energy and water
supply and proximity to raw materials. Thus, nuclear reactors require large amounts of water
for cooling, heavy industries such as steel and aluminum production need large amounts of
electricity, and so on. Transportation costs can be major factors. In service organizations,
possible dominating factors are market related and include traffic patterns, convenience, and
competitors’ locations, as well as proximity to the market. For example, car rental agencies
locate near airports and mid-city, where their customers are.

The factors affecting location decision in manufacturing organizations are as follows:

 Figure 3.4: Location Selection Decision

Location Selection Decision


 Selection of Region or Area Selection of Community Selection of the Site

 Availability of Raw Materials  Labour Facility  Soil, Size and Topography

 Location of Markets  Quality of Life  Easy Availability of Cheap
  Labour Supply  Community & Labour Attitudes Land
 Transportation Facilities  Local Taxes and Restrictions  Transport Facility
  Climate and Taxes  Finance and Research  Disposal of Waste Materials
 Power Sources Facilities  Water Supply
  Governmental Policies etc.  Other Factors  Risk of Uncertainties etc.

1. Selection of Region or Area

i. Availability of Raw Materials: As a manufacturing unit is engaged in the conversion of
raw materials into finished products, it is very essential that is should be located in a place
where the supply or raw materials is assured at minimum transport cost. Firms locate near or
at the source of raw materials for three primary reasons: necessary, perishability, and
transportation costs. Mining operations, farming, forestry, and fishing fall under necessity.
Obviously, such operations must locate close to the raw materials. Firms involved in canning
or freezing of fresh fruit and vegetables, processing of dairy products, baking, and so on, must
consider perishability when considering location. Transportation costs are important in
industries where processing eliminates much of the bulk connected with a raw material,
making it much less expensive to transport the product or material after processing. Examples
include aluminum reduction, cheese making, and paper production. Where inputs come from
different locations, some firms choose to locate near the geographic center of the sources. For
instance, steel producers use large quantities of both coal and iron ore, and many are located
somewhere between the Appalachian coal fields and iron ore mines. Transportation costs are
often the reason that vendors locate near their major customers. Moreover, regional
warehouses are used by supermarkets and their retail operations to supply multiple outlets.
Often the choice of new locations and additional warehouses reflects the locations of existing
warehouses or retail outlets.
Nearness to raw materials offers such advantages as:
a. Reduced cost of transportation;
b. Regular and proper supply of materials uninterrupted by transportation breakdowns; and
c. Saving in the cost of storage of materials.
ii. Location of Markets: After determining where the demand for services and goods is
greatest, management must select a location for the facility that will supply that demand.
Locating near markets is particularly important when the final goods are bulky or heavy and
outbound transportation rates are high. For example, manufacturers of products, such as
plastic pipe and heavy metals, all require proximity to their markets.
Profit-oriented firms frequently locate near the market they intend to serve as part of their
competitive strategy, whereas nonprofit organizations choose locations relative to the needs of
the users of their services. Other factors include distribution costs or the perishability of a
finished product.
Retail sales and services are usually found near the center of the markets they serve. Examples
include fast-food restaurants, service stations, dry cleaners, and supermarkets. Quite often their
products and those of their competitors are so similar that they rely on convenience to attract
customers. Hence, these businesses seek locations with high population densities or high traffic.
The competition/convenience factor is also important in locating banks hotels and motels, auto
repair shops, drugstores, newspaper kiosks, and shopping centers. Similarly, doctors, dentists,
lawyers, barbers, and beauticians typically serve clients who reside within a limited area.
Since goods are produced for sale, it is very essential that the factory should be located near
their market. A reduction in the cost of transporting finished goods to the market; the ability
to adjust the production programme to suit the likes and dislikes of consumers; the ability to
render prompt service to the consumers, provide after-sale services, and execute replacement
orders without delay- these are some of the advantages that accrue to the entrepreneur if
he/she establishes his/her factory near his market. Industries using pure or non-weight-losing
raw materials, industries producing perishable or bulky products and servicing units tend to
be located near their market. To be specific, pesticides and insecticides manufacturing
concerns, auto-servicing and repairing units, tyre retreading concerns, concerns
manufacturing wooden accessories for electrical wiring, distilled water concerns and hosiery
units, most be located near their market.
Locations of many government services are near the markets they are designed to serve.
Hence, post offices are typically scattered throughout large metropolitan areas. Police and
emergency health care locations are frequently selected on the basis of client needs. For
instance, police patrols often concentrate on high crime areas, and emergency health care
facilities are usually found in central locations to provide ready access from all directions.
ii. Labour Supply: Primary labor considerations are the cost and availability of labor, wage
rates in an area, labor productivity and attitudes toward work, and whether unions are a
serious potential problem.
Labor costs are very important for labor-intensive organizations. The shift of the textile
industry from the New England states to southern states was due partly to labor costs.
Skills of potential employees may be a factor, although some companies prefer to train new
employees rather than rely solely on previous experience. Increasing specialization in many
industries makes this possibility even more likely than in the past. Although most companies
concentrate on the supply of blue-collar workers, some firms are more interested in scientific
and technical people as potential employees, and they look for areas with high concentrations
of those types of workers.
 Worker attitudes toward turnover, absenteeism, and similar factors may differ among
potential locations- workers in large urban centers may exhibit different attitudes than
workers in small towns or rural areas. Furthermore, worker attitudes in different parts of the
country or in different countries may be markedly different.
Some companies offer their current employees jobs if they move to a new location. However,
in many instances, employees are reluctant to move, especially when it means leaving families
and friends. Furthermore, in families with two wage earners, relocation would require that
one wage earner give up a job and then attempt to find another job in the new location.
iv. Transportation Facilities: While making a study of a location, an entrepreneur considers
the question of the availability of transport facilities. Transport facilities are essential for
bringing raw materials and men to the factory and for carrying the finished products from the
factory to the market. A place which has well connected rail, road and water transport is ideal
for a plant location. It may be said that industry follows transportation. In other words, places
with well-developed means of transport attract industries. In extreme cases, transport may
follow industries. But generally speaking, a place with existing transport facilities is perfect for
locating a plant.
v. Climate and Taxes: Climate and taxes sometimes play a role in location decisions. For
example, a string of unusually severe winters in northern states may cause some firms to
seriously consider moving to a milder climate, especially if delayed deliveries and work
disruptions caused by inability of employees to get to work have been frequent. Similarly, the
business and personal income taxes in some states reduce their attractiveness to companies
seeking new locations. Many companies have been attracted to some Sun Belt states by ample
supplies of low-cost energy or labor, the climate, and tax considerations. Also, tax and
monetary incentives are major factors in attracting or keeping professional sport franchises.
 vi. Power Sources: Power is essential to move the wheels of an industry. Coal, electricity, oil
and natural gas are the sources of power. Because of coal is the source of power, as in the case
of the iron and steel industry, the factory has to be located near the coal fields. Examples of
such industries are the iron and steel industry in Germany, in Pennsylvania in the U.S.A. and
in Jamshedpur in India. Industries using electrically have to be located at a place where
electric power is available regularly and at cheap rates. The aluminum extraction plant and a
semi-mechanized bakery have to be located in places where electric power is cheaply available
in plenty. Electricity as a source of power has become very significant in modern industries
because of ease in handling, its cleanliness, flexibility and cheapness. In fact, its emergence as
a source of power has reduced the importance of coal as a natural factor influencing plant
location. Similarly, huge pipelines traversing long distances have kept up oil supplies to
Industries located in different regions.
vii. Government Policies: The influence of Government policies and programmes on plant
location is apparent in every country, particularly in planned economies like ours. In the name
of balanced regional development, many backward regions in India have selected for the
location of new industries, which would generate the region’s economy and on a larger
canvas, the national economy.

2. Selection of Community
Many communities activity try to attract new businesses, offering financial and other
incentives, because they are viewed as potential sources of future tax revenues and new job
opportunities. However, communities do not, as a rule, want firms that will create pollution
problems or otherwise lessen the quality of life in the community. Local groups may activity
seek to exclude certain companies on such grounds, and a company may have to go to great
lengths to convince local officials that it will be a “responsible citizen”. Furthermore, some
organizations discover that even though overall community attitude is favorable, there may
still be considerable opposition to specific sites from nearby residents who object to possible
increased levels of noise, traffic, or pollution. Examples of this include community resistance
to airport expansion, changes in zoning, construction of unclear facilities, and highway
construction.
i. Labour Facility: Despite the talk of mechanization and automation, the importance of
labour on the industrial side has not been completely lost. Labour is an important factor in the
production of goods. An adequacy of labour supply at reasonable wages is very essential for
the smooth and successful working of an organization. The development of the plantation
industry in Nepal has been due to, among other things, the availability of adequate labour at
cheap rates. The labour required may be skilled or unskilled. It is skilled labour which
influences plant location because unskilled labour is supposed to be available everywhere,
especially in our country.
ii. Quality of Life: Good schools, recreational facilities, cultural events, and an attractive
lifestyle contribute to quality of life. This factor can make the difference in location decisions.
Nowadays, more than 50 percent of new industrial jobs are being shifted towards non-urban
regions. Reasons for this movement include high costs of living, high crime rates, and general
decline in the quality of life in many large cities.
iii. Community and Labour Attitudes: Community attitude towards their work and towards
the prospective industries can make or mar the industry. The community attitudes towards
supporting trade union activities are important criteria. Facility location in specific location is
not desirable even though all factors are favouring because of labour attitude towards
management which brings very often the strikes and the lockouts.
vi. Local Taxes and Restrictions: Local authorities collect changes for the supply of water,
electricity and other facilities. They also collect various taxes from industrials units. They
impose restrictions on the location of new units in the public interest. It is natural, therefore,
for industrials to prefer an area where such taxes and restrictions are the least irksome.
iv. Finance and Research Facilities: Adequate capital is essential for the successful working
of any organization. A place where facilities for raising capital are available attracts new
industries. This is particularly true in developing countries, where capital is not available
uniformly throughout the country. In advanced countries, the case is different because, in
such counties, capital is distributed uniformly.
In the course of its working, a factory may encounter a number of problems. Whenever a
problem crops up, it has to be examined and a suitable solution has to be found. Moreover, a
manufacturing unit has to be dynamic, i.e., it should always be on the lookout for new
technology. For this purpose, research facilities are essential; and a place where such facilities
are available naturally attracts new industries.
v. Other Factors: Still other factors may need to be considered, including room for
expansion, construction costs, accessibility to multiple modes of transportation, the cost of
shuffling people and materials between plants, insurance costs, competition from other firms
for the workforce, local ordinances (such as pollution or noise control regulations), community
attitudes, and many others. For global operations, firms need a good local infrastructure and
local employees who are educated and have good skills. Many firms are concluding that large,
centralized manufacturing facilities in low-cost countries with poorly trained workers are not
sustainable. Smaller, flexible facilities located in the countries that the firm serves allow it to
avoid problems related to trade barriers like tariffs and quotas and the risk that changing
exchange rates will adversely affect its sales and profits.

3. Selection of the Site

i. Soil, Size and Topography: For factories producing engineering goods, the fertility or
otherwise of the soil may not be a factor influencing plant location. But for agro-based
industries, a fertile soil is necessary for ensuring a strategic plant location.
The area of the land should be such as to accommodate not only the existing manufacturing
facilities, but offer scope for future expansion programmes as well. Besides the area, the cost of
land deserves consideration. If the land is to be purchased, and if the place enjoys all the
facilities for plant location, its price should not affect the decision to locate the plant in that
particular place, because the cost of land forms a small percentage of the total fixed
investment. But if the land is to be leased, the question of rent, rates and taxes has to be
seriously considered because they constitute a part of the permanent working expense.
The topography of the place deserves consideration to some extent. A hilly, rocky and rough
terrain is unsuitable for plant location because a great deal of expenditure has to be incurred
to level it. In the absence of such leveling, the construction of the building and the installation
of plant equipment would be difficult tasks. Moreover, such places do not attract population;
and it is difficult and uneconomical to provide infrastructure facilities in such areas.
ii. Easy Availability of Cheap Land: Land is the basic necessity for the construction of a new
plant. Before deciding any site as a location for the factory establishment we have to analyze
availability and cost of land.
iii. Water Supply: In the manufacturing organizations, facility of water supply plays
important roles in manufacturing products. Therefore, before deciding any site for factory
establishment manager should analyze adequate water supply facility in that particular site.
iv. Transport Facility: Speedy transport facilities are needed for the regular and timely
supply of raw materials at low cost and for transporting finished products on time to the
market. Transport facilities with a good speed and capacity are needed for transporting
labourers and establishing contacts in the market, and controlling supply according to changes
in demand. A producer has to choose a speedy and cheap means of transport in a local site.
v. Disposal of Waste Materials: The problem of the disposal if an effluent is common to many
industries, particularly, chemical, sugar, steel and leather industries and breweries. The site
selected for the location of the plant should have provision for the disposal of waste. There must
be enough vacant land for the dumping of solid waste. For liquid waste, satisfactory sewer
connections or a river or sea should be available. Leather and chemical industries locate where
there is a provision for the disposal of waste.
vi. Risk of Uncertainties: Risk of change in demand have their impact on the trends in the
size of the firms. Firms have to face fluctuations in demand for their products and accordingly
adjust their policies and strategies in order to survive and maintain the position in the market.
The firm should have the necessary strength to absorb the shocks of fluctuations in demand
and they should be flexible enough to adapt to new trends in demand. Therefore, before
deciding any site for the factory establishment manager should have to analyze risk of
uncertainties in that particular site.
Procedure for Facility Location Decision
The problem of location decisions can be solved by using two techniques: Qualitative Techniques and
Quantitative Techniques.Qualitative techniques involve two methods: Simple Comparative Chart Analysis
and Factor Rating Method. Similarly, quantitative techniques involve three methods: Centre of gravity
method, Least cost method.

A. Qualitative Techniques
The qualitative factors which cannot be measured in terms of money and expressed in terms of
numerical values are analyzed by using following techniques:
1. Simple Comparative Chart Analysis
Simple comparative chart is one of the techniques of analyzing intangible factors for selecting
facilities location. The following steps should be followed:
Step 1: Recognize the critical intangible factors affecting location decision. For example: labour
supply, business climate, community attitude, union activities, employee morale,
competence of managers, reputation of enterprises, goods public relation.
Step 2: Compare and rank all alternative locations on the basis of these factors like good or bad,
favourable or unfavourable, important or not important, etc.
Location A Location B Location C
Suitable More suitable Unsuitable
Good Very Good Worst
Step 3: Select the best location for organization.
Simple Comparative Chart
Intangible factors Location A Location B Location C
Labour supply Suitable More suitable Unsuitable
Business climate Good Very good Worst
Community attitude Unfavourable Favourable More favourable
Union activities Important Less important More important
Decision: On the basis of above simple comparative chart, location 'B' is selected as the best
location than 'A' and 'C'.
2. Factor/Point Rating Method
Factor rating method is also used for evaluating wide range of intangible factors associated
importantly with location. It is recognized as a most applicable method so it is most widely used
technique. It is improved technique than simple rating method because simple comparative chart
method does not break down factors into sub-factors but factor rating method breakdowns factors
into sub-factors for evaluation and analysis. Factor rating method is a kind of survey technique
which follows following steps:
Step 1: Identify the sensitive factors for location decisions. For example, direct materials, direct
labour, power, taxes, insurance etc.
Step 2: Rate each factor from 1(very poor) to 5 (very good) according to their merit basis. For
example, Factor rate – 4, 3, 2, 5, 1.
Step 3: Rate the alternative location from 1 (very low) to 10 (very high) according to their merits
of each characteristics. For example, 10, 6, 8, 4, 2, so on.
Step 4: Multiply the factor rate and alternative location rate and find the total score of each
alternative location.
 Step 5: Select the location with highest score.

Analysis of location under Factor Rating Method

Location A Location B
Factors Factor Location Factor Location
Total Total
Rate Rate Rate Rate
Direct Materials 5 10 50 2 8 16
Direct Labour 4 9 36 3 10 30
Climate 3 7 21 4 7 28
Transportation 2 5 10 5 5 25
Power 1 4 4 1 3 3
Taxes 5 2 10 2 2 4
Insurance 4 1 4 3 4 12
Total 135 118
Decision: From above analysis, location A is the best location because it has the maximum score
i.e. 135.
Example 1
Location Selection for a Sugar Factory
Factor Location A Location B Location C
Factors Location Location Location
Rating Total Total Total
Rate Rate Rate
1. Availability of sugarcane 5 8 40 10 50 6 30
2. Transportation 4 10 40 4 16 10 40
3. Labour costs 3 3 9 8 24 6 18
4. Proximity to market 5 7 35 5 25 10 50
5. Power supply 3 8 24 1 3 8 24
6. Governmental / Local rules 4 9 36 10 40 8 32
& regulations
7. Environmental condition 3 8 24 9 27 7 21
8. QOL issues 2 10 20 5 10 10 20
9. Banking 1 9 9 2 2 10 10
Total 237 197 245

Decision: Since total cumulative score for the location 'C' is highest i.e. 245, location 'C' is selected for the
purposed sugar factory.
 Quantitative Techniques
The quantitative factors which can be measured in terms of money and expressed in terms of
numerical values are analyzed by using following techniques:
1. Centre Gravity Method
Centre of gravity or weight centre is a technique of quantitative method for locating a facility such
as a warehouse at the centre of movement in a geographic are based on weight and distance. It is a
mathematical technique that can be used for locating a distribution centre that will minimize
distribution cost. This method identifies a set of coordinates designating a central location on a
map relative to all other locations. This has following steps:
 Step 1: Place location on a coordinate system.
Step 2: Determine the centre of gravity using equations/formula.
The coordinates for the location of the new facility are computed using the following
formulas:
n n
 XiWi  YiWi
i=1 i=1
X= , Y=
n n
 Wi  Wi
i=1 i=1

Where,
X, Y = Coordinates of the new facility at centre of gravity.
Xi, Yi = Coordinates of existing facility i.
Wi = Annual weight shipped from facility i.

Example 2
A supplier to the electric utility industry has a heavy product, and the transportation costs are high. One
market area includes the lower part of the Great Lakes region and the upper portion of the southeastern
region. More than 600000 tons are to be shipped to five major customer locations. Calculate the centre of
gravity.
Customer location Tons Shipped '000' X, Y coordinates
A 5 (8, 14)
B 92 (7, 12)
C 70 (10, 14)
D 40 (11, 9)
E 35 (7, 14)
Solution
n
 Wi = 5 + 92 + 70 + 40 + 35 = 242
i=1

n
 XiWi = 5(8) + 92(7) + 70(10) + 40(11) + 35(7) = 2069
i=1

n
 XiW i
i=1 2069
X= = 242 = 8.6
n
 Wi
i=1

n
 Wi = 5 + 92 + 70 + 40 + 35 = 242
i=1

n
 YiWi = 5(14) + 92(12) + 70(14) + 40(9) + 35(14) = 3004
i=1
 n
 YiW i
i=1 3004
Y= = 242 = 12.4
n
 Wi
i=1

The centre of gravity is (8.6, 12.4).

2. Least cost method / Locational Break-Even-Analysis (BEA)
Locational Break-even analysis is the use of cost-volume analysis to make an economic comparison of
location alternatives. By identifying fixed and variable costs and graphing them for each location, we
can determine which one provides the lowest cost. It is particularly useful when the operation manager
wants to define the ranges over which each alternative is best. Locational break-even analysis can be
done mathematically or graphically. The graphic approach has the advantage of providing the range of
volume over which each location is preferable. The steps to locational break-even analysis are as
follows:
Step 1: Determine the fixed and variable cost for each location.
Step 2: Plot the total cost for each location, with costs on the vertical axis of the graph and annual
volume on the horizontal axis.
Step 3: Select the location that has the lowest total cost for the expected production volume.

Example 3
Lal Prasad, owner of Hallmark Shopping Mall, wants to expand his capacity. He is considering three
locations-Lajimpat, Baneshwor and Boudha. He wishes to find the most economical location for an
expected volume of 2,000 units per year.
Location Fixed cost($) Variable cost ($)
Lajimpat 30000 75
Baneshwor 60000 45
Boudha 110000 25
Solution
For each of the three locations, total cost is calculated with 2000 units of volume of production.
We know,
Total cost = Fixed cost + Cost per unit × Volume of production.
For Lajimpat,
Total cost = $ 30000 + $75 × 2000 = $ 180,000
For Baneshwor,
Total cost = $60000 + $45 × 2000 = $150,000
For Boudha,
Total cost = $110000 + $25 × 2000 = $ 160,000
Hence, with an expected volume of 2000 units per year, Baneshwor provides the lowest cost location. So,
Baneshwor is selected as best location.
Expected profit at Baneshwor = Total revenue – Total cost
= $ 120(2,000) – $ 150,000 = $ 90,000 per year
Calculating the Cross-Over Point
For Lajimpat and Baneshwor
30000 + 75x = 60000 + 45x
or, 30x = 30000
 x = 1000 units.
For Baneshwor and Boudha
60000 + 45x = 110000 + 25x
or, 20x = 50000
 x = 2500 units
Results
Volume range Lowest cost location
0-1000 units Lajimpat
1000-2500 units Baneshwor
 2500 units Boudha

$ 180,000

$ 160,000
$ 150,000

$ 130,000

$ 110,000
Total Cost

$ 80,000

$ 60,000

$ 30,000

Lajimpat is best Baneshwor is best Boudha is best

$ 10,000

500 1000 1500 2000 2500 3000 3500

Expected Volume of Production Units

Unit 7 Inventory Management and Control

7.1 Nature of Inventory Management and Control

The management and control of inventory is a problem common to all organizations in any sector of the
economy. The problems of inventory do not confine themselves to profit making business firms. The same
types of problems are encountered by social and non-profit organizations too. Inventories are common to
besides industries- agriculture, wholesalers, retailers, hospitals, temples, churches, prisons, zoos,
universities, and national, state and local governments.
An inventory is a stock of goods. Firms typically stock hundreds or even thousands of items in inventory,
ranging from small things such as pencils, paper clips, screws, nuts, and bolts to large items such as
machines, trucks, construction equipment, and airplanes, naturally, many of the items a firm carries in
inventory related to the kind of business it engages in. Thus, manufacturing firms carry suppliers of raw
materials, purchased parts, partially finished items, and finished goods, as well as spare parts for
machines, tools, and other supplies. Department stores carry clothing, furniture, carpeting, stationery,
cosmetic, gifts, cards, and toys. Some also stock sporting goods, paints, and tools. Hospitals stock drugs,
surgical supplies, life-monitoring equipment, sheets and pillow cases, and more. Supermarkets stock fresh
and canned foods, packaged and frozen foods, household supplies, magazines, baked goods, dairy
products, produce, and other items.
In other words, inventory generally refers to the materials in stock. It is also called the idle resource of an
enterprise. Inventories represent those items which are either stocked for sale or they are in the process of
manufacturing or they are in the form of materials which are yet to be utilized.
Inventory control is a planned approach of determining what to order, when to order and how much to
order and how much to stock so that costs associated with buying and storing are optimal without
interrupting production and sales.
Inventory control basically deals with two problems,
i. When should an order be placed? (Order level)
ii. How much should be placed? (Order quantity)
These questions are answered by the use of inventory models. The scientific inventory control system
strikes the balance between the loss due to non availability of an item and cost of carrying the stock of
an item. Scientific inventory control aims at maintaining optimum level of stock of goods required by the
company at minimum cost to the company.

Need/Importance/Reasons for Keeping Inventories

1. To Take Advantage of Price Discounts: Usually the manufactures offer discounts for bulk buying
and to gain this price advantage the materials are bought in bulk even though it is not required
immediately. Thus inventory is maintained to gain economy in purchasing.
2. To Stabilize Production: The demand for an item fluctuates because of the number of factors. E.g.
seasonally production schedule etc. The inventories (raw materials and components) should be made
available to the production as per the demand failing which results in stock out and the production
stoppage takes place for want of materials. Hence, the inventory is kept to take care of this fluctuation
so that the production is smooth.
3. To prevent Loss of Orders (Sales): In this competitive scenario, one has to meet the delivery schedules
at 100% service level, means they cannot afford to miss the delivery schedule which may result in loss of
sales. To avoid this organizations have to maintain inventory.
4. To Meet the Demand During the Replenishment Period: The lead time for procurement of materials
depends upon many factors like location of the sources, demand supply condition etc. So inventory is
maintained to meet the demand during the procurement (replenishment) period.
5. Others: Sometimes the organizations have to stock materials due to other reasons like suppliers minimum
quantity condition, seasonal availability of materials or sudden increase in prices.
6. To Keep Pace with Changing Market Conditions: The organizations have to anticipate the changing
market sentiments and they have to stock materials in anticipation of non availability of materials or
sudden increase in prices.
Objectives of Inventory Control
Inventory management involves the ‘development and administration of policies, systems, and procedures
which will minimize total costs relative to inventory decisions and related functions such as customer
service requirements, production scheduling, purchasing and traffic’. Viewed in that perspective,
inventory management is broad in scope and affects a great number of activities in a company’s
organization. Because of these numerous inter-relationships, inventory management stresses the need for
integrated information flow and decision making, as it relates to inventory policies and overall systems.
Inventory control, on the other hand, is defined in a narrower sense than inventory management and
pertains primarily to the administration of established policies, systems and procedures. For example, the
actual steps taken to maintain the stock levels or stock records refer to inventory control. Some specific
objectives of the inventory control are as follows:
1. To ensure adequate supply of products to customer and avoid shortages as far as possible.
2. To make sure that the financial investment in inventories is minimum (i.e. to see that the working
capital is blocked to the minimum possible extent)
3. Efficient purchasing, storing, consumption and accounting for materials is an important objective.
4. To maintain timely record of inventories of all the items and to maintain the stock within the desired
limits.
5. To ensure timely action for replenishment.
6. To provide a reserve stock for variations in lead times of delivery of materials.
7. To provide a scientific base both short term and long term planning of materials.

Costs of Inventory
1. Purchase (or Production) Cost
The value of an item is its unit purchasing (production) cost. This cost becomes significant when
availing the price discounts. This cost is expressed as Rs/ unit.
2. Ordering Cost
It is also known by the name procurement cost or replenishment cost or acquisition cost. Cost of
ordering is the amount of money expended to get an item into inventory. This takes into account all
the costs incurred from calling the quotations to the point at which the items are taken to stock.
There are two types of costs Fixed costs and Variable costs. Fixed costs do not depend on the number
of orders where as variable costs change with respect to the number of orders placed. The salaries and
wages of permanent employee involved in purchase function and control of inventory purchasing,
incoming inspection, accounting for purchase orders constitute the major part of the fixed costs. The
cost of placing an order varies from one organization to another. They are generally classified under
the following heads:
i. Purchasing: The clerical and administrative cost associated with the purchasing cost of
requisitioning material, placing the order, follow-up, receiving and evaluating quotations.
ii. Inspection: The cost of checking material after they are received by the supplier for quantity and
quality and maintaining records of the receipts.
iii. Accounting: The cost of checking supply against each order making payments and maintaining
records of purchases.
3. Inventory Carrying Costs (Holding Costs)
These are the costs associated with holding a given level of inventory on hand and this cost vary in
direct proportion to the amount of holding and period of holding the stock in stores.
The holding costs include,
i. Storage costs (rent, heating, lighting etc.)
ii. Handling costs: Costs associated with moving the items such as cost of labour, equipment for
handling.
iii. Depreciation, Taxes and insurance.
iv. Costs on record keeping.
v. Product deteriorations and obsolescence.
vi. Spoilage, breakage, pilferage and loss due to perishable nature.
4. Shortage Cost:
When there is a demand for the product and the item needed is not in stock, then we incur a shortage
cost or cost associated with stock out.
Then storage costs include:
i. Backorder costs.
ii. Loss of future sales.
iii. Loss of customer good will.
iv. Extra cost associated with urgent, small quantity ordering costs.
v. Loss of profit contribution by lost sales revenue.
The unsatisfied demand can be satisfied at a later stage (by means of back orders) or unfulfilled demand is
lost completely (no back ordering, the shortage costs become proportional to only the shortage
quantity).

Inventory Classification System

There are two types of inventory systems: Periodic inventory system and Continuous inventory system.
i. Periodic Inventory System (P- Model)
In this, the stock position of each item of material is regularly reviewed. When the stock level of a
given item is not sufficient to sustain the production operation until the next scheduled review, an
order is placed replenishing the supply. The frequency of reviews varies from firm to firm. It also
varies among materials within the same firm, depending upon the importance of the materials,
specific production schedules, market conditions and so forth. Order quantities, likewise vary for
different materials.
Under this system, inventory is counted in fixed time interval (T) to determine the quantity of
inventory to place an order (Q). In this system, order quantity (Q) depends on the actual quantity of
period. This concept can be better understood with the help of figure below.
Figure Periodic Inventory System
Inventory levels (Q)

Base stock
Q4 level
Q3
Q1 Q2

0 T 2T 3T 4T
Time (T)
 From the figure 6.5, it is clear that inventory will be inspected in certain time interval. There is no
constant order quantity (Q). On the first order quantity Q 1, second order Q2, third order Q3 and fourth
order Q4 should be placed according to the inventory position at the time of inspection. As a result,
sometimes, stock out may occur during the inventory planning period.
Advantages of ‘P’ Model
This system has some distinct advantages.
1. The ordering and inventory costs are low. The ordering cost is considerably reduced though
follow-up work for each delivery may be necessary.
2. The suppliers will also offer attractive discounts as sales guaranteed.
3. The system works well for materials which exhibit an irregular or seasonal usage and whose
purchase must be planned in advance on the sales estimates.
Disadvantages of ‘P’ Model
The system has certain limitations also.
1. It compels a periodic review of all items; this in itself makes the system somewhat inefficient.
Because of differences in usage rates, supplies may not have to be ordered until the succeeding
review. Conversely, the usage of some items during the period may have increased to the point
where they should have been ordered before the current review date. Consequently, this system
must be augmented with a minimum balance figure which signals the need for an early reorder in
the case of a sharp usage increase.
2. Equally important, the system demands the establishment of rather inflexible order quantities in
the interest of administrative efficiency. Theoretically, there exists an optimum economic order
quantity for each item, depending upon its price structure, its rate of usage and attendant
internal costs. However, because all items must fit reasonably well into a limited number of
ordering cycles under this system, actual order quantities may deviate substantially from the
optimum.
3. The periodic review system tends to peak the purchasing work around the review dates.
ii. Continuous or Perpetual Inventory System (Q - Model)
In this model or system, a fixed quantity of material is ordered whenever the stock on hand reaches
the reorder point. The fixed quality of material ordered each time is nothing but the economic order
quantity (EOQ). When the new consignment arrives, the total stock (existing plus new arrival) shall
be within the maximum and the minimum limits.
In other words, this system first of all determines the fixed order quantity Q, and reorder stock level
ROL. Fixed order may be in units or amount but the reorder level should be in the units. In other words,
order quantity of stock Q, and the level of stock ROL, at which level the order should be placed is
predetermined. Therefore it is also called fixed order quantity/perpetual inventory system or economic
order quantity model (EOQ) or Q/R model.
Figure : Continuous or Perpetual Inventory System

MS Maximum
Stock Level
Inventory levels (Q)

Q1 Q2 Q3 Q4

ROL

0 LT LT2 LT3 LT4

Time
 The basic assumptions of the fixed order quantity model are as follows:
 Demand for product (A) is constant throughout the period.
 Lead time (LT) is constant.
 Price/cost (P) per unit is constant.
 Carrying cost/holding cost (C) depends on average inventory.
 Ordering and setup cost (O) are constant.
 No stock out or back orders (S).
Advantages of ‘Q’ System
The fixed order quantity system has certain advantages. The major advantages claimed are that:
1. Each material can be procured in the economical quantity.
2. Purchasing and inventory control personnel automatically devote attention to the items that are
needed only when required.
3. Positive control can easily be exerted to maintain total inventory investment at the desired level
simply by manipulating the planned maximum and minimum values.
Disadvantages of ‘Q’ System
Its disadvantages are that:
1. The orders are raised at irregular intervals which may not be convenient to the suppliers.
2. In case the lead time is very high, say three months, and the ordering quantity happens to be material
suppliers for one month, there would be two to three pending orders with the suppliers each time
and there is every likelihood that he may supply all orders at a time.
3. The items cannot be grouped and ordered at a time since the reorder points occur irregularly.
4. EOQ may give you an order quantity which is much below the supplier minimum (for a good
discount), and there is always a chance that the ordering level for an item has been reached but
not noticed in which case a stock-out may occur.
5. Further, the system assumes stable usage and definite lead time. When these change
significantly, a new order quantity and a new order point should be fixed, which is quite
cumbersome.
Table : Distinction Between ‘Q’ System and ‘P’ System
Basis Q - System P- System
Initiation of order. Stock on hand reaches to reorder point Based on fixed review period and not stock level.
Period of order Any time when stock level reaches to reorder Only after the predetermined period.
point.
Record keeping. Continuously (perpetual system) each time a Only at the review period.
withdrawal or addition is made
Order quantity. Constant the same quantity ordered each time. Quantity of order varies each time order is placed
Size of inventory Less than the ‘P’ system. Larger than the Q system.
Time to maintain. Higher due to perpetual record keeping Less time due to only at the review period.

ABC Analysis
The inspiration behind the ABC analysis has been drawn from V. Pareto, an Italian economist and
sociologist (1842-1923) who generated some highly debatable concepts of economics and sociology. One of
the most interesting fact to a student of inventory management is the concept known as “Pareto’s Laws”.
One of the widely used techniques for control of inventories is the ABC (always better control) analysis.
The ABC approach is a means of categorizing inventory items into three classes ‘A’, ‘B’ and ‘C’ according
to the potential amount to be controlled. Once inventory is classified, we have a firm base for deciding
where we will put our effort. Logically, we expect to maintain strong controls over the ‘A’ items taking
whatever special actions needed to maintain availability of these items and hold stocks at the lowest
possible levels consistent with meeting demands. At the other end of the scale, we cannot afford the
expenses of rigid controls, frequent ordering, expediting, etc., because of the low amounts in this area.
Thus, with the ‘C’ group we may maintain somewhat higher safety stocks, order more months of supply;
expect lower levels of customer service, or all the three. It is for selective approach, ABC analysis is often
called the Selective Inventory Control Method (SIM).
Pareto’s principle was brought to the attention of people concerned with inventory management by H.F.
Dickie, who applied Pareto’s law to inventory and developed the general concept of ABC analysis. Like so
many ideas, however it has not been completely understood. Many people refer to the ABC system or the
ABC technique. The idea of distribution of value for inventory stratification is neither a system nor a
technique; it is a fundamental management principle with universal application potential.
The following procedure is suggested for developing an ABC analysis:
1. List each item carried in inventory by number or some other designation.
2. Determine the annual volume of usage and rupee value of each value.
3. Multiply each item’s annual volume of usage by its rupee value.
4. Complete each item’s percentage of the total inventory in items of annual usage in rupees.
5. Select the top 10 percent of all items which have the highest rupee percentages and classify them as
‘A’ items.
6. Select the next 20 percent of all items with next highest rupee percentages and designate those as ‘B’
items.
7. The next 70 percent of all items with the lowest rupee percentages are ‘C’ items.
Figure ABC Classifications of Inventory Items

100
90
80
70
60
Percent of Total sales

50
40
30
20
A B C
10

0 10 20 30 40 50 60 70 80 90 100
Percent of Total items

Inventory Management under ABC Analysis

A items B items C items

1. Very strict control 1. Moderate control 1. Loose control
2. No safety stocks (or very low) 2. Low safety stocks 2. High safety stocks
3. Frequent ordering or weekly deliveries. 3. Once in 3 months 3. Bulk ordering once in 6 months
4. Weekly control statements 4. Monthly control statements 4. Quarterly reports
 5. Maximum follow-up and expediting 5. Periodic follow-up 5. Follow-up in exceptional cases
6. Rigorous value analysis 6. Moderate value analysis 6. Minimum value analysis.
7. As may sources as possible for each item 7. Two or more reliable sources 7. Two sources for each a item
8. Accurate forecasts in materials planning 8. Estimates based on past data 8. Rough estimates
9. Minimization of waste, obsolete, and 9. Quarterly review 9. Annual review
surplus (review every 15 days)
10. Individual postings 10. Small group postings 10. Group postings
11. Central purchasing and storage 11. Combination purchases 11. Decentralized purchasing
12. Maximum efforts to reduce lead time 12. Moderate 12. Minimum efforts
13. To be handled by senior officers. 13. To be handled by middle 13. Can be fully delegated.
management.

Advantages of ABC Analysis

 Strict Control
 Reduction in Investment
 Minimum Storage Cost
 Saving in Time
 Economy
Disadvantages of ABC Analysis
 Some time it is very difficult to classify items to A, B and C category. If wrongly classified then
wrong steps may be taken to control.
 It is not important to classify the items available whenever company has to manufacture same
quality products.
 ABC analysis is not one time exercise and items are to be reviewed and re-categorized periodically.
 It is a time consuming method of inventory control.

Economic Order Quantity- EOQ

There are two major costs associated with inventory: Procurement cost (ordering cost) and Inventory
carrying cost. Annual procurement cost varies the number of orders. This implies that the procurement cost
will be high, if the item is procured frequently in small lots. The procurement cost is expressed as Rs/Order.
The annual inventory carrying cost (Product of average inventory × Carrying cost) is directly proportional to
the quantity in stock. The inventory carrying cost decreases, if the quantity ordered per order is small. The
two costs are diametrically opposite to each other. The right quantity to be ordered is one that strikes a
balance between the two opposing costs. This quantity is referred to as “Economic Order Quantity” (EOQ).
In other words, under the fixed order quantity system of inventory management, an order for supplies is
placed when the existing stock reaches recorder point. The relevant question now is – what should be the
size of the order? Buying in large quantities has its virtues, but one of the problems associated with bulk
buying is the high carrying cost. Similarly, buying in small quantities reduces holding cost but adds to
ordering cost. Consequently, the materials manager is torn between a desire to keep inventories low by
ordering in small quantities and a desire to reduce cost by buying large quantities. Economic order
quantity (EOQ) is the technique which solves the problem of the materials manager. EOQ or Q Opt
(Optimum Quantity) is the order size at which the total cost, comprising ordering cost and plus carryi ng
cost, is the least. Figure illustrates the EOQ graphically.
Figure Determination of Economic Order Quantity (EOQ)
Cost (Rs.)

Total cost curve

Carrying cost curve

E
Graphing the two costs, viz., carrying costs and ordering costs show exactly, where the total cost curve is
at its lowest point. An examination of the two curves reveals that the carrying cost curve is linear i.e., the
more the inventory held in any period, greater will be the cost of holding it. Ordering cost curve, on the
other hand, is different. Ordering in small quantities means more acquisition and higher ordering costs.
The ordering costs decrease with increase in order sizes.
Assumptions of EOQ
EOQ can be the carrying with the help of a mathematical formula. Following assumptions are implied in
the calculation:
i. Demand for the product is constant and uniform throughout the period,
ii. Lead time (time from ordering to receipt) is constant,
iii. Price per unit of product is constant,
iv. Inventory holding cost is based on average inventory,
v. Ordering costs are constant, and
vi. All demands for the product will be satisfied (no back orders are allowed).

Unit 8 Supply Chain Management

Concept of Supply Chain

A supply chain encompasses all activities associated with the flow and transformation of goods and
services from the raw materials stages to the end user (customer), as well as the associated information
flows. It is all the assets, information, and processes that provide “supply”. It is made up of many
interrelated members, starting with raw material suppliers, subassembly suppliers, the product and
service producer, and distributors, and ending with end-use customer. In other words, a supply chain is a
sequence of organizations their facilities, functions, and activities that are involved in producing and
delivering a product or service.
A sequence begins with basic suppliers of raw materials and extends all the way to the final customer.
Facilities include factories, processing centers, warehouses, distribution centers, retain outlets, and offices.
Similarly, functions and activities include forecasting, purchasing, inventory management, information
management, quality assurance, scheduling, production, distribution, delivery, and customer service.
Different companies may have different supply chains due to the size, type and nature of their operations
and whether they are primarily a manufacturing operation or a service operation. The figure 11.1 illustrates a
typical supply chain for a manufacturing organization and figure 11.2 illustrates a typical supply chain for a
service organization.
Figure: 11.1 Typical Manufacturing Supply Chain

Supplier A Consumer A
Raw Material Manufacturing Warehousing Distribution
Supplier B Consumer B
(Storage) (Factory Production) (Finished Goods) Channels
Supplier C Consumer C
Supplier Manufacturing Marketing
Management Management Management
Figure: 11.2 Typical Manufacturing Supply Chain

Supplier A

Storage Service Customers

Supplier B

Supply change management is an essential and a hot topic in business today. The idea is to apply a total
system approach to managing the entire flow of information, materials and services from raw materials
suppliers through factories and warehouses to the end customers. It is the integration of the activities that
procure materials and services, transform them into intermediates goods and final products and deliver
them to the customers. Its basic objective is to build a chain of suppliers that focuses on maximizing value
to the ultimate customer. Now a day, competition is no longer between companies; it is between supply
chains and those supply chains are often global.
Supply chain management is one of the most important, strategic aspects of operations management
because it encompasses so many related functions. Whom to buy materials from, how to transport goods
and services, and how to distribute them in the most cost-effective, timely manner constitutes much of an
organization’s strategy planning. Contracting with the wrong supplier can result in poor-quality materials
and late deliveries. Selecting the wrong mode of transportation or carrier can mean late deliveries to
customers that will require high, costly inventories to offset. As firms strive to increase their
competitiveness via product customization, high quality, cost reductions, and speed to market, added
emphasis is placed on the supply chain. Effective supply chain management makes suppliers “partners” in
the firm’s strategy to satisfy an ever-changing market place. A competitive advantage may depend on a
close short-term and long-term strategic relationship with a few suppliers. For the goods and services to be
obtained from outside sources, the firm must decide on a supply chain strategy. There are following
strategies available under supply chain:
 A first strategy is the approach of negotiating with many suppliers and playing one suppliers against
another.
 A second strategy is to develop long-term “partnering” relationships with a few suppliers to satisfy the
end customer.
 A third strategy is a vertical integration, in which a firm decides to use vertical backward integration
by actually buying supplier.
 A forth strategy is a combination of few suppliers and vertical integration, is known as “Keiretsu
network”. In “Keiretsu”, suppliers become part of a company coalition.
 A fifth strategy is to develop virtual companies that use suppliers on an as-needed basis.
The Need for Supply Chain Management
There are following issues that make it clear that management of supply chains is essential to business
success.
1. The Need to Improve Operations: During the last decade, many organizations adopted practices
such as lean production and total quality management (TQM). As a result, they were able to achieve
improved quality while wringing much of the excess costs out of their systems. Although there is still
room for with procurement, distribution, and the major gains have been realized. Opportunity now
lies largely with procurement, distribution, and logistic – the supply chain.
2. Increasing Levels of Outsourcing: Organizations are increasing their levels of outsourcing. Buying
goods or services instead of organizations are spending increasing amounts on supply-related
activities, (wrapping, packaging, moving, loading and unloading, and storing). A significant amount
of the cost and time spent on these and other related activities may unnecessary.
3. Increasing Transportation Cost: Transportation costs are increasing, and they need to be more
carefully managed.
4. Competitive Pressures: Competitive pressures have led to an increasing number of new products,
shorter product development cycles, and increased demand for customization. And in some industries,
most notably consumer electronics, product life cycles are relatively short. Added to this are adoption of
quick-response strategies and efforts to reduce lead times.
5. Increasing Globalization: Increasing globalization has expended the physical length of supply
chains. A global supply chain increases the challenges of managing a supply chain. Having far-flung
customers and/or suppliers means longer lead times and greater opportunities for disruption of
deliveries. Often currency differences and monetary fluctuations are factors, as well as language and
cultural differences.
6. Increasing Importance of E-business: The increasing importance of e-business has added new
dimensions to business buying and selling and has presented new challenges.
7. The Complexity of Supply Chains: Supply chains are complex; they are dynamic, and they have
many inherent uncertainties that can adversely affect the supply chain, such as inaccurate forecasts,
late deliveries, substandard quality, equipment breakdowns, and canceled or changed orders.
8. The Need to Manage Inventories: Inventories play a major role in the success or failure of a supply
chain, so it is important to coordinate inventory levels throughout a supply chain. Shortages can severely
disrupt the timely flow of work and have far-reaching impacts, while excess inventories add unnecessary
costs. It would not be unusual to find inventory shortages in some parts of a supply chain and excess
inventories in other parts of the same supply chain.

Objectives of a Supply Chain Strategy

The basic objectives of a supply chain strategy are as follows:
 To achieve maximum supply chain profitability. Supply chain profitability is the total profit to be
shared across all supply chain stages.
 To maximize the overall value generated. The value that a supply chain generates is the difference
between what the final product is worth to the customer and the effort the supply chain expends in
filling the customer’s request.
 To reduce the supply chain costs to minimum possible level.
 To improved their internal operations and now find it necessary to consider relations with external
customers and suppliers in the supply chain to gain further improvements in their operations.
 To reduce total time for material to travel through the entire supply chain, this is quite long. Since the
materials spend so much time waiting in inventory, there is great opportunity to reduce the total
supply chain cycle time leading to a corresponding reduction in inventory, increased flexibility,
reduced costs and better deliveries.
 To develop the supply chain thinking which is an application of systems thinking and provides a basis
for understanding processes that cut across a company’s internal departments and processes that
extend outside the company as well.