Study Guide Transnational 2015

MFET 5043 - SUPPLY CHAIN MANAGEMENT G

Course Coordinator: Dr Yousef Amer

STUDY GUIDE

Contents
How to use this study guide

Topic 1:

Building a Strategic Framework to Analyze Supply Chains

Topic 2:

Supply Chains Strategy

Topic 3:

Designing the Supply Chain network: Distribution Network Configurations

Topic 4:

Designing the Supply Chain network: Network Design

Topic 5:

Planning: Demand Forecast in a Supply Chain

Topic 6:

Aggregate Planning in a Supply Chain

Topic 7:

Managing inventories in a Supply Chain

APPENDIX 1:

Details of coursework requirements

APPENDIX 2:

List of Equations

APPENDIX 3:

Sample of examination paper

APPENDIX 5:

Peer Assessment Form

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How to use this study guide

This study guide outlines the main points of the subject to assist you in your reading. They are not
lecture notes. Students are expected to complete the required readings listed in each topic. At the end of
each topic, students should attempt all the tutorial questions and problems provided to evaluate their
understanding.
This study guide has been designed to assist you in studying this course. The study guide clearly defines the
number of topics covered by the course, the objective(s) of each topic, specific text and reference materials
for each topic, the amount of work you have to do for each topic, and the sequence of study. The guide
gives you a clear idea of the contents of the course and the amount of work you are expected to do to
achieve the courses objectives. It is NOT meant to be a complete set of lecture notes for the course. To
study this course, you need not only this study guide, but also the resources listed in the section Texts and
references.
The layout of each topic in this the study guide is as follows:

Aims of the topic: This outlines the general concepts and techniques to be covered.
Reading list: This gives you the details of the relevant texts that you have to study for the topic.
Key terms: Important words and concepts from your reading and your study notes, which you
should understand are listed.
Study notes: This provides the main content of each topic, which will assist you in your reading.
Tutorial questions: This section gives you the coursework requirements and tutorial questions that
you should attempt in order to evaluate your learning.

The following is a suggested sequence of study for each topic:

1. Pre-lecture reading: You should read the study guide and any recommended texts before lecture. As
the contents of each topic may not follow the text 100%, it is important that you read the Study Guide
first to identify the key points in each topic before reading the text. At this stage of first reading, you
may not be able to understand all the texts but the pre-lecture reading will give you a general idea about
the topic. This reading also assists you in identifying any difficulties or problems that you may have, so
you can discuss these difficulties with the lecturer. It is also a good idea to have a look at the tutorial
questions foe the topic so you know you are required to do at the end of the topic.
2. Lectures: Lectures are not intended to cover every single point in the topic. Instead, lectures are given
at the beginning of each topic to outline the main points and to explain difficult concepts. This is also the
opportunity for the lecturer, using his/her experience, to add a practical dimension to the topic so that
students can see the relevance of what they are learning.

3. Detailed study and tutorials: Once the lectures for each topic have been given, students can go
through each topic in detail at their own pace provided that they finish the topic at the end of the
allocated time slot. This involves a detailed study of all the recommended texts and any associated
coursework requirements. To evaluate your study, it is important that you attempt all the tutorial
questions at the end of the topic. Tutorial sessions are also conducted to assist those students who may
have difficulties in their learning process. This is the opportunity for individual students to ask questions
to clarify their learning.

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Topic 1: Analysing Supply Chain Frameworks and Metrics

Aims
To introduce you to supply chain management concepts and a strategic framework to
analyse supply chains.
Recommended Readings
Relevant sections in chapter 1 and 3
Key Terms/ Concepts:

1.

Process view of a supply chain, which includes: cycle view & push/pull view

Decision phases in the supply chain: strategy & design, planning, and operations

Decision-making framework

Supply chain drivers: which are the (1) logistical drivers (facilities, inventories,
transportation) and (2) cross-functional drivers (information, sourcing, pricing)

Supply Chain

A supply chain consists of all parties involved, directly or indirectly, in fulfilling a customer
request.

The supply chain not only includes the manufacturer and suppliers, but also transporters,
warehouses, retailers, and customers themselves.

The supply chain includes all functions involved in receiving and filling a customer request
within each element of the chain (such as manufacturer stage).

These functions include, but are not limited to, new product development, marketing,
operations, distribution, finance, and customer service.

Figure 1.1 Stages of an Ice Cream Supply Chain

A typical supply chain may involve a variety of stages, including the following:

Component/Raw material suppliers

Manufacturers

Wholesalers/Distributors

Retailers

Customers
The objective of every supply chain is to maximize the overall value generated.
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The value a supply chain generates is the difference between what the final product is
worth to the customer and the effort the supply chain expands in filling the customers
order.
Therefore, for any supply chain, there is only one source of revenue - and that is the
customer.

For most commercial supply chains, value will be strongly correlated with supply chain
profitability (also known as supply chain surplus).

Supply chain profitability is the difference between the revenue generated from the
customer and the overall cost across the supply chain.

Supply chain management is the management of flows between and among supply chain
stages to maximize total supply chain profitability.

2.

Processes View of a Supply Chain

A supply chain is a sequence of processes and flows that take place between different
stages and combine to fill a customer need for a product.

There are two different ways to view the processes involved in a supply chain:
1. Cycle view
2. Push/ pull view

2.1 Cycle View

The processes are divided into a series of cycles, which are performed at the
interfaces between two successive supply chain stages:
o Customer order cycle
o Replenishment cycle
o Manufacturing cycle
o Procurement cycle

2.2 Push/ Pull View

3.

The processes are divided into two categories depending on how they are
executed:
a. Pull: the processes are initiated in response to a customer order.
b. Push: the processes are initiated in anticipation of customer demand
based on forecast.

Push vs. pull refers to the methodology used to trigger a process in the supply
chain e.g. Replenishment cycle or Manufacturing cycle.

Decision Phases in a Supply Chain

Successful supply chain management requires many decisions relating to the flow of
information, products and funds, depending on the frequency of each decision and the time
frame over which a decision phase has an impact.

The development and operations of a supply chain may be divided into three categories or
phases:
1) Supply Chain Strategy and Design
2) Supply Chain Planning
3) Supply Chain Operation

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3.1 Supply Chain Strategy and Design

o

During this phase, a company decides how to structure the supply chain over the
next several years.

It decides what the chains configuration should be, how resources will be allocated,
and what process each stage will perform.

An organisation must ensure that the supply chain design and configuration
supports its strategic objectives and that it increases the supply chain profitability.

Strategic decisions to be made by the company include:

Whether to perform a supply chain function in-house or outsource
The location and the capacities of production and warehousing facilities
What product is to be made or stored at various locations
The modes of transportation to be made available along different shipping
legs
The type of information system to be used

3.2 Supply Chain Planning

o

In this phase, the supply chains configuration (which has been determined in the
strategic phase) is already fixed.

This configuration establishes constraints within which planning must be done.

For decisions made during this phase, the time frame considered is a quarter to a
year.

Companies start the planning phase with a forecast for the coming year of demand
in different markets.

Planning includes decisions regarding:

Location and market identification

Demand forecasting & aggregate planning

Subcontracting and/or backup locations

Inventory policies to be followed

Timing and size of marketing promotions

3.3 Supply Chain Operation

o

During this phase, companies make decisions regarding individual customer orders.

At the operational level, supply chain configuration is considered fixed and planning
policies are already defined.

The time horizon here is weekly or daily.

The goal of supply chain operation is to handle incoming customer orders in the
best possible manner.

During this phase, organisations need to:

Allocate orders to inventory or production

Set order due dates

Generate warehouse pick lists

Allocate shipments

Set delivery schedules

Place replenishment orders under the weekly or daily time horizon

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4.

Supply Chain Decision Making Framework

The decision-making framework provides a process for the development of a supply chain
strategy and a supply chain structure.

The framework consists of:

decisions with regards to supply chain strategy, which must fit in with the company
competitive strategy

decisions regarding logistical and cross-functional drivers.

A visual respresentation of the framework for supply chain decision-making is shown in

figure 1.2 below.

Figure 1.2 Supply Chain Decision-Making Framework

4.1 Supply Chain Strategy

The companys competitive strategy needs to fit strategically with the supply chain strategy.

As you can see on the figure above, the goal of a supply chain strategy is to strike the
balance between responsiveness and efficiency that fits with the competitive strategy.

To reach this goal, the supply chain strategy dictates and maximises the supply chain
profits, by using the right combination of the three logistical and three cross-functional
drivers outlines below.

4.2 Supply Chain Structure

The supply chain structure consists of:

o

3 Logistical drivers
- Facilities
- Inventory
- Transportation

3 Cross-functional drivers
- Information
- Sourcing
- Pricing

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4.3 Drivers of Supply Chain Performance

Facilities are the actual physical locations in the supply chain network where products are stored,
assembled, or fabricated. The two major types of facilities are (1) production sites and (2) storage
sites.
Critical decisions include:

Role

Location

Capacity

Inventory covers all raw materials, work-in-process (work-in-progress), and finished goods within
a supply chain. Changing inventory policies can directly affect the efficiency and responsiveness of
a supply chain.
Critical decisions include:

Cycle inventory (how many items per order and when to place an order)

Safety inventory

Seasonal inventory

Level of product availability

Transportation involves moving inventory from point to point in the supply chain, which can take
the form of modes and routes. Right choices of transportation have a large impact on supply chain
responsiveness and efficiency.
Critical decisions include:

Design of transportation network

Choice of transportation mode

Information consists of data and analysis concerning facilities, inventory, transportation, costs,
prices, and customers throughout the supply chain. Information is potentially the biggest driver of
performance in the supply chain because it directly affects each of the other drivers in making the
supply chain more responsive and more efficient.
Critical decisions include:

Push vs. pull

Coordination and information sharing

Sourcing is the choice of who will perform a particular supply chain activity such as production,
storage, transportation, or the management of information.
Critical decisions include:

In-house or outsourcing

Supplier selection

Procurement

Pricing determines how much a firm will charge for goods and services that it makes available in
the supply chain. Pricing affects the decision of the buyer of the goods or services, thereby
affecting the supply chain performance.
Critical decisions include:

Pricing and economies of scale

Everyday low pricing vs. high-low pricing

Importance of supply chain decisions: Supply chain design, planning, and operation decisions
play a significant role in the success or failure of a company.

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Tutorials
Multiple Choice Questions
1.

Supply chain profitability is

a.
not correlated to the value generated by the various stages of the supply chain.
b.
the total profit to be shared across all supply chain stages.
c.
the difference between the revenue generated from the customer and the overall cost across
the supply chain.
d.
the total revenue generated by the distributor stage of the supply chain.
e.
b and c only

2.

The cycle view of a supply chain holds that

a.
the processes in a supply chain are divided into 2 categories.
b.
the processes in a supply chain are divided into a series of activities performed at the
interface between successive stages.
c.
all processes in a supply chain are initiated in response to a customer order.
d.
all processes in a supply chain are performed in anticipation of customer orders.
e.
None of the above are true.

3.

Which of the following is not a cycle in the supply chain cycle view?
a.
Analysis cycle
b.
Customer order cycle
c.
Replenishment cycle
d.
Manufacturing cycle
e.
Procurement cycle

4.

The decision phases in a supply chain include

a.
production scheduling.
b.
customer relationship management.
c.
supply chain operation.
d.
supply chain orientation.
e.
all of the above

5.

The cycle view of a supply chain holds that

a.
the processes in a supply chain are divided into 2 categories.
b.
the processes in a supply chain are divided into a series of activities performed at the
interface between successive stages.
c.
all processes in a supply chain are initiated in response to a customer order.
d.
all processes in a supply chain are performed in anticipation of customer orders.
e.
None of the above are true.

6.

The push/pull view of a supply chain holds that

a.
the processes in a supply chain are divided into a series of activities performed at the
interface between successive stages.
b.
all processes in a supply chain are initiated in response to a customer order.
c.
all response in a supply chain are performed in anticipation of customer orders.
d.
the processes in a supply chain are divided into 2 categories depending on whether they are
initiated in response to or in anticipation of customer orders.
e.
None of the above are true.

7.

The cycle view of the supply chain is useful when considering operational decisions, because
a.
it categorizes processes based on whether they are initiated in response to or in anticipation
of customer orders.
b.
it specifies the roles and responsibilities of each member of the supply chain.
c.
processes are identified as either reactive or speculative.
d.
it focuses on processes that are external to the firm.
e.
it focuses on processes that are internal to the firm.

8.

Which of the following is not an accurate statement about push processes?

a.
May also be referred to as speculative processes.
b.
Execution is initiated in anticipation of customer orders.
c.
At the time of execution, demand must be forecast.
d.
May also be referred to as reactive processes.
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e.

All of the above are accurate.

Short Answer Questions

1.

Explain the 3 decision phases (categories) that must be made in a successful supply chain.

2.

Describe the cycle view of the processes within a supply chain.

3.

Explain the push/pull view of the processes within a supply chain.

4.

Consider the purchase of a can of soda at a convenience store. Describe the various stages in the
supply chain and the different flows involved.

5.

What are some strategic, planning, and operational decisions that must be made by an apparel
retailer?

6.

Consider the supply chain involved when a customer purchases a book at a book-store. Identify the
cycles in this supply chain and the location of the push/ pull boundary.

7.

In what way do supply chain flows affect the success or failure of a firm like Amazon? List two supply
chain decisions that have a significant impact on supply chain profitability.

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Topic 2: Supply Chains Strategy and Performance

Aims

Explain what competitive and supply chain strategies are

Describe how a company achieves strategic fit between its supply chain strategy and its
competitive strategy

Recommended Readings

Chapter 2

Key Terms/Concepts:

1.

Strategic fit between competitive strategies and supply chain strategies

Understanding the supply chain: uncertainty in supply and demand,
responsiveness, cost efficiency
Supply chain uncertainty, implied uncertainty spectrum in terms of demand and
supply
Supply chain responsiveness vs. efficiency
Scope of strategic fit across the supply chain

Competitiveness and Supply Chain Strategies

A companys competitive strategy defines the set of customer needs that it seeks to satisfy
through its products and services relative to its competitors.

Factors that contribute to a competitive strategy can include:

Level of quality

Price

Standard product or customisation

Delivery time

Customer support

Once a competitive strategy has been developed, it is necessary to ensure a strategic fit
between the competitive strategy and the supply chain strategy.

Supply chain strategy determines the nature of:

Procurement of raw materials
Transportation of materials to and from the company
Service functions such as manufacturing and operations
Distribution of the product to the customer

2.

Achieving Strategic Fit

The 3 basic steps to achieve strategic fit are:

1) Understanding the customer and supply chain uncertainty
2) Understanding the supply chain capabilities
3) Achieving strategic fit

2.1 Understanding the Customer and Supply Chain Uncertainty

To understand the customer, a company must identify the customer needs: for
example, the desired cost and service level requirements, and the uncertainties the
supply chain faces in satisfying these needs.

Customers need may vary along several attributes:

o

The quantity of the product needed in each lot

The response time that customers are willing to tolerate

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The variety of product needed

The service level required

The price of the product

The desired rate of information for the product

The implied uncertainty depends on two factors:

o

Customers needs

Supply uncertainty

The impact of customer needs (competitive strategy) on implied demand uncertainty is

shown on table 2.1.
Table 2.1 Impact of customer needs on implied demand uncertainty
Customer Need
Effect on Implied Demand Uncertainty
If the range of quantity
the implied demand uncertainty increases, because
required increases, then
a wider range of the quantity required implies greater
variance in demand
If the lead time decreases,
the implied demand uncertainty increases, because
then
there is less time in which to react to orders
If there is an increase in the
the implied demand uncertainty increases, because
variety of products required,
demand per product becomes more disaggregate
then
If the number of channels
the implied demand uncertainty increases, because
through which the product
the total customer demand is now disaggregated
maybe acquired increases,
over more channels
then
If the rate of innovation
the implied demand uncertainty increases, because
increases, then
new products tend to have more uncertain demand
If the required service level
the implied demand uncertainty increases, because
increases, then
the firm now has to handle unusual surges in
demand

If the supply is unreliable (lack of capacity, quality problems, breakdowns, etc) this will also
increase the level of implied uncertainty.

We can create a spectrum of uncertainty by combining the demand and supply uncertainty
as shown on figure 2.1.

Figure 2.1 The Implied Uncertainty (Demand and Supply) Spectrum

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2.2 Understanding the Supply Chain Capabilities

After understanding the uncertainty that the company faces, to effectively manage a
supply chain, a firm must understand how it can best meet demand in an uncertain
environment.

Understanding the supply chain capabilities is important for a company, so that it can
understand what its supply chain is designed to do well, because each type of supply
chain is designed to perform different tasks depending on the uncertainties.

Creating strategic fit is all about creating a supply chain strategy that best meets the
demand a company has targeted (given the uncertainty it faces).

Supply chain performance can be determined by its:

Responsiveness: comes at a high cost (low efficiency)

Cost efficiency: comes at low responsiveness

The responsiveness of a supply chain depends on the supply chains ability to do the
following:
o

Respond to wide ranges of quantities demanded

Meet short lead times

Handle a large variety of products

Build highly innovative products

Meet a very high service level

Handle supply uncertainty

Responsiveness, however, comes at a cost. For instance:

o

Supply chain efficiency is based on the cost of making and delivering a product
to the customer.

For every strategic choice to increase responsiveness, there are additional costs
that lower efficiency.

To respond to a wider range of quantities, capacity must be increased, and this

leads to a cost increase.

The relationship between responsiveness and cost is shown below:

Figure 2.2 Cost-Responsiveness Efficient Frontier

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The responsiveness spectrum is shown below:

Figure 2.3 The Responsiveness Spectrum

2.3 Achieving Strategic Fit

From the preceding discussion, it follows that to achieve strategic fit, the company must
match its level of responsiveness to the level of implied uncertainty it is working with.

The goal is to achieve strategic fit through aiming for:

o

high responsiveness for supply chains which have greater implied uncertainty,
while

less responsiveness or efficiency for supply chains that have low implied
uncertainty.

Therefore, the greater the implied uncertainty, the more responsive the supply chain
should be.

If the implied uncertainty from customers and supply sources increases, it is best
served by increasing responsiveness from the supply chain.

This relationship is represented by the zone of strategic fit illustrated in figure 2.4
below.

For a high level of performance, companies should move their competitive strategy (and
resulting implied uncertainty) and supply chain strategy (and resulting responsiveness)
toward the zone of strategic fit.

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Figure 2.4 Finding the Zone of Strategic Fit

3.

Other Issues Affecting Strategic Fit

3.1 Changes

To achieve strategic fit, a firm must tailor its supply chain to best meet the needs of
different customer segments.

To retain strategic fit, the supply chain strategy must be adjusted over the life cycle of a
product and should also be adjusted if the competitive landscape changes.

For example, at the early stages of a product life cycle, the product will have:

uncertain demand

high margins (because time is important)

product availability as a critical factor

cost as a second priority

While at late stages, the product will have

predictable demand

lower margins

price as priority

3.2 Strategic Scope

A key issue relating to strategic fit is the scope, in terms of supply chain stages, across
which the strategic fit applies.

Scope of strategic fit refers to the functions and stages that devise an integrated
strategy with a shared objective.

The inter-company scope of strategic fit is essential today because the competitive
playing field has shifted from company versus company to supply chain versus supply
chain.

A companys partners in the supply chain may well determine the companys success,
because the company is intimately tied to its supply chain.

3.3 Competitive Pressures to Achieving Strategic Fit

Increasing variety of products

Decreasing product life cycle

Increasingly demanding customers

Fragmentation of supply chain ownership

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Tutorials
Multiple Choice Questions
1.
a.
b.
c.
d.
e.

2.
a.
b.
c.
d.
e.
3.

A companys competitive strategy

defines the set of customer needs that it seeks to satisfy through its products and services.
specifies the portfolio of new products that it will try to develop.
specifies how the market will be segmented and how the product will be positioned, priced,
and promoted.
determines the nature of procurement and transportation of materials as well as
manufacture and distribution of the product.
determines how it will obtain and maintain the appropriate set of skills and abilities to meet
customer needs.
A supply chain strategy includes
supplier strategy.
operations strategy.
logistics strategy.
all of the above
none of the above
A supply chain strategy involves decisions regarding all of the following

except
a.
b.
c.
d.
e.

inventory.
transportation.
new product development.
operating facilities.
information flows.

a.
b.
c.
d.
e.

Which of the following is not a basic step to achieving strategic fit?

Achieving strategic fit.
Understanding the supply chain capabilities.
Determining the response time that customers are willing to tolerate.
Understanding the customer and supply uncertainty.
none of the above

4.

5.

The uncertainty that exists due to the portion of demand that the supply chain
is required to meet is the
a.
rate of strategic uncertainty.
b.
demand uncertainty.
c.
implied demand uncertainty.
d.
average forecast error.
e.
none of the above

6.

Which of the following customer needs will cause implied uncertainty of

demand to increase?
a.
Range of quantity required increases
b.
Lead time decreases
c.
Variety of products required increases
d.
Required service level increases
e.
all of the above

7.

Which of the following is not a supply chain capability that will impact supply
uncertainty?
a.
Evolving production process
b.
Inflexible supply capacity
c.
Limited supply capacity
d.
Product margin
e.
Unpredictable and low yields

8.

The first step in achieving strategic fit between competitive and supply chain
strategies is to
a.
understand the supply chain and map it on the responsiveness spectrum.
b.
understand customers and supply chain uncertainty.
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c.
d.
e.

match supply chain responsiveness with the implied uncertainty of demand.

ensure that all functional strategies within the supply chain support the supply chains level
of responsiveness.
none of the above

a.
b.
c.
d.
e.

The cost of making and delivering a product to the customer is referred to as

supply chain responsiveness.
supply chain efficiency.
cost-responsiveness efficient frontier.
implied uncertainty.
none of the above

9.

10.

The curve that shows the lowest possible cost for a given level of
responsiveness is referred to as the
a.
supply chain responsiveness curve.
b.
supply chain efficiency curve.
c.
cost-responsiveness efficient frontier.
d.
responsiveness spectrum.
e.
none of the above

11.

The relationship where increasing implied uncertainty from customers and

supply sources is best served by increasing responsiveness from the supply
chain is known as the
a.
implied uncertainty spectrum.
b.
responsiveness spectrum.
c.
uncertainty/responsiveness map.
d.
zone of strategic fit.
e.
none of the above

12.

d.
e.

To achieve complete strategic fit, a firm must

consider all functional strategies within the value chain.
ensure that all functions in the value chain have consistent strategies that support the
competitive strategy.
ensure that all sub-strategies within the supply chain such as manufacturing, inventory, and
purchasing be consistent with the supply chains level of responsiveness.
all of the above
none of the above

a.
b.
c.
d.
e.

The drive for strategic fit should come from

the supply chain manager.
the strategic planning department.
the highest levels of the organization, such as the CEO.
middle management.
sales and marketing.

a.
b.
c.
d.
e.

The important points to remember about achieving strategic fit are

there is one best supply chain strategy for all competitive strategies.
there is no right supply chain strategy independent of the competitive strategy.
there is a right supply chain strategy for a given competitive strategy.
all of the above
b and c only

a.
b.
c.

13.

14.

15.

16.

The preferable supply chain strategy for a firm that sells multiple products and
serves customer segments with very different needs is to
a.
set up independent supply chains for each different product or customer segment.
b.
set up a supply chain that meets the needs of the highest volume product or customer
segment.
c.
tailor the supply chain to best meet the needs of each products demand.
d.
set up a supply chain that meets the needs of the customer segment with the highest implied
uncertainty.
e.
set up a supply chain that meets the needs of product with the highest implied uncertainty.
Which of the following is not a major driver of supply chain performance?
a.
Customers
b.
Facilities
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c.
d.
e.

Inventory
Transportation
Information

a.
b.
c.
d.
e.

The two major types of facilities are

distribution sites and storage sites.
production sites and distribution sites.
production sites and storage sites.
retail sites and distribution sites.
distribution sites and inventory sites.

17.

18.

Which component of the supply chain decision-making framework would be

established first?
a.
Customer strategy
b.
Supply chain strategy
c.
Supply chain structure
d.
Competitive strategy
e.
Replenishment strategy

19.
a.
b.
c.
d.
e.
20.

Which of the following is not a component of facilities decisions?

Location
Capacity
Operations methodology
Warehousing methodology
All of the above are components of facilities decisions.

Which of the following is not an issue companies need to consider in facility

location decisions?
a.
quality of workers
b.
product development
c.
proximity to customers and the rest of the network
d.
cost of facility
e.
tax effects

Short Answer Questions

1.

List and explain the three basic steps to achieving strategic fit.

2.
List the attributes/ factors along which customer demand from different market
segments may vary.
3.
List and discuss the abilities/factors that should be considered in supply chain
responsiveness.
4.

Explain the scope of strategic fit.

5.

Consider a high-end department store:

1. How would you characterize its competitive strategy?
2. What are the stores likely characteristics in terms of customer and supply chain uncertainty?
3. Where would you place the demand faced by the store on the implied demand uncertainty
spectrum? Why?
4. What level of responsiveness would be most appropriate its supply chain?
5. What should the supply chain be able to do particularly well?

6.

Consider a discount department store:

1. How would you characterize its competitive strategy?
2. What are the stores likely characteristics in terms of customer and supply chain uncertainty?
3. Where would you place the demand faced by the store on the implied demand uncertainty
spectrum? Why?
4. What level of responsiveness would be most appropriate its supply chain?

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Topic 3: Designing Supply Chain: Distribution Network Configuration

Aims

Identify the key factors to be considered when designing the distribution network
Discuss the strengths and weaknesses of various distribution options.

Recommended Readings

Chapter 4

Key Terms/ Concepts:

1.

The Role of Distribution in the Supply Chain

Distribution refers to the steps taken to move and store a product from the supplier stage to
a customer stage in the supply chain.

Distribution occurs between every pair of stages in the supply chain.

Raw materials and components are moved from suppliers to manufacturers, whereas
finished products are moved from the manufacturer to the end consumer.

Distribution is a key driver of the overall profitability of a firm, because it directly impacts
both the supply chain cost and the customer experience.

Distribution choices affects supply chain objectives from low cost to high responsiveness.

2.

Factors influencing network design

Role of distribution in the Supply Chain

Distribution network design:
o Distribution network configuration
o Location-allocation considerations
o Transportation modes
Factors influencing distribution network design: responsiveness vs. supply costs
(facility cost, inventory cost, transportation cost, etc)
Design options and characteristics of a distribution network:
o Manufacturer storage with direct shipping
o Distributors storage with carrier delivery
o Manufacturer/distributors storage with customer pickup
o Retail storage with customer pickup

Distribution network design involves:

o

Selection of distribution network configuration (covered in this topic)

Selection of the number and location of facilities, allocation of facilities to customer

segments, transportation modes, etc. (covered in next topic)

The performance of a distribution network can be evaluated along two dimensions:

o

Customer needs that are met responsiveness

Cost of meeting customer needs - cost of supply drivers

The choice of network design affects the following supply costs:

Inventory

Transportation

Information

Facilities and handling

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Some general relationships between these factors are shown below:

Inventory
Costs

Number of Facilities

Figure 3.1 Relationship Between Number of Facilities and Inventory Costs

Required
Number of
Facilities

Desired
Response
Time

Figure 3.2 Relationship Between Desired Response Time and Number of Facilities

Transportation
Cost

Number of Facilities

Figure 3.3 Relationship Between Number of Facilities and Transportation Cost

Singapore 2009

Facility
Costs

Number of Facilities

Figure 3.4 Relationship between Number of Facilities and Facility Costs

Response Time

Total Logistics Cost

Number of Facilities

Figure 3.5 Variation in Logistics Cost and Response Time with Number of Facilities

3.

Distribution Network Configurations

Distribution network can be classified into 4 basic configurations:

1) Manufacturer storage with direct shipping
2) Distributor storage with carrier delivery
3) Manufacturer/distributors storage with customer pickup at pick-up points
4) Retail storage with customer pickup at retail stores
*These are the basic distribution networks but many companies may also use a hybrid
distribution network.

3.1 Manufacturer Storage with Direct Shipping

In this option, customers place orders with retailers (where the information flow started)
who then pass the orders to the manufacturer.

Product is shipped directly from the manufacturer to the end customer, bypassing the
retailer (who only takes the order and initiates the delivery request).

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This option is also referred to as drop-shipping with product delivered directly from the
manufacturer to the customer location.

The biggest advantage of this option is its ability to centralise inventories at the
manufacturer, where the manufacturer can take advantage of aggregating all the
demands across all retailers.

Due to advantages over aggregation and ability to postpone production, the following
are the strengths:

Low inventory cost

Low facility cost

High level of variety

High level of product availability

Good customer experience

Fast time to market

Due to increased distance, two stages for order processing, and disaggregated
outbound shipping, the following are the weaknesses:

High transportation cost

Significant investment in information infrastructure required

Slow response time

Difficulty in tracking orders

Difficulty in handling returns

3.2 Distributors Storage with Carrier Delivery

Under this option, customers place orders with retailers who then pass the orders to the
distributors.

Inventory is not held by manufacturers at the factories, but is held by retailer/distributors

in intermediate warehouses.

Carriers are used to transport products from the distributors to the final customers.

Distributor/retailer requires relatively higher inventory level than the manufacturer, due
to lower level of aggregation of demand uncertainty done by a distributor or retailer.

Strengths:

Low transportation cost

Less complex information infrastructure

Fast response time

Good customer experience

Fast time to market

Ease in tracking orders

Ease in handling returns

Weaknesses:

High inventory cost

High facility cost

Low level of variety

Low level of product availability due to cost

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3.3 Manufacturer/Distributors Storage with Customer Pickup

Under this approach, customers place orders with retailers who then pass the orders to
the factories.

Factories aggregate delivery to a cross-dock distribution point, which allocates the

delivery to pick-up points.

Inventory is stored at the manufacturer or distributor warehouse, and products are

distributed to designated pickup points for the customers to collect.

Orders are shipped from the storage site to the pickup points as needed.

Strengths:

Low inventory cost

Low transportation cost

Fast response time

High level of variety

High level of product availability

Fast time to market

Ease in handling returns

Weaknesses:

High facility cost

Significant investment in information infrastructure required

Low customer experience

Difficulty in tracking orders

3.4 Retail Storage with Customer Pickup

In this option, inventory is stored locally at retail stores.

A good example is a supermarket store like Woolworths.

Customers walk into the retail store or place an order online or on the phone for pickup
at the retail store.

Strengths:

Low transportation cost

Fast response time

Fast time to market

Ease in handling returns

Weaknesses:

High inventory cost

High facility cost

Investment in information infrastructure required

Low product variety

Low product availability

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4.

Selecting a Distribution Network Configuration

A network designer needs to consider product characteristics, companys strategic position,

as well as network requirements when deciding on the appropriate distribution network.

Most companies are best served by a combination of delivery network configurations.

The strengths and weaknesses of the various network designs discussed earlier on this
lecture must also be considered in design process.

Only niche companies will end up using a single distribution network.

Most companies are best served by a combination of delivery network configurations

The combination used will depend on product characteristics as well as strategic position
that the firm is targeting.

In table 3.1, the various delivery networks are ranked relative to each other along different
performance dimensions.

The suitability of different delivery designs (from a supply chain perspective) in various
situations is shown in Table 3.2.

Table 3.1 Comparative Performance of Delivery Network Configurations

Note: 1 is the best performance and 6 is the worst.
Performance
Response time
Product availability
Order visibility
Returnability
Inventory cost
Transport cost
Facility & handling
cost
Information system
cost
Product variety
Customer
experience

1
4
1
1
4
1

Manufacturer
storage with
pickup
4
1
5
2
1
1

Distributor storage
with carrier
delivery
3
2
3
4
2
2

Manufacturer
storage with
direct shipping
4
1
5
5
1
4

Retail storage with

customer pickup

Table 2. Performance of Delivery Networks for Different Product/Customer Characteristics

Note: (+2:Very suitable); (+1:Somewhat suitable); (0: Neutral); (-1:Somewhat unsuitable); (-2: Very
unsuitable)
Performance
High-demand product

Retail storage with

Manufacturer
customer pickup storage with pickup

Distributor
Manufacturer
storage with
storage with direct
carrier delivery
shipping

-1

-2

Medium-demand
product
Low- demand product
Very- low- demand
Product

-1

-1

-2

Many product sources

-1

High product value

-1

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Quick desired
response

-2

-1

-2

High product variety

Low customer effort

-1
-2

2
-1

1
2

2
1

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Tutorials
Multiple Choice Questions
1.

The choice of the distribution network can be used to achieve supply chain
objectives such as
a.
low cost.
b.
high responsiveness.
c.
high cost.
d.
high responsibility.
e.
a and b only

2.

On which dimensions should the performance of a distribution network be evaluated

at the highest level?
a.
Profitability of individual supply chain components
b.
Efficiency of overall supply chain network
c.
Customer needs that are met
d.
Cost of meeting customer needs
e.
c and d only

3.

The ease with which the customer can place and receive their order as well as other
aspects of value that the sales staff provides is
a.
customer experience.
b.
order visibility.
c.
product availability.
d.
response time.
e.
returnability.

4.
a.
b.
c.
d.
e.

Outbound transportation costs per unit tend to be

about the same as inbound costs.
higher than inbound costs.
lower than inbound costs.
neither higher or lower than inbound costs.
none of the above

a.
b.
c.
d.
e.

As the number of facilities in a supply chain increases

the inventory and resulting inventory costs also increase.
the inventory and resulting inventory costs decrease.
the inventory increases and resulting inventory costs decrease.
the inventory decreases and resulting inventory costs increase.
the inventory and resulting inventory costs remain the same.

5.

6.
a.
b.
c.
d.
e.
7.
a.
b.
c.
d.
e.
8.

As the number of facilities in a supply chain increases, total transportation cost

decreases.
remains the same.
increases.
increases to a point and then decreases.
decreases to a point and then increases.
Total logistics costs for a supply chain network are a sum of
inventory and facility costs.
inventory, facility, and distributor costs.
facility, transportation, and distributor costs.
inventory, transportation, and facility costs.
none of the above

Which of the following is not a distinct distribution network design that may be used
to move products from factory to customer?
a.
Manufacturer storage with direct shipping
b.
Manufacturer storage with distributor pickup
c.
Distributor storage with package carrier delivery
d.
Distributor storage with last mile delivery
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e.
9.
a.
b.
c.
d.
e.
10.

Manufacturer/distributor storage with customer pickup

Advantages of manufacturer storage with direct shipping include
the ability to reduce cost of inventory by centralizing inventories at the manufacturer.
offering the manufacturer the opportunity to postpone customization until after the customer
order has been placed.
supply chains save on the fixed cost of facilities, because the need for other warehousing
space in the supply chain has been eliminated.
providing a good customer experience in the form of delivery to the customer location.
all of the above

Which of the following is an advantage of manufacturer storage with direct

shipping?
a.
Transportation costs are low because the average outbound distance to the end consumer
is small and package carriers are used to shipping the product.
b.
Supply chains save on the fixed cost of facilities, because the need for other warehousing
space in the supply chain has been eliminated.
c.
Response times tend to be small because the order has to be transmitted from the retailer to
the manufacturer.
d.
Order tracking is easy to implement because of the complete integration of information
systems at both the retailer and the manufacturer.
e.
The handling of returns is likely to be simple and inexpensive, improving customer
satisfaction.

11.
a.
b.
c.
d.
e.

The main advantage of in-transit merge over drop-shipping is

the ability to reduce cost of inventory by centralizing inventories at the manufacturer.
supply chains save on the fixed cost of facilities, because the need for other warehousing
space in the supply chain has been eliminated.
somewhat lower transportation cost and improved customer experience.
order tracking is easy to implement because of the complete integration of information
systems at both the retailer and the manufacturer.
the handling of returns is likely to be simple and inexpensive, improving customer
satisfaction.

12.

Which distribution network design is being used when the distributor/retailer

delivers the product to the customers home instead of using a package carrier?
a. Manufacturer storage with direct shipping
b. Manufacturer/distributor storage with customer pickup
c. Distributor storage with package carrier delivery
d. Distributor storage with last mile delivery
e. Retail storage with customer pickup

13.

Which of the following is a disadvantage of distributor storage with last mile

delivery?
a.
Transportation cost is higher than any other distribution option.
b.
Information cost is similar to distributor storage with package carrier delivery.
c.
Customer experience is very good, particularly for bulky items.
d.
Returnability is easier to implement than other options.
e.
Order traceability is less of an issue and easier to implement than manufacturer storage or
distributor storage with package carrier delivery.

14.

Which of the following is a disadvantage of manufacturer/distributor storage with

customer pickup?
a.
Customer experience is lower than other options because of the lack of home delivery.
b.
Response time is similar to package carrier delivery with manufacturer or distributor storage.
c.
Returnability is somewhat easier given that pickup location can handle returns.
d.
Product availability is similar to other manufacturer or distributor storage options.
e.
Facilities costs are lower if existing facilities are used.

15.

Distributors add value to a supply chain between a supply stage and a customer
stage
a.
b.

if there is a small number of customers requiring a large amount of product.

if there is a large number of customers requiring a large amount of product.

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c.
d.
e.

if there are many small players at the customer stage, each requiring a small amount of the
product at a time.
if there are a few large players at the customer stage, each requiring a large amount of the
product at a time.
Distributors do not add value to a supply chain.

Short Answer Questions

1.

Explain the measures of customer service that are influenced by the structure of the distribution
network.

2.

Explain how the design of a distribution network affects the cost of the four supply chain
drivers.

3.

Explain the following distribution network designs that may be used to move products from factory to
customer: manufacturer storage with direct shipping, distributor storage with carrier delivery,
manufacturer/ distributor storage with customer pickup, and retail storage with customer pickup

4.

Explain how distributors add value to a supply chain and improve its performance.

5.

A distributor has heard that one of the major manufacturers it buys from is considering going direct to
the consumer. What can the distributor do about this? What advantages can they offer the
manufacturer that the manufacturer is unlikely to be able to reproduce?

6.

What types of distribution networks are typically best suited for commodity items?

7.

What types of networks are best suited to highly differentiated products (high value but low volume)?

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Topic 4: Designing Supply Chain: Network Design

Aims

Identify factors influencing supply chain network design decisions.

Develop a framework for making network design decisions.
Use optimization for facility location and capacity allocation decisions.

Recommended Readings

Chapter 5

Key Terms/ Concepts

1.

Classifications of network design decisions

Factors influencing network design decisions: strategic, technological, macroeconomic, competitive environment, and costs
Four-step framework for network design decisions
Models for network analysis and evaluation, mathematic models, multi-attribute
models and simulation models

The Role of Network Design in a Supply Chain

Supply chain network design decisions are classified as follows:

1) Facility role, which answers the following questions:

What role should each facility play?

What processes are performed at each facility?

2) Facility location, which answers the question:

Where should facilities be located?

3) Capacity allocation, which answers the question:

How much capacity should be allocated to each facility?

4) Market and supply allocation, which answers the following questions:

2.

What markets should each facility serve?

Which supply should feed each facility?

In making supply chain network design decisions, you need to consider the following points
for each facility:

facility role

location of manufacturing, storage, or transportation-related facilities

the allocation of capacity and markets to each facility

The network design decisions determine the supply chains configuration and set limitations
in which other supply chain drivers can be used to reduce the supply chains cost or
improve its responsiveness.

Factors Influencing Network Design Decisions

Network design decisions are influenced by the following factors:

o

Strategic factors: competitive strategy (strategic fit), global competition, internal

constraints.

Technological factors: facility costs, economy of scale, available infrastructure,

available technology.

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3.

Macroeconomic factors: tariffs and tax incentives, regional demands, risks

(political, exchange rate, demand fluctuation risk).

Competitive environment: level of competition.

Costs: factor costs (labour, materials, land, etc) and logistic costs (transport, etc)

A Framework for Network Design Decisions

Phase I Define a supply chain strategy

Phase II Define regional facilities and distribution network configuration

locations, roles and capacities of facilities

Phase III Select desirable sites

competitive strategy, internal constraints

no. of location, capacity, transport

Phase IV Select exact location and detailed design

A framework for network design decisions is shown below:

Figure 4.1 Framework for Network Design Decisions

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4.

Models for Network Analysis and Evaluation

There are many models for network analysis and evaluation. These models may be
grouped into 3 categories:
o

Mathematical models

Multi-attribute models, and

Simulation models

4.1 Mathematical Models

Mathematical Models are complex, because their formulation requires expertise.

These models use quantitative approaches to problem solving.

Their limitation is that they optimise only one attribute, and therefore are only suitable
for simple problems.

There are many mathematical models available, but in this lecture, we will closely deal
with the following approaches:

Location Selection Models:

Transportation Cost Model (CVD method)

The Center of Gravity Method

Location Cost-Volume Analysis

4.2 Multi-Attribute Models

Multi-attribute models are somehow one of the easiest and most used approaches in
comparing several alternatives given several preference criteria.

These models deal with both quantitative and qualitative information, based on the
experiences and/or preferences of the group evaluating the alternatives.

The relative importance of several attributes such as cost, flexibility, and other
preferences are considered.

In this lecture, we will closely deal with the multi-attribute model using the weighted
evaluation method.

4.3 Simulation Models

5.

Simulation models are the most complex, since expertise is needed in building and
validating these models.

Models vary from company to company, depending on their system approach and
design.

But simulation can handle complex network design evaluation and run different
scenarios that help companies to deal with what if questions.

There are many simulation software packages available.

Location Selection Models

Transportation Cost Model: Cost-Volume-Distance (CVD)

In the CVD model, the desirability of closeness is based on the total cost of moving
materials. The objective is to minimise the total cost of transportation.

This model is based on distribution costs, supply costs, or both.

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Procedure:

Collect data: average number of trips in terms of volume required

between departments over a period of time (should be long enough for
the data to be representative).

Collect average cost per unit distance between departments (e.g.

$/ton/km).

Use CVD formula to minimize transportation costs

The objective is to minimize the total transportation cost (TC):

n

TC Cij Vij Dij

Minimize

i1 j 1

Cij cost of moving 1 item between departments i and j per unit distance;
Vij - volume between i and j over a period of time;
Dij distance
between i and j

Example: Lets say that as a manager, you were challenged to select the best location for
your warehouse between Adelaide and Sydney given following customer site demands:

Location

Customer Site

Distance Volume
(kms)
(tons)

A
B
C
A
B
C

Adelaide

Sydney

30
22
9
25
26
7

2
4
5
2
4
5

Rate
($/ton/km)
1,000
1,200
1,000
1,000
1,300
1,000

Solution:
n

Minimize

TC Cij Vij Dij

i1 j 1

TCAdelaide = ($1,000/ton/km 2tons 30kms) + (1,200422) + (1,000059)

= $210,600

= ($1,000/ton/km 2tons 25kms) + (1,300426) + (1,000057)

TCSydney
= $220,200
Based on the total transportation cost (minimise), Adelaide has lower cost.

The Centre of Gravity Method (COG)

This method is used to determine the location of a distribution centre by minimizing

distribution costs (location selection model).

The relative coordinates of the distribution points are placed on a map and the location of
the distribution point should be at the centre of gravity of the coordinates.
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Procedure:
1) Map the location: identify the coordinate axes (x-axis and y-axis) of all
the locations being evaluated on a map
2) Collect the demand requirements of all the locations over a period of
time (e.g. units/month)
3) Use COG formula to identify the centre of gravity location that
minimises distribution cost
Where the x and y coordinates of the centre of gravity are given by:
x=

(Di Xi)
Di

where
Di demand at each location;
Xi x-coordinate of each location;
Yi y-coordinate of each location

(Di Yi)
Di

y=

x = sum (demand at each location * x-coordinate of each location) / sum (all demands)
y =sum (demand at each location * y-coordinate of each location) / sum (all demands

Example: This time, as a manager you are assigned to find the best location for the
company to build your centralised warehouse, given the ff. demand rates:
Retail Outlet

Demand
(units/year)

x-coordinate

y-coordinate

Adelaide

40,000

Melbourne

20,000

Canberra

10,000

Solution:
From the given table, the centralised warehouse should be able to serve the three retail
outlets at a minimum distance travel. Given their annual demand and coordinates, you can
use the COG formula to identify the center of gravity for your warehouse.
Where the x and y coordinates of the centre of gravity are given by:
x=

y=

(Di Xi)
Di
(Di Yi)
Di

where
Di demand at each location;
Xi x-coordinate of each location;
Yi y-coordinate of each location

Total Demand = 70,000

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X(warehouse) =

40,000 3 20,000 110,000 3

2.43
70,000

Y(warehouse)
=

40,000 6 20,000 4 10,000 2

4.86
70,000

The warehouse, which serves the 3 outlets, should be located at location (2.43, 4.86)

Location Cost-Volume Analysis

This technique will indicate when a particular location is superior for a particular volume
level by analysing the mix of fixed and variable costs.

Some costs will be fixed (such as the costs of building the facility), while others will vary
with the location (such as the level of demand).

In this method, we will use the breakeven analysis approach in order to identify the point at
which one alternative becomes superior to another, where:
Total cost = fixed cost (FC) + variable cost (VC) output (n)
TC(n) = (FC) + (VC)(n)
Breakeven Analysis (n) comparing two alternatives:
TC (alterntive1) = TC (alterntive2)
FC + nVC (alterntive1) = FC + nVC (alterntive2)

Breakeven (n) =

Fc' Fc
Vc Vc'

where:
FC
fixed cost (Alternative A);
VC variable cost (Alternative A);
FC fixed cost (Alternative B);
VC variable cost (Alternative B)

Example, as a manager you are to determine which of the given facility location option is
better for an annual production of 100,000 units.

Location A

Location B

Variable costs ($ per unit)

1.75

1.25

Annualized fixed costs ($)

200,000

240,000

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Solution:
Let n = annual production (output)
Annual cost (A) = (1.75 n) + 200,000
Annual cost (B) = (1.25 n) + 240,000
Breakeven (cost of A = cost of B):
FC + nVC (Location A) = FC + nVC (Location B)
(1.75 n) + 200,000 = (1.25 n) + 240,000

240,000 200,000 40,000

Fc'Fc

80,000units
1.75 1.25
0.50
Vc Vc'

Breakeven is 80,000 units

So, if n
= 100,000 units, then location B has lower costs

If annual production is less than 80,000 units then location A has lower costs.

6.

Multi-Attribute Model

This section introduces you to decision analysis techniques, which take several criteria into
consideration (multi-attributes)

In many cases, the evaluation criteria may have to include different parameters such as:

Performance

Operability

Effectiveness

Design characteristics

Schedule and

Cost.

Procedure:
1) Identify alternatives
2) Select attributes for evaluation (e.g. logistics attributes and other
attributes such as flexibility, facility location, cost, etc.)
3) Estimate attribute weights
4) Evaluate alternatives against attributes and choose the best alternative
(e.g. Weighted Evaluation Method)

Weighted Evaluation Method:

1. Estimate attribute weights- Rank reciprocal weights
2. Give each alternative a score against each attribute
3. Calculate weighted evaluation for each attribute:
4. Calculate the total score for each alternative

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Estimating attribute weights:

1. Rank all attributes
2. Use appropriate technique to calculate attribute weights (e.g. Rank reciprocal
weights):
Attribute Weight = (1/Ranking)/ (sum of all the inverses of ranking)

Calculating for weighted evaluation for each attribute would be:

Weighted evaluation = (attribute weight score)/10

Example: your team was assigned to compare 2 alternatives: Location X and Location Y for
your project. Given the attributes and weights, your group needs to choose the better
location:
Attribute Weight = (1/Ranking)/ (sum of all the inverses of ranking)

Evaluation of alternatives against attributes:

Using weighted evaluation of alternatives technique:

Give each alternative a score (out of 10) against each attribute

Calculate weighted evaluation for each attribute = (attribute weight x score)/10

Calculate the total score for each alternative by summation

Weighted evaluation = (attribute weight score)/10

Attribute

Score

Attribute
weight

Weighted Evaluation

Loc X

Loc Y

Loc X

Loc Y

44

26.4

30.8

22

7.5

16.5

19.8

14

10

7.5

14

10.5

11

8.8

6.6

7.2

5.4

72.9

73.1

Location Y is the preferred option

Note that there are other multi-attribute techniques such as Analytic Hierarchy Process (AHP).

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7.

Simulation Model

Simulation is the imitation of a real-world process or system over time.

Simulation involves the generation of an artificial history of the system and the observation
of that artificial history to draw inferences concerning the operating characteristics of the
real system being represented.

Simulation as a problem-solving methodology can be utilised for the solution of many real
world problems.

Simulation is used to describe and analyse the behaviour of a system (real or conceptual)
and answers what if questions about the real system.

Model

A simplified representation of an actual system

Contains enough information to answer the question for which it was built

Event

An occurrence that changes state of a system

Types of model

Mathematical: considers the system through the use of formulas, which requires
solving the model

Discrete-event: time-based and are run not solved

Simulation software

There are many simulation software packages available

Advantages of Simulation

Making correct choices simulation allows the testing of every aspect of a proposed
change or additions without committing resources to their acquisition.

Compressing and expanding time simulation allows to speed up or slow down

phenomena to thoroughly investigate them.

Understanding Why the simulation allows reconstructing the scene and conducting
microscopic examination of the system.

Identifying constraints bottlenecks are an effect rather than a cause. By simulation

their cause can be discovered and corrected.

Exploring possibilities, diagnosing problems, preparing for change, etc.

Disadvantages of Simulation

Model building requires special training

Simulation results may be difficult to interpret

Simulation modeling and analysis can be time-consuming and expensive.

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Tutorials
Multiple Choice Questions
1.
a.
b.
c.
d.
e.
2.

d.
e.

Decisions concerning the role of each facility are significant because

they determine the amount of flexibility the supply chain has in demanding change.
they determine the amount of flexibility the supply chain has in changing the way it meets
demand.
they determine the amount of capacity the supply chain has in changing the way it meets
demand.
they determine the amount of inventory the supply chain has in demanding change.
None of the above are true.

a.
b.
c.
d.
e.

Capacity allocation decisions have a significant impact on supply chain performance

because
capacity decisions tend to be permanent.
capacity decisions tend to be changed frequently.
capacity decisions do not tend to stay in place for several years.
capacity decisions tend to stay in place for several years.
none of the above

a.
b.
c.
d.
e.

Allocating too much capacity to a location results in

permanent damage.
poor utilization, and as a result, higher costs.
high utilization, and as a result, higher costs.
poor utilization, and as a result, lower costs.
high utilization, and as a result, lower costs.

a.
b.
c.

3.

4.

5.
a.
b.
c.
d.
e.

6.

Allocating too little capacity results in

temporary damage.
good responsiveness if demand is not satisfied or low cost if demand is filled from a distant
facility.
good responsiveness if demand is not satisfied or high cost if demand is filled from a distant
facility.
poor responsiveness if demand is not satisfied or low cost if demand is filled from a distant
facility.
poor responsiveness if demand is not satisfied or high cost if demand is filled from a distant
facility.

e.

Network design decisions have a significant impact on performance because they

determine the supply chain configuration.
determine the supply chain conflagration.
set constraints within which inventory, transportation, and information can be used to either
decrease supply chain cost or increase responsiveness.
set constraints within which inventory, transportation, and information can be used to either
increase supply chain cost or decrease responsiveness.
a and c only

a.
b.
c.
d.
e.

Firms focusing on cost leadership tend to

locate facilities close to the market they serve.
locate facilities very far from the market they serve.
find the lowest cost location for their manufacturing facilities.
select a high-cost location to be able to react quickly.
none of the above

a.
b.
c.
d.

7.

8.

Supply chain network design decisions classified as facility role are concerned with
what processes are performed at each facility.
where facilities should be located.
how much capacity should be allocated to each facility.
what markets each facility should serve and which supply sources should feed each facility.
none of the above

Firms focusing on responsiveness tend to

a. locate facilities close to the market they serve.
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University of South Australia

b.
c.
d.
e.
9.
a.
b.
c.
d.
e.

If facilities have lower fixed costs,

a few high-capacity facilities are preferred because this helps lower transportation costs.
a few local facilities are preferred because this helps lower transportation costs.
many high-capacity facilities are preferred because this helps lower transportation costs.
many local facilities are preferred because this helps lower transportation costs.
one central facility is preferred because this helps lower transportation costs.

a.
b.
c.
d.
e.

If the production technology is very inflexible and product requirements vary from one
country to another, a firm has to set up
local facilities to serve the market in each country.
a few high-capacity facilities to serve the market in each country.
many local facilities because this helps lower transportation costs.
a few high-capacity facilities because this helps lower transportation costs.
many high-capacity facilities because this helps lower transportation costs.

a.
b.
c.
d.
e.

If the technology is flexible,

it becomes more difficult to consolidate manufacturing in a few large facilities.
it becomes more difficult to distribute manufacturing in many local facilities.
it becomes easier to consolidate manufacturing in a few large facilities.
it becomes easier to consolidate manufacturing in many local facilities.
the firm should have one central facility.

10.

11.

12.

e.

If a country has very high tariffs,

companies either do not serve the local market or set up manufacturing plants within the
country to save on duties.
companies do not serve the local market.
companies set up manufacturing plants within the country to save on duties.
companies will not serve the local market or set up manufacturing plants within the country
to save on duties.
companies will serve the local market by setting up regional manufacturing plants.

a.
b.
c.
d.
e.

Which of the following is not a phase in the design of a global supply chain network?
Define a supply chain strategy.
Define the regional facility configuration.
Select desirable sites.
Location choices.
Implement supply chain strategy

a.
b.
c.
d.

13.

14.
a.
b.
c.
d.
e.

15.

locate facilities very far from the market they serve.

find the lowest cost location for their manufacturing facilities.
select a high-cost location to be able to react slowly.
none of the above

The objective of the first phase of network design is to

maximize total profits, taking into account the expected margin and demand in each market.
select a precise location and capacity allocation for each facility.
select a set of desirable sites within each region where facilities are to be located.
identify regions where facilities will be located, their potential roles, and their approximate
capacity.
specify what capabilities the supply chain network must have to support a firms competitive
strategy.

It is very important that long-term consequences be thought through when making facility
decisions, because
a.
network designers can use this fact to influence the role of the new facility and the focus of
people working there.
b.
facilities last a long time and have an enduring impact on a firms performance.
c.
it is astounding how often tax incentives drive the choice of location.
d.
the location of a facility has a significant impact on the extent and form of communication
that develops in the supply chain network.
e.
the quality of life at selected facility locations has a significant impact on performance.

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Short Answer Questions

1.
2.
3.
4.

Explain how supply chain network design decisions are classified.

Describe the factors that influence supply chain network design decisions.
Describe the four phases in the framework for network design decisions.
Consider a firm like Dell with very few production facilities worldwide. List the pros and cons of this
approach and why it may or may not be suitable for the computer industry.
5. Consider a firm like Ford with over 150 facilities worldwide. List the pros and cons of this approach and
why it may or may not be suitable for the automobile industry.

Problems
1. A manufacturing organization is looking at the following two locations:
Variable costs
Annual fixed costs
a.
b.

Birmingham
$14/unit
$18,000,000

Manchester
$16/unit
$16.000,000

At what volume do these locations have equal costs?

If the volume is 1,200,000 units, which location should be selected?

2. A newly formed firm must decide on a plant location. There are two alternatives under
consideration: location near the major raw materials or near the major customers. Locating
near the raw materials will result in lower fixed and variable costs than locating near the
market, but the owners believe there would be a loss in sales volume because customers
tend to favour local suppliers. Revenue per unit will be $185 in either case. Using the
following information, determine which location would produce greater profit.

Annual fixed costs ($ millions)

Variable cost per unit
Expected annual demand (units)

Geelong
$ 1.2
$ 36
8,000

Ballarat
$ 1.4
$ 47
12,000

3. A company has decided to relocate from three separate facilities: plant A, plant B, and plant
C to a new facility: plant D. using the centre of gravity method determine the best location
for plant D to serve its customers using the facility locations and yearly demand shown
below.
Facility Location coordinates Demand (per year)
A
(175,280)
6000
B
(50,200)
8200
C
(150,75)
7000

4. A retail chain has four major stores in the East Midlands area, which have the following
monthly demand rates.
Store location Monthly demand (units)
Derby
2000
Nottingham
1000
Leicester
1000
Sheffield
2000

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The following map shows the relative coordinates of the four outlets:

The organization has decided to find a central location in which build a warehouse. Find
the coordinates of the centre that will minimize distribution costs.

5. The following table lists the weightings representing the relative importance of factors for
the location of a retail site. Four potential sites have been a score out of 100 for each factor:

Factor
Construction cost
Operating cost
Population density
Convenient access
Ranking area

Weight
0.1
0.1
0.4
0.2
0.2

Site
B
60
80
90
80
70

A
90
90
70
75
60

C
80
90
80
90
85

D
70
85
75
90
75

Rank the four sites in order of their total weighted points score for suitability for the
proposed location.

6. A manager has received an analysis of several cities being considered for a new office
complex. The data (10 points maximum) are
Factor
Business services
Community services
Real estate costs
Construction costs
Cost of living
Taxes
Transportation

A
9
7
3
5
4
5
6

Location
B
5
6
8
6
7
5
7

C
5
7
7
5
8
4
8

a. If the manager weights the factors equally, how would the locations stack up?
b. If business services and construction costs are given weights that are double the
weights of the other factors, how would the locations stack up?
Answers to problems
1. 1 million units, Birmingham
3. (118.4, 181.4)
5. C, B, D, A
Dr Yousef Amer- School of Engineering

2. Ballarat with a profit of $256K

4. (2.67, 2.67)
6. B & C the same rank, then A, B> C > A
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University of South Australia

Topic 5: Demand Forecasting in a Supply Chain

Aims

Understand the role of forecasting for both an enterprise and a supply chain.
Identify the components of a demand forecast.
Forecast demand in a supply chain given historical demand data using time series
methodologies
Analyse demand forecasts to estimate forecast error.

Recommended Readings

Chapter 7

Key Terms/ Concepts

1.

The roles and characteristics of forecast in a supply chain:

Demand forecasting: capacity planning
Forecasting methods:
Qualitative methods
Causal
Time Series methods (quantitative)
Simple Moving Average
Simple Linear Regression
Seasonal Adjustments
Measures of Forecast errors: such as Mean Absolute Deviation (MAD), Mean
Square Error (MSE) and Mean Absolute Percentage Error (MAPE)

The Role of Forecasting in a Supply Chain

The forecast of demand forms the basis for all strategic and planning decisions in a supply
chain.

Let us consider the push/pull view of the supply chain discussed on topic 1. Throughout
the supply chain, all push processes are performed in anticipation of customer demand,
while all pull processes are performed in response to customer demand.

For the push process, a manager must plan the level of production, while for the pull
process, a manager must plan the level of available capacity and inventory.

In both instances, the first step a manager must take is to forecast what customer demand
will be.

Here are some of the decisions that utilize forecasts and can be enhanced through
collaborative forecasting among supply chain partners:
Production: scheduling, inventory, aggregate planning
Marketing: sales force allocation, promotions, new production introduction
Finance: plant/equipment investment, budgetary planning
Personnel: workforce planning, hiring, layoffs

All of these decisions are interrelated.

2.

Characteristics of Forecast

If forecasts are always wrong, the firm should include expected value and measure of error.

Long-term forecasts are less accurate than short-term forecasts

o

Forecast horizon is important

Aggregate forecasts are more accurate than disaggregate forecasts

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3.

Basic Approaches to Demand Forecasting

Forecasting may include:

Technological forecasts

Economic forecasts

Demand forecasts

The basic approach in performing effective forecasting is as follows:

1) Understand the objective of the forecasting
2) Integrate demand planning and forecasting throughout the supply chain
3) Understand and identify customer segments
4) Identify major factors that influence the demand forecast, e.g. Technological,
economic trend, seasonal fluctuations, past demand, competitors
5) Determine the appropriate forecasting technique
6) Establish performance and error measures for the forecast

4.

Consider factors such as:

Past demand

Lead time of product

Planned advertising and marketing efforts

State of the economy

Planned price discounts

Actions competitors have taken

There are many forecasting methods, including:

Qualitative methods

Causal

Time series methods

Qualitative Methods

Qualitative forecasting methods are primarily subjective and rely on human judgment.

They are most appropriate when there is little historical data available or when experts have
market intelligence that is critical in making the forecast.

Such methods may be necessary to forecast demand several years into the future in a new
industry.

Some qualitative methods include:

Field sales force this represents a direct point of contact that provides
information with regards to the anticipating future consumer expectations, which
other people may not have.

Jury of executives this is the most common type of forecasting method for the
long-term strategic planning process.

Delphi method this involves gathering of consensus forecast information about

future consumer expectations from the experts.

Qualitative methods are usually suitable for medium to long-term forecasting such as
technological or economic forecasts
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5.

Causal Methods

These methods assume that the demand forecast is highly correlated with certain factors in
the environment, such as economy, interest rates, etc.

Causal forecasting methods find correlation between demand and environmental factors,
and use these correlations in forecasting future demand.

6.

Quantitative Methods (Time Series)

Time Series

use historical demand only.

based on the assumption that past demand history is a good indicator of future
demand.

most appropriate when the basic demand pattern does not vary significantly.

We will focus on the following techniques:

Simple moving average: smooth the random fluctuations

Simple linear regression: identify trend

Seasonal index: account for seasonal fluctuations

6.1 Simple Moving Average (SMA)

A simple moving average (SMA) is a method of computing the mean of a specified

number of the most recent data values in a series in order to smooth out random
fluctuations.

Moving averages are computed for specific periods.

These may be within three months to six months, depending on the extent by which
the forecast would like to smooth the demand data.

The longer the moving average period, the smoother the demand data will be.

The formula for computing SMA is:

n

SMAt+1 =

i(t 1n )

where:
SMAt+1 = simple moving average at the end of a period t, which

typically will be used as a forecast for next period (t +1)

Di = actual demand in period i
n = number of periods in the moving average

6.2 Simple Linear Regression

Simple regression determines the equation for a straight line that passes through a
set of points so that the sum of the squared distances from the points to the linear
line will be the minimum amount for any straight line that could be drawn through
the points.

That is, it determines the least-squares line, or the line with the minimum squared
error.

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The trend equation has the form:

y = a + bx
where:

y is the demand forecast for the time period x;

The slope of line b and the intercept a, can be found by using least squares
formulas:

a y bx

xy n x y
x nx
2

or

y bx

n xy x y
n x 2 ( x ) 2

where:
the mean of the x values

the mean of the y values

n = number of periods
y = actual values of dependent variable
x = actual values of independent variable

6.3 Seasonal Index

Seasonal adjustments are focused by computing the average ratio of actual

demand to the trend value for each period of interest.

Such a ratio is referred to as a seasonal index.

Seasonal Index Formula:

where:
Si = seasonal index of a period i
Di = actual demand of a period i
Fi = trend value of a period i, which is typically from linear trend
Applying the three techniques: (1) Simple moving average, (2) Simple linear regression,
and (3) Seasonable index, here is an example of time series problem:
A companys quarterly demand figures for the past 2 years are given below:

Year 1

Year 2

Quarter

Demand

Quarter

Demand

26,209

25,390

21,402

19,064

18,677

18,173

24,681

23,866

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You are asked to:

1. Deseasonalize the data using four-quarter moving average
2. Compute a linear regression equation for the trend in demand using centre of
period from 2.5 to 6.5
3. Compute the average seasonal index for each of the four quarters
4. Using the trend and seasonal indices you have developed a forecast for the
demand in each of the quarters of the following year
Solution:
1) Deseasonalizing the data using four-quarter moving average:
The first years moving average would be centred between the second quarter and the
third quarter, that is, at the x-coordinate of 2.5. The x-coordinate for the next moving
average will be 3.5, etc.
The four-quarter moving averages and the corresponding x-coordinates are shown in
the following table:
n

i1

Actual Demand

Sum of 4
Quarters
Year 1- Q1
Year 1- Q2
Year 1- Q3
Year 1- Q4
Year 2- Q1
Year 2- Q2
Year 2- Q3
Year 2- Q4
Year 3- Q1

26,209

21,402
18,677
24,681
25,390
19,064
18,173
23,866

i1

4-quarter moving
xaverage
coordinate

90,969
90,150
87,812
87,308
86,493

2.5
3.5
4.5
5.5
6.5

22,742.25
22,537.50
21,953.00
21,827.00
21,623.25

SMA4

D
i1

26,209 21,402 18,677 24681

22,742.25 demand for next
quarter at 2.5 (x)
4

2) Computing the linear regression equation for the trend in demand, using centre of
period from 2.5 to 6.5:

4-quarter moving
averages
y

1
2
3
4
5

Period
2

xy

22,742.25
22,537.50
21,953.00
21,827.00
21,623.25

2.5
3.5
4.5
5.5
6.5

56855.63
78881.25
98788.50
120048.50
140551.13

x
6.25
12.25
20.25
30.25
42.25

110,683.00

22.50

495,125.00

111.25

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n 5
x

xy n x y 495,125 54.522,136.60 294.85

111.25 54.5
x nx

22.5
4.5
5

110,683
22,136.60
5

a y bx 22,136.60 (294.85)(4.5) 23,463.425

Linear regression
equation:

y 23,463.425 294.85(x)
3) Computing the average seasonal index for each of the four quarters:
The time
period at which actual demand occurs corresponds to periods 1, 2, 3, 4, etc.,
on the time scale. Using the values for (x), we can determine the trend value at each of
these times, so that we can compute seasonal relatives or seasonal indices for a
multiplicative model:

Si

Fi = yi = 23,463.425 - 294.85(x)
Year

Period (x)

Forecast (Fi)

1
2
3
4
1
2
3
4

1
2
3
4
5
6
7
8

23,168.58
22,873.73
22,578.88
22,284.03
21,989.18
21,694.33
21,399.48
21,104.63

Di
Fi

Actual
Seasonal Index
Demand (Di)
(Si)
26,209

21,402
18,677
24,681
25,390
19,064
18,173
23,866

1.131
0.936
0.827
1.108
1.155
0.879
0.849
1.131

Average Si
per quarter
YEAR 3
1.143

Q1

0.907

Q2

0.838

Q3

1.119

Q4

Computation for forecast:

Forecast (Fi) = yi = 23,463.425 - 294.85(x)
F1 = 23,463.425 - 294.85(1) =23,168.58
F2 = 23,463.425 - 294.85(2) =22,873.73
F3 = 23,463.425 - 294.85(3) =22,578.88
F4= 23,463.425 - 294.85(4) =22,284.03
F5 = 23,463.425 - 294.85(5) =21,989.18
F6 = 23,463.425 - 294.85(6) =21,694.33
F7 = 23,463.425 - 294.85(7) =21,399.48
F8 = 23,463.425 - 294.85(8) =21,104.63
Computation for average seasonal:
The seasonal index in the first quarter of year 1 is 1.131, and the seasonal index of the first
quarter of year 2 is 1.155. Thus the average index for the first quarter over the 2 years
period is 1.143.

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S(Q1)

1.1311.155
1.143
2

S(Q 3)

0.827 0.849
0.838
2

S(Q 2)

0.936 0.879
0.908
2

S(Q 4 )

1.108 1.131
1.120
2

4) Developing a forecast for the demand in each of the quarters of the following year using
linear regression trend and seasonal
indices:

Fi = yi = 23,463.425 - 294.85(x)
Year

Quarter

Period (x)

Forecast (Fi)

1
2
3
4
1
2
3

1
2
3
4
5
6
7

23168.58
22873.73
22578.88
22284.03
21989.18
21694.33
21399.48

21104.63

1
2
3
4

9
10
11
12

20,809.78
20,514.93
20,220.08
19,925.23

Average
seasonal index
per quarter
1.143
0.908
0.838
1.120

Demand
Forecast
23,786
18,628
16,945
22,317

Computation for forecast:

Forecast (Fi) = yi = 23,463.425 - 294.85(x)
F9 = 23,463.425 - 294.85(9) =20,809.78
F10 = 23,463.425 - 294.85(10) =20,514.93
F11 = 23,463.425 - 294.85(11) =20,220.08
F12= 23,463.425 - 294.85(12) =19,925.23
The trend value for the 1st quarter of year 3 using the regression equation (y= 23,463.425 294.85(x) with x= 9, i.e. period 9) is 20,809.78. This is then multiplied by the average
seasonal index of 1.143 to give the forecast for the 1st quarter of year 3, which is 23,786.
The same procedure can be done for other quarters.

7.

Measures of Forecast Accuracy

Demand is influenced by many factors

It is unrealistic to expect a demand forecast to be exactly right every time

Forecast error (error deviation)

o

the difference between the forecast value and the actual demand

Measures of forecast error:

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Mean Absolute Deviation (MAD)

Mean Square Error (MSE)

Mean Absolute Percentage Error (MAPE)

7.1 Mean Absolute Deviation (MAD)

A common measure of forecast error that is fairly easy to compute.

The average absolute of the difference of the actual and forecast demand:

where:
Di = actual demand in period i
Fi = forecast demand in period i
n = number of periods
= absolute value
* The smaller the MAD, the more accurate the forecast

7.2 Mean Square Error (MSE)

A method of measuring errors that penalizes large errors more than small errors is
sometimes desired.

The average squared of the difference of the actual and forecast demand:
n

D F

MSE

i1

n 1

where:
Di = actual demand in period i

Fi = forecast demand in period i

n = number of periods

7.3 Mean Square Error (MSE)

Measures the absolute error as a percentage of demand.

It eliminates the difficulty of analysing the accuracy of demand and forecast value,
as MAD does.

where:
Di = actual demand in period i
Fi = forecast demand in period i
= absolute value
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*The lower the % deviation, the more accurate the forecast

Example- Computing for MAD and MAPE:

Demand

Forecast

Deviation

Squared Deviation

Di

Fi

(Di-Fi)

(D -F )

120

125

-5

25

130

125

25

110

125

-15

225

15

140

125

15

225

15

110

125

-15

225

15

130

125

25

D F

D 740

| Di-Fi |

5
6

D F

750

MAD

i1

60
10
6

60

D F

i1

i1

Computation:

Absolute Deviation

D F

MSE

i1

n 1

750
150
5

D F
MAPE
D
i

i1

60
100%
100% 8.11%
740

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Tutorials
Multiple Choice Questions
1.

For push processes, a manager must forecast what customer demand will be
in order to
a.
plan the service level.
b.
plan the level of available capacity and inventory.
c.
plan the level of productivity.
d.
plan the level of production.
e.
none of the above

2.

For pull processes, a manager must forecast what customer demand will be
in order to
a.
plan the service level.
b.
plan the level of available capacity and inventory.
c.
plan the level of productivity.
d.
plan the level of production.
e.
none of the above

3.

The result of each stage in the supply chain making its own separate forecast
is
a.
b.
c.
d.
e.

an accurate forecast.
a more accurate forecast.
a match between supply and demand.
a mismatch between supply and demand.
none of the above

a.
b.
c.
d.
e.

The resulting accuracy of a collaborative forecast enables supply chains to be

more responsive but less efficient in serving their customers.
both more responsive and more efficient in serving their customers.
less responsive but less efficient in serving their customers.
both less responsive and less efficient in serving their customers.
None of the above are true.

4.

5.

In general, the further up the supply chain a company is (or the further they are
from the consumer),
a.
the greater the distortion of information they receive.
b.
the smaller the distortion of information they receive.
c.
the information they receive is more accurate.
d.
the information they receive is more useful.
e.
none of the above

6.

Forecasting methods that are primarily subjective and rely on human judgment
are known as
a.
qualitative forecasting methods.
b.
time series forecasting methods.
c.
causal forecasting methods.
d.
simulation forecasting methods.
e.
none of the above

7.
a.
b.
c.
d.
e.
8.

Time series forecasting methods are most appropriate when

there is little historical data available.
the basic demand pattern varies significantly from one year to the next.
the basic demand pattern does not vary significantly from one year to the next.
experts have critical market intelligence.
forecasting demand several years into the future.

Which forecasting methods are the simplest to implement and can serve as a
good starting point for a demand forecast?
a.
qualitative forecasting methods
b.
time series forecasting methods
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c.
d.
e.
9.

causal forecasting methods

simulation forecasting methods
none of the above

Managers perform a thorough error analysis on a forecast for which of the

following key reasons?
a.
To establish a closely linked systematic forecasting method to accurately predict the level
season component of demand.
b.
To determine whether the current forecasting method is accurately predicting the systematic
component of demand.
c.
In order to develop contingency plans that account for forecast error.
d.
all of the above
e.
b and c only

Short Answer Questions

1. Explain the role of forecasting in a supply chain.
2. Explain the following types of forecasting methods and their applications: qualitative, quantitative (time
series), and causal.
3. Explain the basic, six-step approach to help an organization perform effective forecasting.
4. What role does forecasting play in the supply chain of a build-to-order manufacturer such as Dell?
5. How could Dell use collaborative forecasting with its suppliers to improve its supply chain?
6. What role does forecasting play in the supply chain of a mail order firm?

Problems
1.
Here is a series of weekly demand data, covering 8 weeks that the Forever Young Cosmetic
Company collected on one of its products and forecasts for the corresponding weeks, made by forecast
model 1, which the cosmetic company is testing.

Week
1
2
3
4
5
6
7
8

Demand
218
275
244
262
271
273
261
236

Forecast
240
245
250
255
260
265
270
275

a) Compute the mean absolute deviation based on all 8 weeks of data.

b) Compute the mean squared error based on these 8 weeks of data.

2.
The Forever Young Cosmetic Company used forecast model 2 to forecast demand for a different
product. Eight weeks of actual data and forecast data are shown below.
Week
1
2
3
4
5
6
7
8
Dr Yousef Amer- School of Engineering

Demand
136
151
185
144
127
183
172
158

Forecast
150
160
165
150
150
160
165
160

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a) Calculate the MAD based on these 8 weeks of data.

b) Calculate the MSE based on these 8 weeks of data.

3.
On the basis of the mean absolute percentage error, does it appear that the forecast model in
Problem 1 or the model in Problem 2 does a better job of forecasting? If you worked the two previous
problems, discuss the MADs for the two forecast models.
4.

Here are 2 years worth of monthly demand data for fleece jackets at a large sporting goods store:
Month of
January
February
March
April
May
June
July
August
September
October
November
December

Year 1
115
116
79
65
39
16
15
13
29
58
89
97

Year 2
127
131
83
67
39
19
15
13
29
58
89
97

a) Calculate the 3-month moving averages for the data.

b) Calculate the 6-month moving averages for the data.
c) Which seems to be more stable? Why?

5.
A Midwest distributor has handled a particular brand of two-cycle motor oil for the past 5 years. The
demand data for the product during those years are given below.
Year
1
2
3
4
5

Demand
428
631
740
778
841

a) Plot the data. Should the first years data be included in computing a linear regression model to
estimate the trend in annual demand? Give a reason to support your answer.
b) Calculate a linear regression equation for annual demand based on the data you concluded in part a
to be most appropriate.
c) Use your equation to estimate demand for years 6 and 7.

6.
Given below are 2 years of quarterly demand data for a particular model of personal computer from
a local computer store.
Quarter
1
2
3
4

Year 1
40
46
39
42

Year 2
44
57
43
45

a) Deseasonalize the data with four-quarters moving average (for centre of data from 2.5 to 6.5), and
compute a linear regression equation for the trend in demand
b) Compute the average seasonal index for each of the four quarter of a year.
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c) Using the trend and seasonal indices you have developed, compute a forecast for the demand in
each of the quarters of the following year.

7.

Here are 2 years of quarterly data on demand for ruckasacks from an outdoor retailer.
Quarter
1
2
3
4

Year 1
218
119
138
199

Year 2
257
110
156
201

a) Deseasonalize the data with four-quarters moving average (for centre of data from 2.5 to 6.5), and
compute a regression equation for the trend in demand
b) Compute the average seasonal index for each of the four quarters of a year.
c) Using the trend and seasonal indices you have developed, compute a forecast for the demand in
each of the quarters of the following year.

8.
Given below are 2 years of quarterly data on demand for a particular model of electric
blender at a mail-order warehouse.
Quarter
1
2
3
4

Year 1
916
822
840
928

Year 2
902
794
818
902

a) Deseasonalize the data with four-quarters moving average (for centre of data from 2.5 to 6.5), and
compute a regression equation for the trend in demand
b) Compute the average seasonal index for each of the four quarters of a year using data from previous
2 years
c) Using the trend and seasonal indices you have developed, compute a forecast for the demand in
each of the quarters of the following year.

Answers to problems
1.
2.
3.
4.
5.

6.

7.
8.

MAD= 16.5, MSE= 407

MAD= 13.0, MSE= 228
MAPE for Tut. 2 = 6.638, MAPE for Tut. 3 = 8.425
The 6-month average is more stable because it contains more previous levels along with the current
demand level
The first year is not in line with the trend, perhaps because start-up sales are often difficult to
achieve. The equation using data from year 2 to year 5 is y = 66.8 x + 513.7. Estimate for year 6 is
914.5 and year 7 is 981.3
The moving averages from 2.5 to 6.5 are 41.75, 42.75, 45.50, 46.50, 47.25, and the regression
equation is y= 1.475 x + 38.1125. The average index for quarters 1 to 4 is 0.989, 1.167, 0.903 and
0.928 respectively. The demand forecast for quarter 1 to 4 of year 3 is 50.80, 61.69, 49.04 and 51.79
respectively.
The regression equation y= 2.727 x + 164.588. The demand forecast for quarters 1 to 4: 259.56,
125.44, 160.34, 218.24
The regression equation y= -5.75 x + 891.875. The demand forecast for quarters 1 to 4: 873.74,
775.97, 796.31, 878.01

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Topic 6: Aggregate Planning in a Supply Chain

Aims

Identify the type of decisions that are best solved by aggregate planning.
Understand the importance of aggregate planning as a supply chain activity.
Describe the kind of information needed to produce an aggregate plan.
Explain the basic trade-offs a manager makes when producing an aggregate plan.

Recommended Readings

Chapter 8

Key Terms/ Concepts

1.

The roles of aggregate planning in a supply chain: Planning the required capacity
(at an aggregate level) to meet demand forecasts.
The aggregate planning problem: determine the production level, inventory level,
and the capacity level to meet demand forecasts at a minimum cost.
Aggregate planning tools: mathematical models, trial & error method
Aggregate planning strategies:
Chase strategy,
Time flexibility,
Level (pure inventory) strategy
Mixed strategy

The Role of Aggregate Planning in a Supply Chain

Aggregate planning is a process by which a company determines levels of capacity,

production, subcontracting, inventory, stockouts, and even pricing over specified time
horizon.

The goal of aggregate planning is to satisfy demand in a way that maximizes profit.

Traditionally, much of aggregate planning is focused within an enterprise and may not
always be seen as a part of supply chain management.

Aggregate planning however, is an important supply chain issue because, to be effective, it

requires inputs from throughout the supply chain and its results have a tremendous impact
on the supply chain plan.

As we saw in the chapter on forecasting, collaborative forecasts are created by multiple

supply chain enterprises and an important input for aggregate planning.

The aggregate planners main objective is to identify the following operational parameters
over the specified time horizon:

Production rate: the number of units completed per unit time (such as per week or
per month).

Workforce: the number of workers/units of capacity needed for production.

Overtime: the amount of overtime production planned.

Machine capacity level: the number of units of machine capacity needed for
production.

Subcontracting: the subcontracted capacity required over the planning horizon.

Backlog: demand not satisfied in the period in which it arises but carried over to
future periods.

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2.

Inventory on hand: the planned inventory carried over the various periods in the
planning horizon.

The Aggregate Planning Problem

We can formally state the aggregate planning problem as follows:

o

Given the demand forecast, the following should optimise the supply chain
profitability over the planning horizon:

production level

inventory level

capacity level

Specify the following:

planning horizon (typically 3-18 months)

the duration of each period

key information required to develop an aggregate plan

An aggregate planner requires the following information:

o

Demand forecast Ft for each period t in the planning horizon that extends over T
periods

Production costs

Labour costs, regular time ($/hour)

Cost of subcontracting production ($/units or $/hour)

Cost of changing capacity; specifically, cost of hiring/laying off workforce

($/worker) and cost of adding or reducing machine capacity ($/machine)

Labour/ machine hours required per unit

Inventory holding cost ($/units/period)

Stockout or backlog cost ($/units/period)

Constraints

Limits on overtime

Limits on layoffs

Limits on capital available

Limits on stockout and backlogs

Constraints from suppliers to the enterprise

This information is used to create an aggregate plan that in turn helps a company make the
following determinations (output of aggregate plan):
o

Production quantity from regular time, and subcontracted time: used to determine
number of workers and supplier purchase levels.

Inventory held: used to determine how much warehouse space and working capital
is needed.

Backlog/stockout quantity: used to determine what the customer service level will
be.

Workforce hired/laid off: used to determine any labour issues that will be
encountered.

Machine capacity increase/ decrease: used to determine if new production

equipment needs to be purchased or idled.

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3.

A poor aggregate plan can result in lost sales, lost profits, excess inventory, or excess
capacity.

Aggregate Planning Tools

Mathematical models
o

4.

Linear programming: often suitable only for small-scale problems

Trial and error method

o

This is the most widely used method in aggregate planning.

It evaluates the cost of alternative ways of using resources to provide the necessary
production capacity.

It is relatively easy to understand and use (does not involve elaborate mathematics
to develop the best plan).

It involves tedious repetition of simple calculations to evaluate the cost of alternative

plans.

It is helpful to develop a table to display these calculations.

Aggregate Planning Strategy

There are essentially three distinct aggregate planning strategies for achieving balance
between costs.
o

These strategies involve trade-offs between capital investments, workforce size,

work hours, inventory, and backlogs/lost sales.

Most strategies that a planner actually uses are a combination of these three and are
referred to as mixed strategies. The 3 basic strategies are:
1. Chase strategy: uses capacity as the lever
2. Time flexibility: uses utilization as the lever
3. Level strategy: uses inventory as the lever

Most strategies that a planner actually uses are a combination of these three and are
referred to as mixed strategies.

3.1 Chase strategy using capacity as the lever

With this strategy, the production rate is synchronized with the demand rate by
varying machine capacity or hiring and laying-off employees as the demand rate
varies.

In practice, achieving this synchronization can be very problematic because of the

difficulty in varying capacity and workforce on short notice.

Should be used when inventory holding costs are high and costs of changing
capacity are low.

Example: Given the following information:

Current Inventory = 200 items
Current workers = 30
Holding/Inventory cost = $1.10 /quarter/unit
Hiring/sacking rate/person = $10
Safety Inventory = 100 items
1 worker can produce 10 items per quarter
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Forecast: 200, 400, 200, 300 for each quarter

You are asked to compute for the cost of Chase Strategy.
Solution:

Quarter (q) Demand

Beg. Inventory
(end. inventory
of previous
quarter)

Production

End. Inventory/
Safety Stock

No. of
Workers
Needed

200

30

Sack

Hire

200

200

100

100

10

20

400

100

400

100

40

30

200

100

200

100

20

20

300

100

300

100

30

10

# employee

*Initial ending inventory of 200 and 30 workers

are based on the previous quarter, as given in the
problem.

production
workforce(capacity )

100 items
10 item /quarter

10 employee

Computation for the total cost:

Cost of hiring/sacking = $10* (20+20+30+10) = $800
Inventory cost = safety stock * holding cost/unit
= 100 items * 4 q * $1.10/q/unit = $440

Total cost = cost of hiring + cost of sacking + inventory cost

= $1,240 (excluding labour & mat costs)

3.2 Time flexibility strategy using utilization as the lever

This strategy may be used if there is excess machine capacity.

In this strategy, the workforce is kept stable but the number of hours worked is
varied over time to synchronize production with demand (overtime work).

Should be used when inventory holding costs are high and capacity is relatively
inexpensive.

3.3 Level strategy using inventory as the lever

In this strategy, a stable machine capacity and workforce maintained with a constant
production rate.

Here production is not synchronized with demand but built-up in inventory during
low demand periods is used to meet the high demand periods.

Shortages and surpluses result in fluctuations in inventory levels over time

Backlogs are carried over from high to low demand periods.

Should be used when inventory holding and backlog costs are relatively low.

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Example: Given the following information:

Current Inventory = 200 items
Current workers = 30
Holding/Inventory cost = $1.10 /quarter/unit
Hiring/sacking rate/person = $10
1 worker can produce 10 items per quarter
Forecast: 200, 400, 200, 300 for each quarter
Solution:

Quarter

1
2
3
4

Production
Demand (average of total End Inventory
demand)
200
200
275
275
400
150
275
200
225
275
300
200
275

No. of Employee
Needed

*Initial ending inventory of 200 and 30 workers

are based on the previous quarter, as given in the
problem.

Sack

Hire

30
28
28
28
28

# employee

production
workforce(capacity )

275 items
10 item /quarter

28 employee

Computation for the total cost:

Cost of sacking = $10* 2 = $20
Inv cost = total ending inventory * holding cost/unit
= 850 items * $1.10/quarter/unit = $935

Total cost = cost of hiring + cost of sacking + inventory cost

= $955 (excluding labour & mat costs)

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Tutorials
Multiple Choice Questions
1.
a.
b.
c.
d.
e.

Aggregate planning, to be effective, requires inputs from

all customers.
all departments.
all suppliers.
throughout the supply chain.
throughout the company.

a.
b.
c.
d.
e.

Much of aggregate planning has traditionally been focused

on short-term production scheduling.
on customer relationship management.
within an enterprise.
beyond enterprise boundaries.
all of the above

2.

3.

Which of the following are not operational parameters the aggregate planner
is concerned with?
a.
production rate
b.
workforce
c.
overtime
d.
backorders
e.
inventory on hand

4.

c.
d.
e.

The aggregate plan

serves as a broad blueprint for operations.
establishes the parameters within which short-term production and distribution decisions are
made.
allows the supply chain to alter capacity allocations and change supply contracts.
all of the above
b and c only

a.
b.
c.
d.
e.

Aggregate planning is concerned with determining

the production level, sales level, and capacity for each period.
the demand level, inventory level, and capacity for each period.
the production level, inventory level, and capacity for each period.
the production level, staffing level, and capacity for each period.
none of the above

a.
b.
c.
d.
e.

The planning horizon is

the time period over which the aggregate plan is to produce a solution.
the duration of each time period in the aggregate plan.
the length of time required to produce the aggregate plan.
the solution to the aggregate plan.
none of the above

a.
b.
c.
d.
e.

To create an aggregate plan, a company must specify

the planning horizon for the plan.
the duration of each period within the planning horizon.
key information required.
all of the above
a and b only

a.
b.
c.
d.
e.

Which of the following is not information needed by the aggregate planner?

demand forecast for each period in the planning horizon
production costs
labor costs
cost of subcontracting production
cost of changing the demand forecast

a.
b.

5.

6.

7.

8.

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9.

The strategy where the production rate is synchronized with the demand rate
by varying machine capacity or hiring and laying off employees as the demand
rate varies is the
a. adjustable strategy.
b. chase strategy.
c. level strategy.
d. mixed strategy.
e. time flexible strategy.

10.
a.
b.
c.
d.
e.

How frequently should the aggregate plan be rerun?

weekly
monthly
every 3 to 8 months
as inputs to the aggregate plan change
never

Short Answer Questions

1.
2.
3.
4.
5.

Discuss the primary objective and operational parameters of aggregate planning.

Discuss the information required for aggregate planning.
Explain the basic strategies that an aggregate planner has available to balance the various costs
and meet demand.
How does the availability of subcontracting impact the aggregate planning problem.
If a company currently employs the chase strategy and the cost of training increases dramatically,
how might this change their aggregate planning strategy?

Problems
1. The following information relates to a companys aggregate production planning activities:
Quarter
Demand Forecast
1
75,000
2
100,000
3
75,000
4
125,000
Beginning Workforce = 35 workers
Production per Employee = 1,250 units per quarter
Hiring Cost = $500 per worker
Firing Cost = $1,000 per worker
Inventory Carrying Cost = $20 per unit per quarter
If a chase demand strategy is used then the number of workers hired at the start of quarter 2 would be
a. 10
b. 20
c. 35
d. 80
2. The following information relates to a companys aggregate production planning activities:
Quarter
Demand Forecast
1
75,000
2
100,000
3
75,000
4
125,000
Beginning Workforce = 35 workers
Production per Employee = 1,250 units per quarter
Hiring Cost = $500 per worker
Firing Cost = $1,000 per worker
Inventory Carrying Cost = $20 per unit per quarter
If a chase demand strategy is used then the total firing cost for the plan would be
a. $10,000
b. $15,000
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c. $20,000
d. $25,000
3. The following information relates to a companys aggregate production planning activities:
Quarter
Demand Forecast
1
75,000
2
100,000
3
75,000
4
125,000
Beginning Workforce = 35 workers
Production per Employee = 1,250 units per quarter
Hiring Cost = $500 per worker
Firing Cost = $1,000 per worker
Inventory Carrying Cost = $20 per unit per quarter
If a level production strategy is used then the required quarterly output would be
a. 75,000
b. 87,350
c. 93,750
d. 125,000
4. The following information relates to a companys aggregate production planning activities:
Quarter
Demand Forecast
1
75,000
2
100,000
3
75,000
4
125,000
Beginning Workforce = 35 workers
Production per Employee = 1,250 units per quarter
Hiring Cost = $500 per worker
Firing Cost = $1,000 per worker
Inventory Carrying Cost = $20 per unit per quarter
If a level production strategy is used then the number of workers required for the plan would be
a. 35
b. 75
c. 100
d. 125
5. The following information relates to a companys aggregate production planning activities:
Quarter
Demand Forecast
1
75,000
2
100,000
3
75,000
4
125,000
Beginning Workforce = 35 workers
Production per Employee = 1,250 units per quarter
Hiring Cost = $500 per worker
Firing Cost = $1,000 per worker
Inventory Carrying Cost = $20 per unit per quarter
If a level production strategy is used then the inventory at the end of quarter 3 would be
a. 18,750
b. 12,500
c. 25,650
d. 31,250 units
6. The following information relates to a companys aggregate production planning activities:
Quarter
Demand Forecast
1
75,000
2
100,000
3
75,000
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4
125,000
Beginning Workforce = 35 workers
Production per Employee = 1,250 units per quarter
Hiring Cost = $500 per worker
Firing Cost = $1,000 per worker
Inventory Carrying Cost = $20 per unit per quarter
If a level production strategy is used then the cost of the level production plan (inventory costs plus hiring
and firing costs) would be
a. $20,000
b. $645,000
c. $1,250,000
d. $1,270,000

7.
A manufacturing company has a seasonal demand pattern with the forecast demand for each month
next year equal to 1,300, 1,000, 800, 700, 700, 700, 800, 900, 1,000, 1,200, 1,400, and 1,500 units,
respectively. The company plans to end the current year with about 800 units in inventory. The company
requires a minimum of 500 units in inventory for safety stock and work in process. It costs $1.10 per month to
hold a unit in inventory.
The company will end the current year with 40 employees, and it costs $400 to hire and $600 to lay off an
employee. It takes an employee 5 hours to make a product, and the company operates 160 hours per
month.
a) Compute the cost of a chase strategy, in which the number of employees is changed so the monthly
production rate is made equal to the monthly demand rate.
b) Compute the cost of a pure inventory strategy, with the work force and production rate held constant
at the average demand rate and the variation in demand rate accounted for by accumulating and
depleting inventory.
c) Which strategy is more cost-efficient?
Notes - Use the following rules in rounding off the number of employees
For Inventory strategy:
Round up the number of employees
For chase strategy:
If the decimal is 0.5 or more, round up, e.g. round 32.6 to 37
If the decimal is less then 0.5, round down if the number of employees is decreasing, i.e. lower than
the previous period.
If the decimal is less than 0.5, round up if the number of employees in increasing, i.e. higher than the
previous period.
Answers to selected problems
Problem 7
Chase strategy: Hiring and layoff cost = $20,800; Inventory cost = 500 items * $1.1 * 12 months
= $6,600; Total cost = $27,400
Inventory strategy: Layoff cost of 8 employees = 8 * $600 = $4800; Inventory cost = 1250 items
* $1.10 * 12 = $16,500; Total cost = $21,300

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Topic 7: Managing Inventories in a Supply Chain

Aims

This topic introduces you to a number of techniques for managing independent-demand

inventory.

Recommended Readings

Relevant sections of chapters 10 and 11 with emphasis on the following

sections:
o Inventory costs
o EOQ model
o Evaluating quantity discount opportunities
o Determining re-order levels
o Safety stock

Key Terms/ Concepts

1.

Inventory management
Component costs of inventory
Models for constant demand
Economic order quantity
Production quantity model
Discounts model
Models for fluctuating demand
Discrete
Continuous

Inventory Management

The objective of inventory management is to ensure that stocks are available to meet
production or customer demand at a minimum cost.

Issues in inventory management include: when to order and order quantity.

To target the objective of inventory management, there are several inventory models that
can be considered: these are

2.

Economic Order Quantity (EOQ)

Production Lot Size Model

Price Break Order Quantity (Discounts)

Probabilistic Models

Inventory costs

Inventory costs consist of four components:

o

Costs of invested funds in stock

Costs of storage space

increases with increasing/ high inventory

Ordering costs: costs of ordering stock or setup

increases with increasing/ high inventory

decreases with large orders of stock, i.e. high inventory

Shortage costs: costs of missed sales or delay

decreases with high inventories

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3.

Constant Demand Models

3.1

Economic Order Quantity (EOQ)

Is the optimal-quantity ordered when inventory decreases to the point of replenishing or
reordering.
Is a formula used to determine the optimal order size that minimises the sum of carrying
and ordering costs.

The model formula is derived under the following assumptions:

Demand rate is known and constant over time
Lead time in receiving orders is constant
No quantity discounts
Cost of order is the same regardless of ordered quantity
Ordered quantity is received all at the same time

Inventory order cycle:

Figure 7.1 Inventory Order Cycle

1. As shown on the figure 7.1, an order quantity, Q that is received will be used up
after a certain period of time at a constant rate.
2. The inventory level will decrease to a certain point, called the reorder point, ROP, at
which new order has to be placed.
3. The period of time between placing an order and order receipt is referred to as
delivery lead time.
4. Right at the moment when demand depletes the entire stock of inventory, the new
order would be received.
5. As a result, there will be no shortages.
6. This cycle is repeated continuously for the same order cycle and assumptions.

Analysis of order cycle:

C = cost per item
RH = holding rate as a % of C
CH = holding cost per unit (C RH)
Co = ordering cost per order
Q = order quantity
Q/2 = average inventory level
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D = annual demand
Annual Holding Cost = item cost holding rate average stock

C RH

Q
2

CH

or

Q
2

Annual Ordering Cost = order cost no. of orders per year

CO

D
Q

Total Annual Inventory Cost: Annual Holding Cost + Ordering Cost

TC C H

Q
D
CO
2
Q

Optimisation: EOQ Cost Model

Figure 7.2 EOQ Cost Model

Optimization to find the order quantity Q at which the total cost, TC, is at a minimum
Differentiate TC with respect to Q to find optimum Q, i.e. EOQ
EOQ occurs at minimum total cost, where holding cost equals ordering cost.

EOQ

2DCO
CH

or

2DCO
(CRH )

The total minimum cost considering the optimal order quantity (EOQ) can be determined by
substituting the economic order quantity (EOQ) to the ordered quantity (Q) into the total
cost equation.

TCmin C H

QEOQ
D
CO
2
QEOQ

where:
C = item cost
RH = holding rate as a (%)
CH = holding cost (C RH)

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D = annual demand
Co = ordering cost
QEOQ = economic order quantity
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Note: Students are expected to know how to derive EOQ

Reorder Point (ROP)
o The level of inventory where a new order is placed
o Order must be made while there is enough stock in place to cover the demand
during lead time

ROP = d LT

Formula:
where:

d = demand rate per time period

LT = lead time

Example: EOQ Problem

Lets have an example, given the following data:
D = 500 items/yr. (10 items/wk 50 weeks)
C = $10 per item
RH = 10% of item cost
Co = $10 per order
LT = 1 wk
You are asked to compute for EOQ, Total Cost minimum, and ROP.
Solution:
1) Calculation for Holding Cost:
CH = $10 0.10 = $1per item per yr.
2) Calculation for ROP:
ROP = d LT = (500/50)(1) = 10 items
Therefore, re-order must be made when stock is down to 10 items
3) Calculation for EOQ and TC:

EOQ

2DCO
2(500)($10)

100items
CH
$1

TCmin C H

QEOQ
D
100
500
CO
$1
$10
$100
2
QEOQ
2
100

Therefore, place an order for 100 items when stock is down to 10 items. This will
keep the annual inventory cost to a minimum at $100 per year.

3.1

Production Quantity Model or Economic Production Lot (EPL)

Same as EOQ except when stocks are manufactured, this model is used to find the
optimum batch/lot size.
EPL approach is almost similar to EOQ, but they differ in the equations for the average
inventory and annual inventory cost due to different inventory profile
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First, we define the two parameters unique to this model:

p = production rate, which is the rate at which the order is received over time
d = demand rate, which is the rate at which inventory is demanded

Production time is influenced by production lot size and production, where production time
is the divisor of production lot size (Q) and production rate (p).
The formula for maximum and average inventory equations was derived from equating the
slope of slope (production rate minus demand rate) multiplied by production time.
Therefore maximum inventory for EPL is equal to the production lot size (Q) multiplied by
one minus demand rate over the production rate:

Max. Inventory Level Q1

Total Holding Cost

CH

Ave. Inventory Level

Q d
1
2 p

Total Annual Inventory Cost =

CH

Q d
1
2 p

Q d
D
1 CO
2 p
Q

Q d
D
1 CO
Economic Production Lot (EPL) = C H

2 p
Q
where:
Q = production lot size
Co = production setup cost per run
d = demand rate
p = production
rate
Note: d & p should have the same unit. Students are expected to know how to derive
the equation.

Example: EPL Problem

Lets have an example, given the following data:
D = 500 items/yr. (10 items/wk 50 weeks)
C = $10 per item
RH = 10% of item cost
Co = $10 per setup
p = 20 items per week
You are asked to compute for EPL, Total Cost minimum, and Production Run.
Solution:
1) Calculate the Holding Cost:
CH = $10 0.10 = $1per item per yr.
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2) Calculation for EPL and TC:

d= 10 items/week

EPL

2DCO
2(500)($10)

142items
d
10 /week
$11

C H 1

20
/week
p

TCmin C H

QEPL d
D
142 10
500
$1
$70.71
1 $10
1 CO
2 p
QEPL
2 20
142

Set up equipment to make a batch of 142 items when stock is down to zero (no
buffer). This will keep the annual inventory cost (holding and setup) to a minimum at
$70.71 per year.

3) Calculation for Production Run:

Production Run = EPL p = 142 20 = 7.10 weeks per order
Therefore, the length of time to receive and order for this production set-up is 7.10
weeks per order

3.2

Quantity Discounts Model

This model is used when discounts are given for large orders.
The strategy is to use EOQ to take advantage of the lowest price.
If not feasible to take advantage of the discounts because the EOQ is below the discount
limit, then use the total cost of inventory as a criterion to determine optimum order quantity.
The model involves the use of trial and error procedure.
The formula for total cost of inventory as a criterion to determine optimum order quantity is:
TC = annual holding cost + ordering cost + cost of items

TC C H

Q
D
CO PD
2
Q

where: P = per unit price of the item

D = annual demand

Example: Using the same example from our EOQ model, but this time cost of item
varies from quantity orders:
o for every 120 items or more, the cost of item is $10
o for lower than 120 items, cost will be at $12.30 per item

Given:
D = 500 items/yr. (10 items/wk 50 weeks)
Co = $10 per order
RH = 10% of item cost
C = $10 per item >= 120 items
= $12.30 per item <120
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Solution:
1. We need to calculate each EOQ and check if the EOQ is higher than the discount limit.
If yes, use the calculated EOQ.
Table 7.1 Solving for EOQ given the price break/quantity discounts:
C ($)*
EOQ (units)
Quantity
Unit Cost ($)
Feasibility
H
<120
120

12.30
10

1.23
1

91
100

Option 1
Option 2

*CH= 0.10 unit cost

= 0.10 12.30 = 1.20
= 0.10 10.00 = 1.00

EOQ

2DCO
2(500)($10)

91
CH
$1.23

2(500)($10)
100
$1

items
items

2. Table 7.1 shows that EOQ at option 1 is feasible since the optimum quantity computed
is within the range of order size of the seller. Option 2 is not feasible since EOQ
computed
is less than the minimum order quantity set by the price break.
3. Since the EOQ is lower than the discount quantity rate, we ended up with two options
which should be evaluated using total cost for each option:
a. Place an order for 90 items (EOQ) and pay $12.30 per item, or
b. Place an order for 120 items (ignore the EOQ) and pay $10 per item
4. Looking at the total inventory cost of the two options, considering the cost of material,
will help us compare and decide which options is better in term of minimum total
inventory cost:
Option 1: Using the EOQ in evaluating total cost for quantity discount model:

TCmin . C H

QEOQ
D
91
500
CO
PD $1.23 $10
$12.30 500 $6,260.91
2
QEOQ
2
91

Option 2: Using 120 items (considering discount and ignoring EOQ) in

evaluating total cost for quantity discount model:

TCDiscount C H

Q
D
120
500
CO PD $1
$10
$10 500 $5,101.67
2
Q
2
120

So based on the computations, we have to place an order for 120 items and pay $10
per item. Therefore choose the option of getting the discount and disregard the
EOQ, which will keep the total cost (including cost of items) to a minimum of
$5,101.67 per year.

4.

Variable Demand Models

Variable demand models deal with situations where both lead times and demand rates
fluctuate.

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4.1 Rule of thumb

One of the most used approaches in variable demand model is the rule of thumb.
Rule of thumb uses experience to determine the suitable size for a buffer to cater
fluctuations in demand.
Buffer or safety stock is an additional inventory on hand used as a hedge against stock out
during lead time.
Having this additional on hand inventory, the total annual inventory cost is determined
according to this formula:
TC = holding cost per unit (ave. inventory + buffer) + ordering cost

D
TC C H Buffer CO
2

Example: Having the same example in EOQ problem, except that demand (D) fluctuates
between 8 and 12 items/week: to cater to the demand fluctuations, a buffer size of 2 items
is used.

This additional inventory would definitely impact out minimum cost.

EOQ

2DCO
2(500)($10)

100items
CH
$1

Adding the buffer in our previous EOQ problem, the total cost at minimum this time is at
$102.

QEOQ

100
D
500
TCmin C H
Buffer CO
$1
2 $10
$102
2

QEOQ
100
2

Therefore, having the optimal order size of 100 items, plus a buffer of 2 items will
keep the annual inventory cost to a minimum of $102/yr. Note that the buffer
increases the inventory cost per year from $100 (EOQ without buffer) to $102
(considering buffer).

4.2 Discrete Model

Another example of variable demand model is the discrete model, which collects data used
as a basis for analysis.
There are 2 approaches, which can be used to determine suitable buffer size (safety stock):
service approach and economic approach.
Example:
The following are the records of the number of items used per week for a period of 50 wks.
This is the same example of what we have in the EOQ model.
Demand
(items pw)
0
5
10
15
20

Freq.
Prob.
(no of wks)
0
0
10
0.2
30
0.6
10
0.2
0
0
--------------------------------------

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Cumulative probability
of stockout (CPS)
1.0
0.8
0.2
0
0
University of South Australia

50 wks

1.0

Note that CPS is the sum of all probabilities below that quantity, e.g. the CPS at stock level
of 10 items is 0.2
Ave. demand = sum of all (no of items used * frequency)
= (5*10 + 10*30 + 15*10)/50 = 10 items
Interpreting the data using Service Approach:

For 100% service level: place an order for 100 items when stock is down to 15 items
with no probability of stockout.
For 80% service level: place an order for 100 items when stock is down to 10 items
with 20% probability of stockout.
For 20% service level: place an order for 100 items when stock is down to 5 items
with 80% probability of stockout.

Service level is probability that amount of inventory on hand is sufficient to meet demand
during lead time (probability stockout will not occur).
o Therefore the desired service level determines the timing of the order placement.

Economic Approach (minimize cost):

Total Cost is at a minimum when: CPS N CS = CH so, below is the formula in
determining cumulative probability of stockout:

CPSoptimum

CH
N CS

D
EOQ

where: CS = Stockout Cost

Using the same data as in the EOQ example:

D = 10 items * 50 wks = 500 items/year
Co = $10 per order
CH = $1 per item per year
Additional data is given with regards to the cost of stockout, CS at $1 per unit stock-out.
Solving for the number of order per year is given the formula: N is equal to 500, which is the
demand divided by the optimum quantity, which is our EOQ, 100. There are 5 orders per
year given the optimum order size of 100 items:

D
500

5
EOQ 100

EOQ

2DCO
100items
CH

The optimum cumulative probability of stockout (CPS) is determined by dividing the holding
cost of $1 to the product of the number of order of 5 and stockout cost of $1. CPS for this
given example is 20%.

CPSoptimum

$1
0.20 20%
5 $1

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Thus, under the optimal order size of 100 items, the optimum probability of stock-out
is 20%. This will keep the annual inventory cost at a minimum with a corresponding
service level of 80%.

4.3 Normal Distribution Model

Another approach in determining suitable buffer size or safety stock is normal distribution
model.

If the demand pattern is observed to follow a normal distribution with a certain mean and
standard deviation, then the Reorder Point (ROP) or sometime called Reorder Level is
given by:
ROP = dLT + Buffer (safety stock)

Buffer Z d LT
d standard deviation

where:
d = demand rate per period
LT = lead time

Figure 7.3 ROP with Buffer (Service Level)

From the figure 7.3, the shaded area is the service level, the probability to the left of reorder
point. The probability of stockout also refers to the CPS discussed in the previous slides.

Example:
Given: Normal distribution pattern with a mean=10 items per week and standard deviation
of 4.7. Using the same data as previous example:
EOQ = 100 items
d = 10 items/week
CPS (optimum) = 0.2 LT = 1 week
we can calculate the ROP as follows:

ROP dLT Z d LT 10(1) 0.84 4.7 1 14items

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Z = 0.84, from the table of normal distribution, the Z value that corresponds to a cumulative
probability of stock out of 0.2 (or service level of 0.8).
Place an order for 100 items when stock is down to 14 items. This will keep the
annual inventory cost at a minimum with a corresponding service level of 80%.

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Tutorials
Multiple Choice Questions
1.
The average inventory in the supply chain due to either production or purchases in lot sizes that are
larger than those demanded by the customer is
a.
annual inventory.
b.
distribution inventory.
c.
cycle inventory.
d.
physical inventory.
e.
b and c only
2.

A graphical plot depicting the level of inventory over time is

a.
an inventory graph.
b.
a distribution inventory.
c.
an inventory drawing.
d.
an inventory profile.
e.
an inventory picture.

3.

Which of the following is not a cost that must be considered in any lot sizing decision?
a.
Average price per unit purchased, $C/unit
b.
Fixed ordering cost incurred per lot, $S/lot
c.
Holding cost incurred per unit per year, $H/unit/year = hC
d.
Manufacturing cost per unit, $M/unit
e.
All of the above are costs to be considered.

4.

Economies of scale in purchasing and ordering motivate a manager to

a.
increase the lot size and cycle inventory.
b.
decrease the lot size and cycle inventory.
c.
eliminate inventory.
d.
increase the lot size and reduce cycle inventory.
e.
none of the above

5.

Which of the following would not be an example of a fixed ordering cost?

a.
administrative cost incurred to place an order
b.
trucking cost incurred to transport an order
c.
labor cost incurred to receive an order
d.
labor cost incurred to manufacture a part
e.
none of the above

6.

Which of the following would not be included in holding cost?

a.
cost of capital
b.
cost of physically storing the inventory
c.
cost of manufacturing
d.
cost that results from the product becoming obsolete
e.
none of the above

7.

Total ordering and holding costs

a.
are relatively stable.
b.
are relatively stable around the economic order quantity.
c.
are relatively unstable around the economic order quantity.
d.
are unstable.
e.
none of the above

8.

Aggregating across products, retailers, or suppliers in a single order allows for

a.
an increase in lot size for individual products.
b.
an increase in customer demand.
c.
a reduction in holding cost per unit.
d.
a reduction in lot size for individual products.
e.
a reduction in purchase price per unit.

9.

A key to reducing cycle inventory is

a.
the reduction of holding cost.
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b.
c.
d.
e.

the reduction of manufacturing cost.

the reduction of lot size.
the reduction of warehouse space.
all of the above

10.

A key to reducing lot size without increasing costs is to

a.
reduce the holding cost associated with each lot.
b.
reduce the fixed cost associated with each lot.
c.
reduce the material cost associated with each lot.
d.
reduce the manufacturing cost associated with each lot.
e.
increase the holding cost associated with each lot.

11.

Quantity discounts lead to

a.
a significant buildup of cycle inventory in the supply chain.
b.
a slight buildup of cycle inventory in the supply chain.
c.
a decrease in cycle inventory in the supply chain.
d.
minor fluctuations of cycle inventory in the supply chain.
e.
a major drop in cycle inventory in the supply chain.

12.
When the retailer decides to pass through some or all of the promotion to customers to spur sales,
the result is
a.
a lowering of the price of the product for the end customer.
b.
increased purchases and thus increased sales for the entire supply chain.
c.
an increase in the amount of inventory held at the retailer.
d.
all of the above
e.
a and b only
13.
Inventory carried for the purpose of satisfying demand that exceeds the amount forecasted for a
given period is
a.
cycle inventory.
b.
demand inventory.
c.
safety inventory.
d.
security inventory.
e.
all of the above
14.

The trade-off that a supply chain manager must consider when planning safety inventory is
a.
increasing product availability versus increasing inventory holding costs.
b.
decreasing product availability versus decreasing inventory holding costs.
c.
increasing product availability versus raising the level of safety inventory.
d.
decreasing product availability versus decreasing the level of safety inventory.
e.
none of the above

Short Answer Questions

1. Discuss the role of cycle inventory in the supply chain.
2. Describe the impact of trade promotions on cycle inventory.
3. Consider a supermarket deciding on the size of its replenishment order from Procter and Gamble. What
costs should it take into account when making this decision?
4. Discuss how various costs for the supermarket change as it increases the lot size ordered from Procter
and Gamble.
5. As demand at the supermarket chain grows, how would you expect the cycle inventory (average
inventory) to change? Explain.
6. Derive the EOQ equation and state any assumptions used.
7. Discuss the role of safety inventory in the supply chain and the trade-offs involved.
8. Describe the two types of ordering policies and the impact each has on safety inventory.
9. Explain the impact of supplier lead-time on safety inventory.

Problems
1.
Extended Play Stereo, Inc., sells 750 Super Power amplifiers per year and expects sales to continue
at that rate. The holding cost is 22 percent of the unit cost per year, and the amplifiers cost $180 each. The
cost to process a purchase order is $15.
a.
What is the EOQ?
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b.

How much will the company spend each year to order and hold Super Power amplifiers?

2.
Suppose that Extended Play Stereo opens a second outlet but continues to use one central
purchasing location. The holding cost, order cost, and item cost remain the same as in problem 1, but the
annual demand doubles to 1,500 units per year.
a.
What will be the new EOQ? How much has it increased from the EOQ of problem 1?
b.
How much will the company spend each year to order and hold this model of amplifier with
the higher level of demand?
c.
Do economics of scale apply to inventory under some conditions?
3.
Each year, the Black Hills Company purchases 22,000 of an item that costs $14 per unit. The cost of
placing an order is $8, and the cost to hold the item for 1 year is 24 percent of the unit cost.
a.
Determine the economic order quantity for the part.
b.
Compute the average inventory level, assuming that the minimum inventory level is zero.
c.
Determine the total annual ordering and holding costs for the item if the EOQ is used.
4.
Suppose that the Black Hills Company described in problem 3 uses an order quantity of 350 units
and maintains a minimum inventory, or safety stock, of 65 units.
a.
Determine the average inventory level.
b.
Determine the total annual ordering and holding costs for the item if the order quantity is 350 and the
minimum inventory is 65 units.
c.
Look at your figures in problem 3. How much of the difference in total cost is caused by the change
from the EOQ in problem 3 to the order quantity of 350?
5.
Super Sports Shoes, Inc., sells a special shoestring at a uniform rate of 2,400 pairs per year. The
order cost is $10, and the holding cost is 20 percent of the unit cost. For less than 1,000 pairs, each pair of
strings costs $0.22; from 1,000 to 1,499 pairs, each pair costs $0.20; and for 1,500 pairs or more, the cost is
$0.18 per pair. What is the EOQ for this item?
6.
Alien Auto Co. distributes parts for foreign cars in a large Midwestern city. Demand for a particular
size of oil filter has been uniform. The lead time to obtain the filters is 1 month, and the average use rate is
500 per month. The lead-time use is normally distributed with a standard deviation of 70 units. Order cost is
$12, and holding cost is $0.30 a year per filter. The estimated cost of a stockout is $10.
a.
What is the EOQ?
b.
How many orders per year will be placed at this EOQ?
c.
What is the optimum probability of a stockout?
d.
What is the optimum reorder level? Note: The Z value for for a service level of 99.65% is 2.7
e.
How much will Alien Auto spend per year to hold inventory on this filter if it implements the
values you determined above?
7.
JAL Trading is a Hong Kong manufacturer of electronic components. During the course of a year it
requires container cargo space on ships leaving Hong Kong bound for the US, Mexico, South America and
Canada.
The company needs 280,000 cubic feet of cargo space annually. The cost of reserving cargo space is $7000
and the cost of holding cargo space is $0.80 per cubic foot.
Determine how much storage space the company should optimally order, the total cost, and how many times
per year it should place an order to reserve space.
Answers to problems
1.
24 units, $943.95 per year
2.
EOQ = 34 units. Compared to tutorial 1, the EOQ has increased by 42% while the demand has
increased by 100%.
Inventory cost = $1334.96 per year. The inventory cost went up by only 41% while the demand was doubled.
So there are economies of scale if the transportation cost (not considered here) is not greater than the
savings in ordering and holding costs.
3.
324 units, 162 units, $1087.53
4.
240 units, annual inventory cost = ($3.36 * 240 units) + (22000/350)* $8 = $1309.26. This is only
$3.34 higher
5.
EOQ (using $0.18)= 1155 units, not feasible, EOQ (using $0.20)= 1095 units, feasible, EOQ (using
$0.22)= 1044 units, not feasible. Total inventory cost including item costs for 1095 units per order and $0.20
per unit = $523.82. Total inventory cost including item costs for 1500 units per order and $0.18 per unit =
$475. The company should order 1500 units per order.
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6.
EOQ= 693 units, 9 (8.66) orders per year, Optimum probability of stockout = 0.0035 or 99.65%
service level, RL= 689 units, $160.65 per year
7.
4 orders per year at a total cost of $56,000

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Appendix 1: Details of coursework requirements

Coursework requirements: Satisfactory completion of the coursework listed below is
compulsory.

Assessment 1 Continuous assessment (20%)

1.

This consists of a pre-lecture work to be submitted on the first day of

lecture (10%) and a class & tutorial participation (10%)
a. Pre-lecture component to be submitted to the lecturer on the first day
of lecture (10%)
This component consists of the following tasks: self study, identification of problems and
multiple choice questions.
a. Self study
The following hints may be useful for your self study:

The first step is to read the Study Guide for each topic. The Study Guide identifies the key points that
you are required to study for each topic. In other words, these key points define the boundary for
each topic.
Once you know what the key points for each topic are, you can then go to the relevant chapter in the
textbook to develop further understanding of those key points that have been identified. There is no
need to read from the first line to the last line of each chapter if they are not related to the identified
key points for the topic. You may also like to comment on any problems that you have.
In some cases, the relevant chapter for a topic may not cover all the key points in the topic, or
difficult to understand. In those cases, you may like to go to reference books or the Internet.
You may like to try a few tutorial questions to verify your understanding of each topic.

b. Identification of problems
For each topic, discuss the problems that you have encountered in your self study. The maximum
limit for your discussion of the problems for all 8 topics is two pages.
c. Multiple Choice Questions (MCQ)
Do the first 8 multiple choice questions at the end of EACH topic. Your answers must
be in the following format:
Topic 1
1. a
2. b
etc
Submit your discussion of problems (maximum of 2 pages) and answers to the
MCQs (first 8 MCQs in each topic) directly to the lecturer on the first day of
lecture, no extension.

b. Tutorial component (10%)

Students are required to attend lectures and tutorial sessions, and do tutorial questions

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2. Assessment 2 - Group Assignment (30%) with peer assessed (see

Peer Assessment form)
The group assignment consists of two case studies with a weighting of 70% (i.e. 35% for each
case study) and a collection of problems and discussion questions with a weighting of 30%.

Case Study 1: Planning strategies at Kangaroo P/L

Kangaroo P/L has the following demand forecast next year, expressed in six bimonthly (2-month) periods:

Period
1
2
3
4
5
6

Forecast Demand
(Standard U nits of
Work)
400
380
470
530
610
500

The following costing data have been obtained:

Each employee works 176 regular working hours per month

Each unit requires 20 standard hours to produce
The labour costs are $6 per normal hour and $9 per overtime hour
It costs $3 per month to hold an item in inventory

The company has 22 employees at the end of the current year (i.e. at the beginning of period 1 of the
following year which is being planned), and wants to end period 6 of the planning year with the same number
of employees, i.e. 22 employees. It costs $400 to hire and $500 to lay off an employee. The company begins
the planning year with no inventory.
Question 1
a) How many employees will be needed during the peak demand of 610 units in period 5 if no overtime
production is to be scheduled? (round up the number of employees)
b) What will be the average labour cost for each unit if the company maintains for the entire year
sufficient staff to meet the peak demand without overtime?
c) What percentage above the standard-hour cost is the companys average labour cost per unit in this
year due to the companys decision to maintain stable employment sufficient to serve the peak
demand period without overtime?
Question 2
The company is considering using overtime subject to a maximum of 25 percent of regular-time hours.
What is the average cost per unit if the work force is maintained at a level so that overtime can be used to
the maximum of 25% of regular hours during the peak period in period 5?
Note: round up the number of employees
Question 3
The company wants to determine the cost of meeting the demand by using a mixed strategy which involves
changes in the number of employees and the use of overtime work. To keep from adding too many
temporary employees during the peak demand period, the company will use overtime equal to up to 25
percent of the regular-time hours available.
If at least 50% of a new employees regular-time capacity could be utilized during the current period as well
as the next period, it will add an employee, otherwise overtime will be used. An example is shown below:
Period 1

20.5

Period 2
Period 3

19.3
21.5

round down to 20 employees as the extra 50% cannot be used in period 2,

& extra time is used to cover for the 50%
round down to 19 plus overtime
round up to 22 employees as the extra 50% can be used in period 4

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Period 4

23

The company will continue to add employees as required until the maximum employment level as
dictated by the constraint of using overtime subject to a maximum of 25 percent of regular-time
hours during the peak period, i.e. period 5 (see question 2). Once the maximum employment level is
reached, overtime will be used and no more employees are added.
a) Find the employment level for each bimonthly period.
b) Find the total payroll-related costs for the year.
c) What cost per unit results from these payroll-related costs? (Ans. $126 per unit)

Question 4
The company plans to maintain a constant production rate, begin and end the year with the same inventory
level, and absorb all demand fluctuation by accumulating and depleting inventory. The number of employees
will be set at a level so that no overtime will be required.
What will be the average cost per unit due to the cost of labour and the additional inventory held during the
year?
Note: round up the number of employees

Case Study 2: Delivery Strategy at MoonChem

John Moon was very concerned as he left the meeting at MoonChem, a manufacturer of specialty chemicals.
The year-end meeting had evaluated financial performance and discussed the fact that the firm was
achieving only two inventory turns a year. A more careful look revealed that over half the inventory
MoonChem owned was consignment inventory with its customers. This was very surprising given that only
20 percent of its customers carried consignment inventory. John Moon was Vice President of Supply Chain
and thus responsible for inventory as well as transportation. He decided to take a careful look at how
consignment inventory was managed and come up with an appropriate plan.
MOONCHEM OPERATIONS
MoonChem is a manufacturer of specialty chemicals used in a variety of industrial applications. MoonChem
has eight manufacturing plants and forty distribution centres. The plants manufacture the base chemicals
and the distribution centres mix them to produce hundreds of end-products that fit customer specifications. In
the specialty chemicals market, MoonChem has decided to differentiate itself in the Southeast region by
providing consignment inventory to its customers. MoonChem would like to take this strategy national if it
proves effective. MoonChem keeps the chemicals required by each customer in the Southeast region on
consignment at the customers sites. Customers use the chemicals as needed and MoonChem ensures
replenishment to ensure that the customers do not run out of inventory. In most instances, consumption of
chemicals by customers is very stable. MoonChem is paid for the chemicals as they are used. Thus, all
consignment inventories belong to MoonChem.
DISTRIBUTION AT MOONCHEM
MoonChem currently uses Golden trucking, a full truckload carrier for all its shipments. Each truck has a
capacity of 40,000 kg and Golden charges a fixed rate given the origin and destination, irrespective of the
quantity shipped on the truck. Currently MoonChem sends full truckloads to each customer to replenish their
consignment inventory.
THE PARADISE PILOT STUDY
John decided to take a careful look at his distribution operations. He decided to focus on the Paradise area
of the Southeast region as a pilot study. The Paradise area is supplied from a distribution centre in Heaven.
A careful study of the Paradise area revealed two large customers, six medium-sized customers, and twelve
small customers. The annual consumption of each type of customer is as shown in the table below. Golden
currently charges $400 for each shipment from Heaven to Paradise and MoonChems policy is to send a full
truckload to each customer when replenishment of consignment inventory is needed.
John checked with Golden to find out what it would take to include shipments for multiple customers on a
single load. Golden informed him that they would continue to charge $350 per truck and would then add $50
for each drop-off that Golden was responsible for. Thus, if Golden carried a truck that had to make one
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delivery, the total charge would be $400. However, if a truck had to make four deliveries, the total charge
would be $550.
Table 1: Customer Profile for MoonChem in the Paradise area
Customer Type
Small
Medium
Large

Number of
Customers
12
6
2

Consumption
(Kg per Month)
1000
5000
12000

Each kg of chemical in consignment cost MoonChem $1 and MoonChem had a holding cost of 25 percent
per annum. John wanted to analyse different options for distribution available in the Paradise area to decide
on the optimal distribution policy. The detailed study of the Paradise area would provide the blueprint for the
distribution strategy that MoonChem planned to roll out nationally.

Questions
Question1
What is the current annual cost of MoonChems strategy of sending full truck-loads to each customer in the
Peoria region to replenish consignment inventory?
Question 2
Consider the following delivery options and evaluate the cost of each.
1. Deliver appropriately sized loads (EOQ) separately to each customer
2. Deliver to 6 small, 3 medium, and 1 large customer on each truck
3. Deliver with varying frequencies to each segment. This is similar to strategy 3 but small
customers will miss out every second delivery.
Question 3
What delivery option do you recommend for MoonChem?

Problems and Discussion Questions

Submit the solutions/ answers to the following questions:
Topic 2: SAQs 3 and 5
Topic 4: SAQs 4 and Problem 2
Topic 5: Problems 4 and 5

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Appendix 2: List of Equations

Transportation Cost Model
The objective is to minimize the total transportation cost (TC):
n

Minimize

TC Cij Vij Dij

i 1 j 1

Cij cost of moving 1 item between departments i and j per unit distance;
Vij - volume between i and j over a period of time;
Dij distance between i and j
Where the x and y coordinates of the centre of gravity are given by:

x=

(D * X )
D
i

y=

(D * Y )
D
i

where
Di demand at each location;
Xi x-coordinate of each location;
Yi y-coordinate of each location
x = sum (demand at each location * x-coordinate of each location) / sum (all demands)
y = sum (demand at each location * y-coordinate of each location) / sum (all demands

Rank reciprocal weights

Attribute Weight = (1/Ranking)/ (sum of all the inverses of ranking)

Simple Moving Average (SMA)

The formula for computing SMA is:
n

SMAt+1 =

i(t 1n )

n
where:
SMAt+1 = simple moving average at the end of a period t, which
typically will be used as a forecast for next period (t +1)
Di =actual demand in period i
n = number of periods in the moving average

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Simple Linear Regression

The trend equation has the form:

y = a + bx
where:
y is the demand forecast for the time period x;
The slope of line b and the intercept a, can be found by using least squares formulas:

a y bx

xy n x y
x nx
2

or

y b x

n xy x y
n x 2 ( x ) 2

where:

x the mean of the x

values
y the mean of the y values
n = number of periods
y = actual values of dependent variable
x = actual values of independent variable
Seasonal Index (SI)
SI = Actual demand / Trend Value
Measures of Forecast Accuracy
n

Mean Absolute Deviation (MAD) = MAD

D F
i

i 1

D F

Mean Square Error (MSE) =

MSE

i1

n 1
n

Mean Absolute Percentage

Error (MAPE) =

D F
MAPE
D
i 1

*100%

where:
Di = actual demand in period t
Fi = forecast demand in period t
n = number of periods being used
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Economic Order Quantity (EOQ)

EOQ

2DCO
CH

or

2DCO
(CRH )

TCmin C H

QEOQ
D
CO
2
QEOQ

where:
C = item cost
RH = holding rate as a (%)
CH = holding cost (C RH)

Economic Production Lot (EPL) = CH

D = annual demand
Co = ordering cost
QEOQ = economic order quantity

Q d
D
1 Co
2 P
Q

where:
Q = production lot size
Co = production setup cost per run
d = demand rate
p = production rate
Probabilistic Models

CPSoptimum

CH
N CS

D
EOQ

where: CS = Stockout Cost

ROP = dLT + Buffer (safety stock)

Buffer Z * d * LT

d Stand ard d eviation

where:
d = demand rate per period
LT = lead time

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Appendix 3: Sample of Examination Paper

UNIVERSITY OF SOUTH AUSTRALIA

SCHOOL OF ENGINEERING
Sample
SUPPLY CHAIN MANAGEMENT

TIME: THREE (3) HOURS

GENERAL INSTRUCTIONS TO CANDIDATES:
1. Reading time: 10 minutes.
2. Non English Speaking Background Students (NESB) students are allowed an extra 10 minutes
per hour of writing time to complete their examination. Therefore, the duration of the exam is
3hrs 40mins (including reading time).
3. Attempt ALL questions.
4. Calculators are allowed.
5. Marks allocated to each question are indicated in brackets.
6. Books and study materials are not allowed in the examination room.
7. A list of formulae is shown in Attachment 1 at the end of the paper.
-----------------------------------------------------------------------------------------QUESTION 1
1. Explain the three decision phases (categories) that must be made in a successful supply
chain.
2. Explain the push and pull view of the processes within a supply chain.
3. List and explain the three basic steps to achieving strategic fit.
4. List and discuss the attributes/ factors that should be considered in supply chain
responsiveness.
[20 marks]
QUESTION 2
1. Explain the measures of customer service that are influenced by the structure of the
distribution network.
2. Explain how the design of a distribution network affects the cost of the four supply chain
drivers.
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3. Discuss the four phases in the framework for network design decisions.
4. Discuss the role of safety inventory in the supply chain and the trade-offs involved.
[20 marks]
QUESTION 3
A company is considering opening a store in Singapore. Three potential sites are being evaluated
for the new store.
Each factor used in the evaluation has been assigned a weight to indicate its relative importance.
The three sites have been evaluated and assigned points on a scale of 0 to 100 (best).
The data are shown below:
Factor

Weight Site A Site B Site C

Construction cost
Operating cost
Traffic count
Convenient access
Parking area
Surrounding population

0.1
0.1
0.3
0.2
0.2
0.1

60
60
90
75
60
70

70
70
80
80
75
60

80
80
70
70
90
75

Rank the 3 sites and advise the company of the preferred site.
[15 marks]
QUESTION 4
The historical data on the quarterly demand for a product are shown below for the last 2 years (Year
1 and Year 2):
Quarter
1
2
3
4

Year 1
218
119
138
199

Year 2
257
110
156
201

1. De-seasonalize the data with four-quarters moving average (for centre of data from 2.5 to
6.5), and compute a regression equation for the trend in demand.
2. Compute the average seasonal index for each of the four quarters of a year.
3. Using the trend and seasonal indices you have developed, compute a forecast for the
demand in each of the quarters of the following year (Year 3).
[15 marks]

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QUESTION 5
A manufacturing company has a seasonal demand pattern with the forecast demand for each month
next year equal to 1,300, 1,000, 800, 700, 700, 700, 800, 900, 1,000, 1,200, 1,400, and 1,500 units,
respectively.
The company plans to end the current year with about 800 units in inventory. The company requires
a minimum of 500 units in inventory for safety stock and work in process. It costs $1.10 per month
to hold a unit in inventory.
The company will end the current year with 40 employees, and it costs $400 to hire and $600 to lay
off an employee.
It takes an employee 5 hours to make a product, and the company operates 160 hours per month.
1. Compute the cost of a chase strategy, in which the number of employees is changed so the
monthly production rate is made equal to the monthly demand rate.
2. Compute the cost of a pure inventory strategy, with the work force and production rate held
constant at the average demand rate and the variation in demand rate accounted for by
accumulating and depleting inventory.
[15marks]
QUESTION 6
A company sells 750 units of a certain product per year. The holding cost is 22 percent of the unit
cost per year, and the amplifiers cost $180 each. The cost to process a purchase order is $15.
1. What is the EOQ?
2. How much will the company spend each year to order and hold the inventory, i.e. the
inventory cost?
Suppose that the company opens a second outlet but continues to use one central purchasing
location. The holding cost, order cost, and item cost remain the same, but the annual demand
doubles to 1,500 units per year.
3. What will be the new EOQ?
4. How much will the company spend each year to order and hold the inventory for this higher
level of demand?
5. Do economics of scale apply to inventory under some conditions? Explain.
[15 marks]

*****END OF EXAMINATION PAPER*****

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Appendix 4 Peer Assessment Form

UNIVERSITY OF SOUTH AUSTRALIA
SCHOOL OF ENGINEERING
PEER ASSESSMENT FORM
COURSE & ASSIGNMENT NAME ((eg Tutorial, Assignment 1 etc.)
.....................................................................................................................................................
NAME OF PERSON MAKING ASSESSMENT: .................................................................
GROUP NUMBER: .........................................
In the table below, list the members of your Group (including yourself as the first name). For each
member, assess the contribution that the member made to the submitted work. The areas assessed
are:
Attendance and participation at Group meetings (Attendance)
Willingness to work and share with the Group (Teamwork)
Contribution made to the assessment component (Contribution)
Please give a score out of ten in each category in the table below.
Name of other team
members

Attendance

Teamwork

Contribution

Average

Comment on the performance of Group members to justify the scores given above:
.....................................................................................................................................................
.....................................................................................................................................................
.....................................................................................................................................................
.....................................................................................................................................................
..................................................................................................................................................................................

PLEASE HAND UP IN A SEALED ENVELOPE

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