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SESSION 7: ITEM INVENTORY MANAGEMENT (86 pages)

ORDER QUANTITIES how much to order?
2 major objectives of Aggregate or Business-level inventory management are:
Provide high level of customer service to both internal and external customers
Minimize the sum of all costs involved (i.e. various inventory costs)
At the item/operational level, material managers use these decision rules to make the following two types of ordering
decisions:
How much to order? (Also known as the Lot Size Decision Rules)
When to buy?
How much to order decision?
Lot for Lot
Fixed order quantity
Economic order quantity
Order n periods of supply
Decisions made for Individual End Items (Called Stock Keeping Units SKUs). Unique SKU numbers or end items with
unique part numbers.
LOT SIZE DECISION RULES
A. Lot for Lot:
a. Items are ordered in the amounts needed when they are needed
b. Order quantities change in each order
c. No un-used inventory. No inventory costs and no storage needs
d. Examples:
i. Ordering off MRP (for dependent demand) or MPS (for independent demand)
ii. Ordering A items expensive to inventory critical need items
iii. Perishable items
iv. Lean environment (no waste)
B. Fixed Order Quantity:
a. Order the same amount each time
b. Quick and simple
c. Based on what seems reasonable
d. Leads to inventory buildup
e. Does not always produce the best results
C. Economic Order Quantity: Cost of ordering = Cost of carrying inventory
D. Order n periods of supply
a. Estimate of what is required to satisfy demand for n periods.
b. May use the EOQ system. Then order for certain number of periods
c. This is called the Period Order Quantity System.
ECONOMIC ORDER QUANTITY SYSTEM (EOQ)
Drawback of fixed order quantity: high inventory, high inventory carrying costs.
Drawback of lot for lot: small lots, several orders, high ordering and handling costs.
Assumptions:
Demand is relatively constant and known
Items are produced or purchased in lots or batches
Ordering costs and Inventory carrying costs are constant and known
Replacement occurs all at once
Economic Order Quantity Steps:
1. Calculate annual ordering costs
2. Calculate annual inventory ordering costs
3. Calculate total annual costs
4. Evaluate alternative ordering quantities
5. Calculate EOQ
Nomenclature:
A = Annual demand
Q = lot size / order size / order quantity / EOQ
S = cost / order
C = cost / unit of inventory
i = inventory carrying cost rate (%)

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STEP 1: Annual Ordering Costs
Annual ordering cost = number of orders x cost / order
Number of orders = A / Q
Annual ordering cost = A*S/Q
STEP 2: Annual inventory carrying Costs
Average Inventory = Q / 2
Inventory carrying cost = Q/2 * c * I = QCi/2
STEP 3: Calculate total cost
Total cost = annual ordering cost + annual inventory carrying cost
EOQ = Quantity / lot size to be ordered so that the ordering cost is equal to the carrying cost
STEP 4: Evaluate alternative order quantities (Q varies)
Total cost of ordering + cost of carrying inventory is lowest and both are equal when Q is the EOQ.
When order quantity increases, the cost of carrying inventory increases
When order quantity increases, the cost of ordering (cost / order) decreases
When order quantity decreases, the cost of carrying inventory decreases
When order quantity decrease, the cost of ordering (cost / order) increases
ECONOMIC ORDER QUANTITY FORMULA
QCi/2 = AS/Q
Q=

( 2 AS )
Ci

Validity of the EOQ equations

Not valid if demand is irregular or lumpy rather than uniform.
EOQ Lot Size Control
Annual Demand (A):
depends on marketplace
should be high
if increased, then increases the EOQ
Cost of Carrying Inventory (i):
depends on cost of product and cost of carrying the inventory
should be as low as possible
If decreases, then increases the EOQ
Unit Cost / cost per unit of inventory (S):
Cost set by supplier or internal cost of manufacture
Should be as low as possible
If decreased, then increases the EOQ
Ordering Cost (c):
Cost of placing one order
Should be as low as possible
If decreased, then decreases the EOQ (following costs are reduced: cost of issuing PO, cost of issuing a
manufacturing order, setup costs, teardown costs, etc). First two are related to ordering costs. The last two are
related to Lean.
INDEPENDENT DEMAND ORDERING SYSTEMS (When to order?)
When should we order the independent demand items? Tradeoff between
Ordering too soon (builds up inventory and associated costs of carrying inventory)
Ordering too late (stockouts)
Decision Rules for when to order are as follows:
Order Point System (based on the # of units that are still in inventory) reorder based on quantity left
Periodic Order System (based on time lapse between the last order placed) reorder based on time
Q. How do you determine the order point for dependent demand items?
A. Based on consolidated MRP (order release dates) reports.
Order Point System
When the on hand quantity falls to a predetermined limit (order point), then the replenishment order is placed
Order Point = Demand During Lead Time + Safety Stock. Lead time is the amount of time for the replenishment
order to arrive
OP = DDLT + SS
Assumptions for the Order Point System

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o Order quantity if fixed (usually EOQ). Time is not fixed (depends on rate of usage)
o Intervals between order replenishments are not fixed
o Demand is stable and shows random variation
Demand will be higher in some periods, lower in other periods net demand will balance out. Safety Stock will provide
protection against a stockout if demand is higher than normal.
Rules:
If DDLT is higher than expected, then start using safety stock
To prevent a stockout, the following can be done: Increase safety stock, increase the lead time buffer, carry more
DDLT inventory, order more frequently in smaller quantities.
Safety Stock
It is also known as buffer stock or fluctuation inventory. Protects against uncertainty/fluctuations in supply and
demand. Prevents stockouts. The two ways to deal with uncertainty are to:
1. Increase safety stock
2. Increase the safety lead time (order early).
The amount of safety stock carried depends on 5 factors:
1. Variability of demand during lead time (random variations)
2. Frequency of ordering
3. Desired service level
4. Length of Lead time
5. Ability to forecast and control the lead time
Two types of forecast error are Bias and Random. Safety Stock is maintained for Random Variation only.
If there were no random error (forecasts are perfect), then we dont need to carry any safety stock.
Scenarios
Random variation increases and service levels remains the same safety stock increases.
Stockout reasons ordering frequency, towards the end of safety stock usage, surge in demand, infrequent
ordering, late orders, heavy demand, incorrect forecasting, high random variations
One order per year: chance of 1 stockout per year
One order per week: chance of 52 stockouts per year
If lead time is zero, then we dont need any safety stock
If lead time increases and the service level remains the same increase safety stock
Service Levels
Service Level = ability to supply the customer with what is needed when it is needed. Carrying more safety stock
increases the service level that can be delivered to customers.
How much safety stock? Balance cost of carrying inventory vs. cost of stockout.
Cost of stockouts Difficult to calculate = cost of backorder + cost of lost customers + cost of lost sales.
Management decides the number of acceptable stockouts per year.
Q. Do you always carry safety stock? Yes. Except for perishables, MTO, ETO
Q. What products would carry safety stock? All products except perishables, MTO, ETO
Formula to calculate Safety Stock
Step 1: find the number of order per year. E.g. 100 orders per year
Step 2: find the number of allowable stockouts per year. E.g. 5 stockouts per year
Step 3: find the % service level required. In above example service level = 95%.
Step 4: find the mean absolute deviation for the required service level (find the MAD for 95% service level)
Step 5: find the safety stock.
Safety Stock = MAD * Safety Factor corresponding to that MAD
How do you determine when the order point has been reached?
3 methods:
1. Two-Bin system: Bin 1 goes empty first. When Bin 2 needs to be used, it is time to order.
a. Bin # 2 = DDLT + SS
b. This system is used to manage low value (C) items that need minimal attention.
2. Kanban: Just in time production that uses a visual signal to authorize production or material replenishment
a. Japanese word meaning card or signal
b. Visual
3. Perpetual Inventory Recording System: Computer based inventory transaction that will let you know when the
order point has been reached. It is accurate and reliable.
Periodic Review System
It is also called Fixed Reorder Cycle Inventory Model or Fixed internal order system.

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Characteristic
Interval between orders
Quantity ordered

Order Point System

Varies and depends on usage
Fixed Quantity (usually EOQ)

Periodic Review System

Same interval between each order fixed
Varies

Advantages of the Periodic Review System

Perishable items limited shelf life, so needs to be ordered at regular intervals (e.g. daily)
Retail locations / warehouses hold several MTS items. They get replenished consolidated items from a central
supply on a regular interval. The mix might vary, but the time does not.
If ordering costs are very low, order small quantities on a regular basis (e.g. daily, weekly or monthly)
For several small items from inventory since ordering each one separately is expensive, all orders can be
clubbed together and ordered periodically.
Logical steps for the Periodic Review System
1. Decide a review period for ordering (e.g. 30 days)
2. Place a replenishment order for the product at the end of the review period
3. Estimate the demand during the following three time periods: DDLT, SS and Demand during Review period
4. Calculate the Target or the Maximum Inventory Level called T
5. T = DDRP + DDLT + SS
6. Check to see how much inventory you have on hand right now. Say this is I
7. Order Quantity, Q = T I
8. At the end of the next review period, once again, calculate I and then find the next order quantity.
ABC Inventory Control
SKU an individual item in a specific inventory. All items in an inventory would have the same SKU number.
4 Basic questions need to be answered:
How much do you ordered at one time?
When should the order be placed?
What is the importance of the item in overall inventory?
How are they to be controlled?
ABC inventory control has three principles:
1. Small number of items will represent the most critical value/importance (in terms of $$)
2. Separate the most significant items from the less important
3. Determine the degree and level of control for each category (A, B, C)
Paretos LAW: A small % of items account for largest % of impact, value.
Class
% of items (count line item)
% of value / impact ($$)
A
20%
80%
B
30%
15%
C
50%
5%
Segregation is based on actual $ value of usage. Other criteria could be significance, impact, shortage, criticality, etc
Steps for ABC inventory 3 basic steps:
1. Step 1: establish and analyze item characteristics that influence the results of inventory management. These
include annual $ usage, impact, criticality, scarcity, quality problems, etc
2. Step 2: classify items into groups based on criteria established
3. Step 3: Apply a degree of control in proportion to the importance of the group
Distribution of items by Annual $ usage = 80/15/5.
Control based on ABC Classification
There are two general rules:
1. Have plenty of low-value items on hand. Carrying C items will not increase inventory cost much. Only 5% of
inventory ($). It is not worth the risk of being short a C item.
2. Reduce inventory of A items. They are 20% of items, but 80% of $ value highest level of control.
Control Strategy:
A. High priority / Tight Control. Complete accurate records, regular frequent management review, frequent review of
forecasts, low inventory, close follow-up
B. Good records, normal processing
C. Plenty of inventory, n periods of supply, large order quantities.
Auditing Inventory Records
2 methods of checking inventory accuracy
1. Periodic Inventory Audit. Financial value of inventory as part of annual financial statement. Provide stakeholders
with a financial condition of the company. Actual count figures are compared to inventory records. Adjustments
are made as necessary. Once a year periodic inventory audit process.

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2. Cycle counting. Improve processes impacting inventory accuracy and ultimately customer service. Continuous
inventory counting and evaluation process.
Periodic Inventory Audit
Once a year event to check accuracy of inventory records. Adjustments are made to inventory records and financial
valuations. This has several disadvantages:
Production is disrupted while inventory count takes place
Labor and paperwork are extensive
Workers are untrained. Results are uneven. Several errors due to inexperience. Only once a year hence
untrained.
Poor accuracy (hence adjustments to financial records)
Priority is given to doing the job not to understanding why the inventory was inaccurate, or finding solutions
Cycle Counting
Geared towards improving the accuracy of inventory management and control
Counting occurs throughout the year. Sometimes several counts can occur in one day
Staff is trained and dedicated. Results are accurate.
All items are counted a predetermined number of times per year depending on their importance.
Advantages:
Timely detection and correction of problems
High accuracy
Little or no lost production time
Identify and eliminate errors
Count Frequency
This is the number of times that an item is counted during the year
Count frequency depends on the value of the item in the inventory (ABC) higher value means higher count frequency
ABC system is used to determine count frequency
1. Classify items into ABC
2. Set rules for count frequency (# of counts) of each category per year.
3. Calculate count schedule
4. All calculations are done on an annual basis (# of times a year)
SESSION 8: PURCHASING AND PHYSICAL DISTRIBUTION (84 pages)
Purchasing is buying the act of procuring materials, supplies and services.
Industrial Purchasing:
The user may not interact with the supplier
Clear product specifications are needed
Purchase contract may last over a period of time
Controls are needed to ensure sound quality and pricing
Very large sums of money involved affect profitability of the company
Four Types of purchased items:
1. Raw Materials and components
2. Capital Items
3. MRO
4. Services
Purchasing Objectives:
Purchasing is a cross-functional activity it is actually carried out by purchasing with involvement of several departments
Objectives of Purchasing:
1. Obtain goods and services at the right quality and right quantity needed
a. Right quality products meet specifications
b. Right quantity quantity ordered is same as quantity received
2. Obtain goods and services at the right cost
a. Lowest purchase price TCO.
b. Total cost of ownership
3. Ensure best service by suppliers to customers within the organization manufacturing, marketing, engineering
a. Work with marketing/designers/R&D to gain inputs
b. Prompt delivery of goods and services by suppliers
4. Identify qualified suppliers and maintain good relations.
Purchasing supports all internal departments in an organization.

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Purchasing Activities: There are 6 major activities in purchasing.
1. Establish specifications
2. Select suppliers
3. Negotiate contracts
4. Manage purchasing cycle
5. Manage contract buying
6. Monitor supplier performance
Step 1: Establish Specifications
1. Quantity how much to buy?
2. Cost Considerations buy within budget. Cost savings. Give economic value to the buyer.
3. Function
a. Specifications for use: what is the product used for? Functional specifications are the most important
factor. The buyer sets the upper limits and lower limits for specifications for tolerances. Choose a
supplier than can make to these specifications. Inspect incoming goods.
b. Quality level needed: Meet or exceed the quality specified. Send the specification sheet to the suppliers
and inspect incoming goods. Set upper and lower acceptance limits, reject product outside the specs.
4. Functional specifications can be described by the following:
a. Brand
b. Physical and chemical characteristics
c. Performance requirements
d. Engineering drawings
e. Miscellaneous specs such as:
i. Colors / patterns
ii. New parts exactly the same as the old parts
Step 2: Select Suppliers
Select a supplier to partner with. Supplier may be selected by purchasing or by any other cross-function department
Sourcing: Three ways to source goods also called strategic sourcing.
1. Sole Sourcing: Only one supplier can supplier goods. Only they can make it.
2. Multiple Sourcing: buy goods from more than one supplier
3. Single Sourcing: Have a long term and close relationship / partnership with a single supplier to buy goods.
Qualities that a supplier should have:
Technical Ability
Manufacturing capability
Reliability / Delivery
After sales services
Location
Price
Financial Stability
Management Attitude
Supplier Partnering: Three factors to partnership:
1. Long term commitment
2. Shared vision
3. Trust and sharing of information/data.
Managed Inventories:
1. Consignment: Inventory is sent by supplier to the buyer for use. However the inventory is owned by the supplier.
Supplier retains ownership of inventory until it is used by the buyer, then billed to the buyer. Supplier restocks
inventory for the buyer.
2. VMI: Buyer buys and owns the goods. They are stored at the buyers location. Buyer shares inventory visibility
and forecasts with the supplier. The supplier then replenishes the buyers inventory.
In both cases, the buyer and supplier share confidential information so that the supplier can restock automatically.
Step 3: Negotiate the Contract
Agreement with a supplier is called a contract. Planned order releases in MRP can be executed against the contract. The
contracts can specify the schedule, due dates, releases, receipt, delivery and quantities for all these dependent demand
items. Other terms and conditions can be mentioned in the contract. Duly signed by both parties for a period of time.
Two types of agreements:
1. Blanked POs (open orders for items at fixed pricing)
2. Long-term contracts (more strategic in nature)
Scope of a contract: Price, T&C, Delivery, Quantities, Quality, etc
Price Negotiations done before the contract is signed. These include price, delivery, tooling costs, warranties, proper
handling, quality specs, quantity limits, tiered pricing, penalties for late delivery and cost overruns, performance.
Any contract or agreement does not enable the supplier to take undue advantage of unanticipated circumstances.
Step 3.1: Purchasing Execution
Receiving notification to purchase. Purchasing gets the purchasing requisition. This can arrive in different ways.
o Conventional non-MRP purchase requisition: ETO, MTO, Independent demand items, MTS (with no
forecast). Products are unique and the requisitions for these products are also unique. The end user
submits a formal purchasing requisition. The buyer will then issue a regular PO or a blanket PO.

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MRP Planned Order Release: For dependent items. MRP releases the planned order release. Then
purchasing buys these against a long term contract via a blanket PO. Supplier is preselected.
o Kanban Signal (visual or 2-bin): In a lean manufacturing environment, Kanban triggers replenishment of
inventory to the supplier (via consignment or VMI). No inspection and no receiving documents a
contractual relationship between supplier and buyer long term contract / Blanket PO / consignment /
VMI. No requisitions, no POs are issued. Supplier does all the work based on inventory levels.
Backflushing: Method used to calculate the payment due to the supplier when they auto replenish
inventory using Kanban, based on the throughput of the production facility or cell.
o Buffer replenishment: When minimum inventory levels are reached, buyer triggers replacement either by
Kanban, or long term contract, or blanket PO, or a regular purchasing requisition to supplier. All the
above are managed via consignment / VMI.
Step 4: Manage the Purchasing Cycle
5 Step purchasing cycle:
1. Generate purchasing requisition user creates it and sends it to purchasing. OR it may be generated by an MRP
system, a purchase plan, a one-time purchase, or a request for replenishment. A requisition is issued, either as
paper or software.
2. Issue PO to supplier official document sent to supplier to start production. This is now an open order. After
goods are received and payment is made, it is a closed order.
3. Follow up with supplier track PO. Expedite if needed.
4. Receive goods verify against PO, track partial shipments, inspect, release to production.
5. Approve payment to supplier PO becomes a closed order.
Step 5: Manage Contract Buying (via blanket PO / open PO)
Buyer can release POs against a schedule or quantities in a blanket PO or a long term contract.
Contract buying is very useful for Kanban these trigger an automatic replenishment to the supplier
Supplier Scheduling: A specific type of contract buying where required due dates for materials are provided to the supplier
who then includes it into their master scheduling process.
Step 6: Supplier Relationship Management / Monitor supplier performance
Monitor and measure supplier performance. Provide feedback to supplier. Track progress, note issues an provide timely
feedback. Improve communication, ongoing continuous improvement.
Balanced Scorecard: financial measurement system to evaluate supplier performance.
o

Physical Distribution
Scope and Value
Movement of goods from suppliers to the customers through several distribution channels. 2 types of distributions:
1. Physical distribution network
2. Transactional distribution network or sales channel, where ownership of goods is transferred from one party to
another till the final consumer.
Distribution is a value-added supply chain process.
Physical Distribution network adds value in two ways:
1. Place value provides goods where they are needed
2. Time value provides goods when they are needed
Customers are willing to pay for physical distribution.
Global Distribution
Lower manufacturing costs in other countries
Distance, language, culture, currency, taxes, measurement, lead time, tariffs, regulations, etc
Cultural differences
Global supply chain system & International business practices.
Influence of Marketing on Physical Distribution
The 4 Ps of Marketing influence physical distribution:
1. Product. Order qualifiers and Order winners. Distribution may be an order qualifier or order winner.
2. Price. To reduce price inventory cost, distribution network, replenishment cost, etc all matter
3. Promotion. Aggregate product volumes and availability at various locations. Promotion influences aggregate
product volume, location of demand and ties it into demand fluctuations.
4. Place most impact.
a. Scope of physical distribution (local, national, regional, global)
b. Chain of customers sales channels, DCs, intermediaries, etc Marketing can choose from several
different channel strategies.
c. Channel players are: supplier, manufacturer, distributors, retailers, customers and consumers.

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d. Marketings decision on which transaction channels to have will have a major influence on the physical
distribution network and requirements.
Relationship of Production with Distribution
1. Distribution costs and Factory location:
a. Bulky raw materials with low value locate factory closer to raw material source. E.g. waterways.
b. Use DCs to receive TL shipments at low rate, then break them down into LTL shipments for local area
distribution. This is cheaper then shipping LTL shipments from the factory to the customer areas.
2. High Service Levels of supply: Inbound transportation provides raw materials and supply
3. Replenishment of Distribution Inventory: MTS companies generate distribution inventory (finished products). This
inventory is sent to Distribution centers and a Central Supply warehouse.
Relationship of Finance with Distribution
Tradeoff between a high level of customer service vs. a low inventory level. Distribution prefers high inventory movement
to provide a high level of customer service. Finance prefers a low inventory level.
DCs use a order point method to replenish their finished goods inventory.
Bullwhip effect: With every upstream partner in the supply chain, the supplier over-reacts to orders and keeps more than
necessary inventory in the system and extra stock to guard against stockouts. This leads to cumulative buildup of
inventory all along the supply chain.
Total Cost Concept
Balance inventory cost vs. transportation / distribution costs with the aim to provide highest level of customer service.
This is called Total Cost concept.
Calculate the total inventory carrying costs of all options
Calculate the total transportation cost of all options
Balance the two by choosing the lowest total cost option.
E.g. Shipping: Low transportation cost but very high inventory carrying costs
E.g. Air Transportation: High transportation cost but very low inventory carrying costs
Distribution Channels
Distribution Channel: Route along which a product travels from raw material to consumption.
How many channels do we need?
These are called transactional distribution channels change of ownership of goods and services from one party
to another
Each channel offers a mark-up on price and increases cost of the product
Often these physical handoffs add cost without really adding value
Goal is to reduce the number of layers
A manufacturer should always be concerned about the number of channels and the costs and efficiency of each
channel as it affects the final product cost.
Scope of Physical Distribution activities:
Transportation
Distribution Inventory
Materials Handling
Order Administration
4 of these are studied in detail

Warehousing
Protective Packaging

Inventory Control
Reverse Logistics

Distribution Inventory Management

Most valid in an MTS environment
Customer expects quick order delivery and on-hand availability of desired items instantly.
Distribution Inventory is a standard practice and a big management issue in such an environment
The distribution system contains in-transit or Pipeline Inventory which is the factorys customer
Important link between the supplier/factory and the final customer / consumer
Supplier factory central supply warehouse DCs (several) customers (several) consumers
Objectives:
1. Provide required level of customer service
2. Minimize cost of handling and transportation
3. Minimize inventory and cost of carrying inventory
4. Upstream interaction with the factory to minimize scheduling problems
DCs minimize the cost of transportation of goods from factories to local markets by:
1. Full TL shipments from factories to DCs. Reduce the per item cost of transportation

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2. Place finished goods as inventory
3. Cross-dock locations, mixed goods, transported from the DC to the local retail locations or other customers
4. Closer to the customers, they can provide a shorter lead time for delivery
5. Reduced handling cost (per unit). All finished goods inventory is handled at the DC at the same time.
6. DCs can interact with the factory to minimize scheduling problems
Trade-offs to using DCs:
1. Incremental capital, labor, overheads and handling costs
2. Aggregate safety stock level for multiple DCs is higher than the total safety stock level if the inventory was held at
the Central Supply warehouse.
There are three systems used to control the inventory levels at a DC.
Pull (decentralized) System to manage DC inventory level
Distribution Center uses a reorder point method to order with Fixed order quantity lot sizes, based on customer
demand patterns.
DC orders from the Central Supply based on above criteria, irrespective of the needs of the other DCs, the available
inventory at the central supply and production schedules at the factory.
Customer demand on the DC is stable and continuous (as per the forecast with a random variation)
Reorder signal goes upstream to the Central Supply
Central supply has a lumpy irregular demand pattern since it has orders from several DCs
Central supply places an order with the factory based on Reorder Point but the factory may not have enough lead
time to respond to central supplys demand in time to replenish the DC on time.
Advantages of Pull System: Each DC is independent, based on actual customer demand, demand data is timely and
accurate
Disadvantages of Pull System: No co-ordination, Risk of poor customer service, Disrupted irregular factory schedule
Push (centralized) System to manage DC inventory level
Central Supply can view demand pattern, inventory on hand, and forecasts of each DC
Central Supply pushes inventory to a DC based on a central forecast
Advantages better coordination between factory and central supply and DCs
Disadvantages if local developments occur at DC, these cannot be sent to Central Supply
DRP (Distribution Requirement Planning) software:
Software collaboration between DC, central supply and factory
Translate DC demand into forecasts in the factorys Master Scheduling Process
Time-based Netting rather than an order point system (pull system) or a push system
Each DC has a planned order release at different times at different DCs
All of these are consolidated at Central Supply and become a Gross Requirement for central supply
Subtract Scheduled releases and On-hand inventory. Create Net Requirements at central supply
Central Supply does a planned order release to the factory with the required Lead Time.
This becomes the Gross Requirement for the Factorys Master Schedule.
The DCs requirements travel all the way to the factorys Master Schedule.
DCs requirements reflect local events that affect forecast, unlike the Push System.
Transportation
Objectives: The function of planning, scheduling, and controlling activities related to the mode, vendor and the movement
of inventories into and out of an organization. Three objectives are:
1. High level of customer service
2. In transit time, cost and in transit inventory kept to a minimum
3. Minimum cost
All the above priorities are in conflict with each other.
Relationship of transportation with warehousing:
They are both interrelated. Warehousing and DC locations can have an impact on total transportation costs.
Example 1: Direct to customer. Factory to customers via LTL (expensive, inefficient)
Example 2: Direct to Warehouse to DCs via TL and then LTL to customers (cheaper, efficient)
Example 3: Direct from Factory to local DCs via TL and then LTL to customers (best option)
Send full truck-loads to the DCs (TL) and then LTL distribution to the local customers.
Usually, TL shipments to DCs and then LTL shipments to customers works out to be the cheapest option.
Reverse Logistics

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Reverse flow of products and materials for return, repair, remanufacture, reuse or recycling.
Two types of reverse logistics:
1. Asset recovery: the return of actual products for the above reasons.
2. Green logistics: sending product or packaging back to the supplier for environmental reasons
Modes of transport
1. RAIL: Large volumes, bulky goods, long distances over land. Highest Fixed/Capital cost. Less frequency due to
range and size. Good speed of transportation for long distances, Reliable service. Low cost/unit. Flexibility in the
types of goods that can be transported. Cheaper than Road for large volumes of bulky cargo.
2. ROAD: Lower capital costs compared to rail. Bulky goods. Slightly more expensive than Rail. Door to Door
service. TL and LTL available. Fast and Flexible. Small volume goods to a more dispersed local market.
3. AIR: High fixed cost. Expensive. Very fast service. Long distances are possible. Global in nature. Can use
passenger as well as freight aircrafts. Limitation: needs an airport/airstrip. High cost/unit. Suitable for high Value,
low weight cargo, emergency items.
4. WATER: Low operating cost per ton-mile. Slow. Not door to door. Heavy items. Takes lot of time. Low Value,
Bulky cargo over long distances when water routes are available.
5. PIPELINE: for liquid transportation (oil, gas, water). Low operating cost. High infrastructure, Impervious to water.
Can move large volumes of fluids continuously.
Types of Carriers
Carrier is the economic organization that physically transports the goods. Carriers can be unimodal (1) or multimodal
(several). 2 types of carriers:
1. For hire / lease (3rd party):
a. Common Carrier public carriers that are licensed to carry certain commodities
b. Contract Carrier hauls for specific customers under contract arrangements.
2. Private carriers: Completely owned or leased, exclusive for a customer. The shipping volumes need to be high
enough for the carriers to achieve high utilization and justify the high expense.
How to decide what kind of carrier to use?
1. Cost of owning (private) vs. Leasing cost of operations,
2. Flexibility, control and convenience
3. Return on investment
4. In-house vs. Third party
Cost of Moving Goods
1. Shipping Patterns
a. Full Load (or TL) shipments that move directly from the shipper to the consignee. Dedicated. Cheaper
and faster. Need to have the bulk to use this.
b. Less than Full Load (or LTL) shipments. Shipment moves through terminals, additional material handling
costs. Each transaction has a pickup cost, transportation cost, sorting cost, destination and unloading
cost, loading and unloading cost, etc More expensive and slow.
2. Shipping Costs
a. Line Haul Costs depends on distance moved
b. Pickup and Delivery costs Low for TL, higher for LTL (may be multiple for LTL due to several terminals)
c. Terminal Handling Costs only for LTL. Includes loading, handling and unloading
d. Billing and Collecting Costs Low for TL, higher for LTL. Includes paperwork for each shipment.
e. B, C and D above depend upon the number of terminals. For TL, B, C and D are low and occur only
once. For LTL, B, C and D are high and may need to be multiplied depending on how many terminals are
involved. Hence TL is better than LTL.
Line Haul Costs
Includes fuel, wages, distance, wear and tear on the vehicle. Depends on distance moved, not on weight. Weight might
become a factor for dense goods and special deliveries.
TL loads reduces the number of shipments, reduces the cost/unit and decreases the line haul cost per hunderedweight.
Reducing Total Transportation Costs
Increase shipments to justify TL
Consolidate shipments to reduce all other costs in B,C,D bullets above
Carrier Rates
2 rates TL and LTL
Other factors affecting the carrier rate (besides distance) are:
1. Value (cost, insurance, price of goods)
2. Density (Denser the item, heavier the load)

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3. Perishability (require special handling)
4. Packaging (for damage and breaking)
Warehousing
Facilitate the throughput/storage of products from inbound to outbound transportation
Reduce transportation costs by receiving consolidated shipments in TL quantities, then cross docking and breaking
them down into smaller shipments of same or mixed products to delivery for regional or local markets
Better delivery times and better reliability to nearby customers
Provide safe, secure and efficient storage and handling.
Warehouse processes and activities:
Warehouse operations focus on throughput and storage.
Additional activities in the warehouse include cross-docking, flow-through operations, speeding up the flow of goods so
that they can reach the customer on time.
Following are the activities that make up the warehouses order fulfillment functions:
1. Receiving (acceptance, unloading, staging, preparation, put-away, cross-docking, etc)
2. Put-away (moving products to a staging area or staging location)
3. Storage (retention and safeguarding)
4. Picking (moving products to a packing or shipping area)
5. Packaging (special packaging for transportation)
6. Post-manufacturing services (assembly, configuration, packaging, ATO environment, postponing, etc)
7. Staging and shipping (loading, consolidating)
Stock Location Systems
2 systems are:
1. Fixed location goods are assigned a permanent location. Low record keeping, easy to find. Poor space
utilization.
2. Floating (random) location: locate goods based on demand and assign space whenever appropriate. Improves
cube utilization, but items may be hard to fine. This is suitable with a good WMS that tracks and assigns locations
online.
Public Vs. Private warehousing
Public: temporary location for an expanding business. Flexibility to expand and contract. Low volume. New markets.
Private: Volume is high enough to justify a dedicated operation.
SESSION 6: AGGREGATE INVENTORY MANAGEMENT (66 pages)
Inventory from a business-level perspective.
Introduction to Inventory
Necessary cost of doing business
Constantly trying to minimize
Meet profit, customer service, production efficiency goals
Aggregate inventory is looked at from two perspective:
o Enterprise wide level perspective
o Supply Chain perspective
Sales and Marketing want high inventory to meet customer due dates and service levels
Materials management and purchasing want high inventory to keep raw materials on hand at low costs
Manufacturing and finance want to balance production costs and efficiency with inventory costs
Retailers and distributors want to manage inventory costs while servicing customer levels
Inventory definition: items used to support production, supporting activities and customer service.
Two types of inventory:
1. Aggregate inventory:
a. Support business strategy and operations
b. Ensure that inventory management supports financial objectives
c. Balance customer service, operational efficiency and inventory investment cost
2. Item inventory management:
a. Which individual inventory items are most important (ABC)
b. How to control inventory
c. How much to order?
d. When to order?
Inventory and the flow of Materials:

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5 types of inventory:
1. Raw Material: purchasing buys RM and MRO supplies to support production
2. Work in Progress: Production converts RM to WIP inventory
3. Finished Goods: Production converts the RM and WIP to FG. Continuous or Flow operations have minimal WIP
inventory.
4. Distribution Inventory (pipeline/transit): stored by the distribution network at various locations. Final assembly of
some products may also take place within the distribution network.
5. MRO supplies: bought by purchasing and used by all groups. These inventories do not become part of the final
product.
Reasons for carrying inventory:
1. If demand is high, stable and continuous production can make products as per demand, so theoretically there
would be no inventory.
2. Inventory is coupled with demand RM comes in, very little WIP, FG goes out to be sold. Ideal situation.
3. Best reason to hold inventory if the cost of carrying inventory is less than the cost of not carrying it.
4. Inventory helps supply to be decoupled from demand.
5. Inventory helps the company operate with different production rates and batch sizes throughout the supply,
production and distribution systems.
6. The disadvantage of this is a buildup of three types of inventory (RM, WIP, FG)
7. Inventory decouples the following:
a. Supply from demand
b. Customer demand from availability of finished goods
c. Finished goods from availability of supply components
d. Output of one operation from output of the preceding operation
e. Materials needed to begin production from the supplier of the materials
Types of inventory based on their functions:
1. Anticipation Inventory: based on advance events, seasons, anticipation of demand, sales promotions, etc
2. Fluctuation inventory: safety stock. Covers random variations in demand forecasts, supply or lead times. Helps
to prevent stockouts by balancing the cost of stockout vs. cost of carrying inventory. The goal is to balance the
desired customer service level with the cost of carrying inventory.
3. Lot-size inventory: buying in larger lots to minimize purchasing cost and cost/unit. Also called cycle stock.
4. Transportation inventory: called pipeline stock. All the inventory in transit in the distribution network. Depends on
the rate of flow. For faster flow, this number is small, assuming the customer service level remains constant.
5. Hedge Inventory: for events that are speculation or might not happen e.g. weather, political situation, etc
6. Buffer inventory: inventory kept for bottlenecks. Buffers help to ensure that the throughput rate is maintained and
due date performance objectives are met in spite of having a constraint / bottleneck in the system.
Three objectives of inventory that are often in conflict and have to be balanced:
1. Provide best level of customer service
2. Provide low-cost production / plant operations
3. Minimum inventory investment
Customer Service:
Goal is to maximize customer service, especially in an MTS environment
RM, WIP and FG inventory is continually maintained so that customer gets their goods when they want.
Plant Operating Efficiency:
Inventory makes operations more productive.
Load Levelling or Level Production Scheduling: Helps keep the machines running and builds up or drawdowns
occur on the RM, WIP or FG inventories. Helps to reduce changeover costs. Helps to manage seasonal
inventory.
Longer production runs: cost/unit of item reduces
Lot Size: buying more gets higher discounts (although the cost of carrying inventory goes up).
Minimum Inventory Investment:
Customer Service, Sales, and Marketing they prefer high inventory levels to meet customer service demand.
Production they prefer high inventory. Keeps machines running, level production, few changeovers or stoppages
Procurement they prefer high inventory, because ordering costs go down for bigger lot sizes
Transportation they prefer high inventory, because cost/unit of transportation goes down.
However, all of the above lead to high inventory carrying costs.
Supply Chain Management Perspective:

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A supply chain manager has to balance all the above needs to decide how much inventory to carry
Lean techniques are applied. These lead to lower inventory and hence shorter lead times. Lead time is
proportional to inventory. Use of cellular manufacturing can also reduce lead time. Assemble to order and
postponement are examples. Faster setups are also part of lean. Supply Chain manager balances these needs.

5 costs of Inventory
1. Item Cost:
a. Purchased Item Costs: includes the RM cost, any MRO costs consumed, item cost, transportation,
custom duties, insurance. The total of all these costs is called the Landed Costs.
b. Manufactured Item Costs: includes the RM cost, material costs, labor costs and factory overhead.
2. Carrying Costs: includes three components
a. Capital Costs: Also called opportunity costs. It is the cost of all the capital that could have been available
for some other purpose. Higher the inventory, higher the capital cost.
b. Storage Costs: Building, utilities, maintenance, workers, etc
c. Risk Costs: Obsolescence, damage, pilferage, and deterioration, insurance.
d. Add all three to get total Carrying Costs
3. Ordering Costs:
a. Factory orders
i. Production control costs: costs incurred in managing the number of orders placed. These costs
include issuing, closing, scheduling, loading, dispatching, expediting.
ii. Setup and Teardown costs: setting up to run an order and then tearing down once the order is
completed and the next order is ready to run
iii. Lost Capacity Cost: Cost incurred during a setup and a teardown. During this time, all the
machines are in a downtime and the capacity is not being used.
b. Purchase orders these are the costs involved in creating and dispatching a purchase order. This
includes order prep, issuing the PO, follow-up, expediting, receiving, payment, etc
4. Stockout Costs in an MTS environment. Demand exceeds available supply and orders cannot be filled on time.
a. DDLT exceeds the forecast and planned available inventory including safety stock
b. Production problems cause less than planned finished goods inventory
c. Supplier issues parts are not delivered on time.
d. Types of stockout costs: backorder costs, lost customer, lost sales, expediting costs, additional
manufacturing and purchasing costs. Difficult to measure.
5. Capacity Related Costs due to changing production levels. Include overtime, hiring, layoffs, training, shift
premiums. These costs can be minimized by leveling production.
FINANCIAL STATEMENTS
Balance Sheets:
Assets: Items of value to a company (cash, inventory, machines, capital, AR, patents)
Liabilities: Obligations of the business (AP, wages, debt)
Owners Equity: Net worth of the business
OE = A L
Income Statement:

Revenue = From Sales of Goods (Cash, AR)

Expense = COGS (RM, labor, overhead)
General and Administrative Expenses (wages, all other costs)
Gross Profit = R-E
Net Profit = GP GAE

Aggregate Inventory Management and Financial Statements

1. Inventory is an asset on the balance sheet. But too much inventory is not good. Why?
2. RM inventory is tied up in COGS, so it affects the gross profit. Too much COGS means less profit.
3. WIP and FG use up all the COGS and the GAE, which also reduce profit
4. Inventory on the books is not good. Inventory in form of finished goods is not good until it is sold.
5. Once sold, the inventory becomes revenue, and increases the profit. Revenues are higher than the costs leading
to a profit. Additionally, this brings cash into the business and improves cash flow.
6. Converting inventory into sales is a major objective of a supply chain professional because it increases profit,
frees cash and has a positive impact on the financial statement.
7. This transformation can only occur through manufacturing. This is the physical transformation of the product.
8. Inventory management at the aggregate level is integral to supply chain management with strong financial
implications.
Cash flow analysis
How much cash is available to cover operating expenses

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Cash is needed for materials, Labor, overhead, equipment, etc and can only bill the customers once finished
goods are sold and payment is received
All the above lead to Cash Outflow. Once cash outflow occurs, it creates an AP. Once goods are sold, and
payment is received, then cash flow is positive.
With every step, value is created. RM WIP FG. It absorbs costs and overheads to increase value.
Goods generate revenue once they are sold. If a company has negative cash flow, they are not able to pay
employees. Companies have to borrow cash called debt.

Valuation of Inventory
Method to find out the cost of the inventory sold. There are four ways to value this inventory.
1. FIFO (first in first out). Oldest inventory is sold first. In case of rising prices, this sold inventory will be overvalued.
Replacement value of these goods will be higher than assumed cost.
2. LIFO (last in first out). Newest inventory is sold first. In case of falling prices, the sold inventory will be
overvalued. In case of rising prices, the sold inventory will be undervalued.
3. Average cost system average cost of inventory is calculated and applied to COGS and inventory valuation. In
this way the COGS is not affected by which inventory is used (LIFO or FIFO)
4. Standard Cost Accounting System each inventory item is assigned a standard cost that is determined in
advance of production. Standard costs are used for RM, Labor, Overhead. Then Standard Cost is compared to
the actual costs to understand and correct variances.
Financial Inventory Performance Measurement
From a financial performance standpoint, finance wants to sell products fast, with as little inventory investment as
possible, subject to customer service and production cost tradeoffs.
There are two performance measurements:
1. Inventory Turns should be as high as possible.
2. Days of Supply should be as low as possible.
From a supply chain management standpoint, the shorter lead time or throughput time is enabled by lean and quality
management systems and continuous improvement programs.
Inventory Turns
IT = Annual COGS / average inventory (inventory turns per year)
Days of Supply
How many days of inventory are being carried to support annual sales.
DOS = Inventory on hand / daily average usage or daily average sales.
Step 1 = find daily sales (annual sales / 365 or monthly sales / 12)
Step 2 = Inventory on hand / daily sales or usage
Usage can be expressed in sales dollars or in physical units
Lesson 9: Lean and Quality Systems
Product and Quality Cycle
Lean is a productivity system it improves productivity and efficiency
All Lean and quality systems have one purpose: to meet and exceed the needs of the customer
Meeting the needs of the customer starts at the define and design phase and ends after the consumer has
finished using the product.
Objectives
4 stages of Product and Quality: Definition, Design, Manufacture, Consume.
1. Quality of Product Definition: What is the market for this product? Performance level? Tangible and intangible
characteristics that the customer wants? Value? Price point? Inputs from the VOC are important at this stage.
2. Quality of Product Design: specs, performance, tolerance as per customer needs
3. Quality during Manufacturing and Packaging: within specs and tolerances. Meets customer needs.
4. Quality from the perspective of the customer: Customer satisfaction is the ultimate objective of a quality
management system and is a validation of the first three stages of this model. 5 main characteristics group:
a. Performance (primary characteristic). Reliability, Durability and Maintainability
b. Features (secondary characteristic)
c. Conformance
d. Warranty
e. Sustainability

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Systems and Methodology
Purpose: to increase and sustain quality, improve processes, and reduce costs.
1. Lean Systems minimization of activities that do not add any value to the customer. JIT is an aspect of lean as
regards production activity.
2. TQM a management approach to quality improvement and customer satisfaction. It is based on the
participation of all members of an organization in improving processes, goods, services and the culture in which
they work. It is a never ending process to improve everything an organization does to satisfy customers.
Productivity and Quality Systems, Principles, Practices & Tools
1. Focus on the Customer / Value for the Customer
Meet or exceed customer expectations.
Customers can be internal within the company
Customers can be external to the company
There are 6 requirements customers have of their immediate supplier
o High quality level
o High flexibility (to change volume, specifications, delivery)
o High service level
o Short lead time
o Low variability in meeting targets
o Low cost
Value from the perspective of a customer meets or exceeds expectations
Value from the perspective of manufacturing:
o No waste
o Short setup time
o Low cost
o Products that are already being manufactured (conformance)
Value from a design point of view have features that add value to a customer
2. Quality Function Deployment (QFD)
Methodology to ensure all customer requirements are identified, met or exceeded
Captures VOC as input to technical product design and requirements
House of Quality: A structured process that relates customer defined attributes to the products technical
features needed to support and generate these attributes
6 step process to ensure QFD:
o Identify customer requirements
o Identify supporting technical design requirements
o Compare customer requirements to technical requirements and assign relationship ratings
o Assign importance to customer requirements
o Evaluate competitors
o Identify technical features to be deployed in final product design
3. Lean (house of Toyota)
5 components of lean manufacturing
Roof: Eliminate Waste
Pillar #1: JIT. Takt time is the heartbeat of any lean system. It is the rate of customer demand.
Processes are pulled by the customer and they flow at the rate of customer demand.
Pillar #2: Jidoka employees are empowered to stop manufacturing if a defect occurs.
Base: Operational Stability; reduce variability; standardization of work; reducing variation by leveling the
volume and mix of orders evenly over time.
Center: Continuous improvement, perfection, respect for everyone; safe working environment
4. Waste
8 categories of waste:
Process
Movement / Transportation
Methods / Motion
Product defects
Wait time / Queuing time
Overproduction
Excess inventory
Unused people skills

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5. Continuous Flow Production
Even discrete items can be produced in a flow basis
Minimize cycle time and travel distance, eliminate crossover points, create continuous flow by putting
internal customers and suppliers next to each other
Arrange machines / workstations near each other. Expedite material flow in workcells.
Ultimate goal is a one-piece flow with a lot size of one being pulled by the customer.
Also known as one at a time production.
Narrow product line with dedicated equipment that is easily automated.
Work flows in a constant path
Reduced WIP inventories. Shortened lead time.
6. Pull Systems
Push systems products are produced and released as determined by schedules based on forecasts.
Pull systems items are produced or materials are released as needed or pulled to the next workstation
Flow is determined by Takt Time.
Takt Time is the rate of customer demand.
Rate of flow between the work stations is in a fixed routing controlled by a Kanban system.
Kanban triggers the replenishment of parts and subassemblies needed by workstations from preceding
supplier workstations.
The ultimate goal is a one-piece flow, where items are processed directly form one step to the next, one
unit at a time as needed.
This technique avoids the buildup of inventory.
7. Work Layouts
Process or Functional Layout
i. Functional Flow (different from flow or continuous type)
ii. Similar operations are grouped together
iii. Discrete manufacturing sytems
iv. WIP builds up between the workstations, especially before the bottleneck
v. High waste and Long lead times
Cellular Layout
i. Workstations are set up in the form of workcells these are grouped as product families
ii. Operators are cross-trained
iii. Problems are resolved quickly
iv. Lesser waste, lesser WIP, quicker movement, lower lead time.
v. Several shapes of workcells. The most popular is the U shape.
vi. L shape is also common
vii. Reuse of containers, transfer of information, sharing of work, less waste
viii. Advantages of the Cellular Layout are:
1. Reduced queue
2. Simplified PAC
3. Reduced floor space and reduced walking
4. Reduced material movement
5. Immediate feedback.
6. Greater production flexibility
7. Smaller lot sizes
8. Improved quality
8. Process Flexibility
How do companies change their volume and mix easily and quickly? By having flexible processes
Flexible Machines have 2 smaller machines instead of one big one for increased flexibility
Cross-training employees instead of specialization
Quick changeovers
9. Total Productive Maintenance
Preventive Maintenance plus continuing efforts to adapt modify and refine equipment to increase
flexibility, reduce material handling and promote continuous flow. Operator oriented maintenance with the
involvement of all qualified employees in all the maintenance.
Dont wait for a problem to happen just repair the machine as you use it.
Operator has a sense of responsibility for their own machines
Employee engagement, continuous learning.
Advantages less machine downtime, uninterrupted flow and satisfied customers

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10. Process improvement and Continuous improvement
Process Improvement eliminate poor quality, process variation and non-value added activity
Continuous Improvement eliminate root causes of problems (Kaizen).
Small incremental improvements can be made over time. Used in Lean and Six-Sigma.
Helps to improve productivity resources are used more efficiently
Eliminates waste unnecessary steps or processes are removed
Involves Teams workers and managers work together to remove problems. Kaizen means small
incremental improvements. Kaizen helps to remove waste from machinery, labor and processes.
11. Employee involvement and empowerment
Employee involvement respect and ideas of all employees are considered
Employee empowerment giving non-managerial employees decision making power. Employee takes
on decisions that would otherwise have been made by managers or specialists.
Jidoka operator has the authority to stop a process if a production line defect occurs. This should
happen before an actual defect is recorded so that customer can have 100% perfect products.
12. Common Lean Tools and Techniques (4 are discussed here):
Value Stream Mapping
i. Graphical representation of the path from raw material to finished product. It is done with the help
of symbols.
ii. Takt Time and Cycle time are depicted
iii. Value added and non-value added activities are segregated
iv. Purpose: to analyze the process to eliminate waste and continuous improvement
Heijunka
i. Production leveling to match the rate of end product sales.
ii. Production volume and mix are distributed evenly over time
iii. Instead of making large batches of one item, SKUs will be alternated to match demand
iv. Used with a Heijunka Box that contains Kanbal signals to alternate production.
Five Ss:
i. Sort (needed items and non-needed items that are removed)
ii. Simplify (for easy use)
iii. Scrub (shine, clean up)
iv. Standardize (do the above three steps daily)
v. Sustain (keep it up)
Hoshin Planning
i. Lean manufacturing version of strategic planning
ii. Develop vision statement and long term goals
iii. Periodic audits to monitor these goals
iv. Target the critical few problems and rectify them
v. Align resources to respond quickly to the changes in the environment
vi. Use overlapping (PDCA Plan Do Check Action) cycles every three to five years for the top
manages, annual cycles for the line/operating manager) and semi-annual, monthly or weekly
cycles for the operators
13. Supplier Partnerships
Working relationship with a supplier so both organizations act as one.
Supplier is an upstream workcenter of the factory.
Share information, share cost reductions, share quality programs.
Supplier must have reliable quality to reduce the need for inspection
Supplier should be able to produce and make small frequent delivery
Supplier benefits greater share of business and long-term contracts
14. Total Quality Management (TQM)
Product Quality All products are within the lower and upper limit specifications and form a bell curve
around the mean. The lesser the variation from the center, the better the quality.
15. Quality Related Costs / Costs of Quality
Costs of Failure: two costs Internal and External
i. Internal Cost of Failure: within the factory. Defective products are found during production. These
need to be corrected. E.g. rework, spoilage, etc
ii. External cost of Failure: customer reports quality issues. E.g. field service, returns, warranties.
Costs of Controlling Quality Prevention and Appraisal costs
i. Prevention costs prevent a problem from occurring. Design improvements, statistical quality
control, continuous machine maintenance, proper operator training

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16.

17.

18.

19.
20.

21.

ii. Appraisal costs checking and auditing quality periodically inspections, audits, and associated
calibration and testing.
Quality Control Tools 7 basic tools
Flowchart
i. Visual tool showing a process with the steps and sequence.
ii. Use of standard shapes
iii. Diamond = decision. Rectangle = Process steps and Oval = start or terminal steps
iv. Cross-functional flowcharts can be made in Visio
Cause and Effect Diagram, called a fishbone diagram
i. 6 areas: materials, machines, people, method, environment, measurement
ii. 4 step process to create this diagram
1. Using Pareto analysis, find the critical problem, e.g. poor packaging
2. Label the skeleton with the problem and draw 6 bones
3. For each bone, identify the areas that could be a cause. Keep going till you get more and
more small bones. The diagram can become complicated. Brainstorm with other
departments.
4. Identify the most likely root cause and work on a process improvement for this.
Control Charts: Used to track process variation. Two types of charts: X-bar and R-chart. Used to track
the mean and the range of the data.
Start by taking a sample of the production volume.
Measure the mean along the upper control limit (UCL) and lower control limit (LCL).
These control limits are different from the specification limits that are used to measure product quality
Plot the chart of the range in each sample taken over time (difference between the highest and the lowest
data in each sample)
If all readings fall within the control limits and within the range, then the process variation is considered to
be in control.
Statistical Process Control
The use of statistical techniques (like mean and range) such as control charts to monitor and adjust a
process or an operation. The goal is to have processes that are consistently in range without defects to
satisfy customers.
Select the processes that are capable of producing the required quality of the final products
Monitor the processes to ensure that they continue to produce the required level of quality.
Process Capability: the process of being able to produce within the upper and lower specification limits
at all times. It is the ability to produce parts that confirm to the upper and lower engineering specification
limits for the product.
The population of products should always be in control within the USL and LSL, and should be centered
to the mean.
Processes may be out of control if they are within the mean but not centered.
SPC can spot variations which may indicate that there is a problem, hence corrected to prevent future
defects. Hence SPC is of value to the customer.
On the other hand, Inspection finds defects after they occur, so this is wasteful because the customer is
not willing to pay for defective products.
Inspection is expensive and wasteful because it does not ensure that the root cause of the defects is
corrected.
Check Sheets
Summarized tally of a count of event occurrences.
Count data summarized from a check sheet is used to draw conclusions about a defect over time (e.g.
defects per day, defects per person, etc)
Histogram
Vertical bars showing a frequency distribution. Visualization of data.
Pareto chart
Graphical tool to find the most significant to least significant. Shows the largest frequency of items in a
data set. Covers the 80/20 rule.
80% of defects come from 20% of the causes.
Working on the significant few instead of the trivial many allows most resources to focus on biggest gains.
Scatter Diagram
Analyzes the relationship between 2 variables.
If there is no relationship, then all points will be scattered.
If there is a relationship, it will be visual.

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22. 6 sigma
A set of concepts that focus on reducing variation in processes and thereby reducing defects and
improving quality.
3.4 defects or less per million parts
Lean 6 sigma is a combined approach for process improvement and problem solving based on lean and 6
sigma methodologies
Pioneered by Motorola they focused on reducing the variation in a process to improve the process
overall.
6 sigma focuses on the process of measuring process variation, problem solving and improving all
business processes. Built on 3 major concepts:
i. Understand what the customer wants
ii. What causes variation and defects
iii. Output of a process is a function of its inputs
6 sigma must start with top management
23. Causes of Variation
Variation causes defects
Special causes (Assignable causes): isolated and assignable. Outside of the natural historical variations.
Their removal will stabilize a process. E.g. operator error, broken equipment.
Common causes (Chance causes): Variation inherent in a process. They occur naturally. Correcting
these are not easy require long term process improvement activities.
24. 6 Sigma DMAIC
Define the customers problem.
Measure all relevant data and information to understand the problem
Analyze cause and effect relationships
Improve develop and implement solutions to address the problem and minimize variation
Control make sure the gains are maintained
Pre-phase before define problem recognition
Post-phase after control Standardize the improvements by documentation and training. And Integrate
the improvements into the process.
Very similar to the PDCA cycle
DMAIC is used to analyze a situation, determine potential testing and measure to determine root causes,
implement improvements, and track ongoing control of the situation.
25. Benchmarking
Compare performance to best in class companies
Select the process to benchmark
Identify a best in class company
Study the benchmarked company
Analyze the data
Carefully select the measures that you want to base the comparison on. They should be related to the
order qualifying and order winning product characteristics as well as process characteristics.
Benchmarking is an art as well as a science.

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