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Operations Research for Industrial and Manufacturing Engineers

Course Outline

Faculty : Industrial Technology

Department : Industrial and Manufacturing Engineering
Course : Operations Research
Lecturer : Eng. W.M. Goriwondo
Course Code : TIE 5208

Objectives of the course

After completing this course, students should be able to:-
 Understand the history of Operations Research
 Know the tools and techniques used in Operations Research
 Understand and apply Operations Research principles in Operations Management /
Industrial and Manufacturing Engineering
 Use Operations Research principles in Decision Making

Course Content
1. Introduction to Operations Research
1.1. Historical Background of Operations Research
2. Decision Theory
3. Optimization techniques and strategies
3.1. Linear Programming
3.1.1. The Graphical Method
3.1.2. The Simplex Method
4. Transportation Algorithm
5. Assignment Algorithm
6. Project Management and Network Analysis
6.1. Introduction to MS Project
7. Inventory Management

Assessment
Coursework 25%
 1 Test, 1 Individual Assignment and 1 Group Assignment

Final Examination 75%

Recommended Reading List

Lucey T., Quantitative Techniques: An Instructional Manual, 1982

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Hill T., Operations Management, 2005

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Table of Contents
Course Outline.................................................................................................................................ii
Objectives of the course..............................................................................................................ii
Course Content............................................................................................................................ii
Assessment..................................................................................................................................ii
Recommended Reading List........................................................................................................ii
1 Introduction to Operations Research.......................................................................................1
1.1 Defining Operations Research..........................................................................................1
1.1.1 Other definitions........................................................................................................1
1.2 Historical Background......................................................................................................1
1.2.1 Some timelines...........................................................................................................1
1.3 OR methods:.....................................................................................................................2
1.3.1 Simulation..................................................................................................................2
1.3.2 Optimisation..............................................................................................................2
1.3.3 Queuing Theory.........................................................................................................3
1.3.4 Probability and Statistics...........................................................................................3
1.3.5 Decision analysis using Decision Trees....................................................................4
1.3.6 Modelling for Decision Making................................................................................4
1.3.7 Complex algorithms...................................................................................................4
1.3.8 Visualisation..............................................................................................................4
1.3.9 Neural networks.........................................................................................................4
1.3.10 Pattern recognition.....................................................................................................4
1.3.11 Data mining, Data warehousing................................................................................4
1.4 Typical application of OR.................................................................................................5
1.5 The Analytic Decision Process.........................................................................................5
1.5.1 Phases of an OR project.............................................................................................5
1.6 Typical Features of OR.....................................................................................................6
2 Decision Theory.......................................................................................................................8
2.1 Fundamentals of Decision Theory....................................................................................8
2.1.1 Decision Tables.........................................................................................................8
2.1.2 Decision Trees.........................................................................................................12
3 Linear Programming............................................................................................................15
3.1 Major application areas of LP.......................................................................................15

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 3.2 Characteristics of LP......................................................................................................15
3.3 General LP Model Formulation....................................................................................16
3.3.1 Illustration : The Two Mines Company...................................................................16
3.3.2 Illustration : The Production Planning problem......................................................19
3.4 The Simplex Method......................................................................................................22
3.4.1 Definition.................................................................................................................22
3.4.2 Formulating the Simplex Model............................................................................22
3.4.3 Simplex Maximising example................................................................................22
4 Transportation Problem.........................................................................................................29
4.1 Aim :...............................................................................................................................29
4.2 The transportation technique...........................................................................................29
4.2.1 Transportation example...........................................................................................29
4.2.2 Unequal availability and requirements....................................................................34
4.2.3 Maximization and the transportation technique......................................................34
5 Assignment / Allocation Algorithm.......................................................................................37
5.1 The Assignment Technique for minimizing: Example...................................................37
5.2 The Assignment Technique for maximizing...................................................................40
6 Project Management and Network analysis..........................................................................41
6.1 Introduction to Project Management...............................................................................41
6.2 Defining a Project...........................................................................................................41
6.2.1 Common characteristics for all projects..................................................................41
6.2.2 The Project Management Triangle..........................................................................42
6.2.3 Defining Project Management.................................................................................44
6.2.4 Skills required of a Project Manager.......................................................................44
6.3 Network Analysis............................................................................................................45
6.3.1 Basic Network terminology.....................................................................................45
6.3.2 Rules for drawing networks.....................................................................................47
6.3.3 NETWORK ANALYSIS – TIME ANALYSIS......................................................47
6.3.4 NETWORK ANALYSIS – COST SCHEDULING................................................49
6.3.5 NETWORK ANALYSIS – RESOURCE SCHEDULING.....................................50
6.4 Project Management Information Systems.....................................................................50
6.4.1 Introduction to MS Project......................................................................................50
7 Inventory Control...................................................................................................................52
7.1 Introduction.....................................................................................................................52

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 7.2 Reasons for holding stocks.............................................................................................52
7.3 Costs associated with Stock............................................................................................53
7.3.1 Costs of Holding stock.............................................................................................53
7.3.2 Costs of obtaining stock...........................................................................................54
7.3.3 Stock out costs.........................................................................................................54
7.3.4 Costs of Stock..........................................................................................................54
7.4 Types of Control System.................................................................................................54
7.4.1 Re-order level system..............................................................................................54
7.4.2 Periodic Review.......................................................................................................55
7.4.3 Hybrid systems........................................................................................................55
7.5 The Simple Stock Control Model...................................................................................55
7.5.1 Derivation of the EOQ Formula..............................................................................56
8 Tutorials.................................................................................................................................59
8.1 Network Analysis............................................................................................................59
8.2 Inventory Control............................................................................................................64
9 Bibliography..........................................................................................................................66

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1 Introduction to Operations Research

Operations Managers are decision makers. In order to enhance attainment of organizations’ goals, sound
decisions need to be made. It is thus prudent for them to understand how decisions are made and know the
decision making tools to use. To a great extent, the success or failure of people and companies depends on
the quality of their decisions (Heizer, et al., 1996).

1.1 Defining Operations Research

Operations Research is the representation of real world systems by mathematical models together with the
use of quantitative methods (Algorithms) for solving such models, with a view of optimising (Beasley,
n.d.).

“The attack of modern science on complex problems arising in the direction and management of large
systems of men, machines, materials and money in industry, business, government and defence. The
distinctive approach is to develop a scientific model of the system incorporating measurements of factors
such as change and risk, with which to predict and compare the outcome of alternative decisions,
strategies or controls. The purpose is to help management determine its policy and action scientifically”.
(Lucey, 1982).

1.1.1 Other definitions

 The discipline of applying advanced analytical methods to help make better decisions.
 Using techniques such as mathematical modelling to analyse complex situations, OR gives
executives the power to make more effective decisions and build more productive systems.

1.2 Historical Background

Operations Research is a scientific approach to decision making that seeks to best design and operate a
system.
 Usually requires the allocation of scarce resources
 The term originated from WW II era (1930s), when military scientists and engineers were asked to
do “research on military operations”. Thanks to physicists such as Philip M. Morse.
 Logistics, convoy scheduling, anti-submarine operations, radar deployment, mining operations.

1.2.1 Some timelines

1947 : George Dantzig - “Project Scoop”

1950’s : Lots of excitement, mathematical developments ( queuing theory, mathematical programming.

1960’s : More excitement, more development and grand plans

1970’s : Disappointment, and settling down

- More realistic expectations

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1980’s : Widespread availability of personal computers
- increasingly easy access to data
- widespread willingness of managers to use models

1990’s : Improved use of OR systems and technology

- optimization and simulation add-inns to spreadsheets
- modelling languages
- large scale optimization
- more intermixing A.I and OR.

21st Century : Lots of opportunities

- widespread availability of data (network)
- need for increased coordination and resource efficiency
- automated decision making

1.3 OR methods:
The tools of OR are not from any one discipline, rather Mathematics, Statistics, Economics, Engineering,
Psychology etc have contributed to this newer discipline of knowledge. Today, it has become a
professional discipline that deals with the application of scientific methods for decision making, and
especially to the allocation of resources.

1. Simulation:
2. Optimisation : Narrowing your choices to the very best when there are virtually
innumerable feasible options and comparing them is difficult.
3. Probability and Statistics : Helping you measure risk, mine data to find valuable
connections and insights, test conclusions and make reliable forecasts
4. Mathematical modelling
5. Complex algorithms
6. Visualisation
7. Neural networks
8. Pattern recognition
9. Data mining, Data warehousing.
OR can be used to support an indefinite number of business decisions.

1.3.1 Simulation

Giving you the ability to try out approaches and test ideas for improvement. Discrete event system
simulation.
Mathematical imitation of a system over time. A discrete event might be the movement of a truck from
point A to point B, or the receipt of an order.

1.3.2 Optimisation
Linear Programming
Mathematical techniques for optimising an “objective function” subject to certain constraints all
expressed as linear equations. Eg. Maximising revenue subject to plant capacity and transportation
constraints could be an LP problem.

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1.3.3 Queuing Theory
The application of probability, statistics and other mathematical methods to simulate the flow and queuing
of objects eg cars at a toll gate – often in view to reducing congestion.

1.3.4 Probability and Statistics

Helping you measure risk, mine data to find valuable connections and insights, test conclusions and make
reliable forecasts

1.3.4.1 Bayesian probability

It is a statistical approach to decision making that quantifies uncertainty, often combining probabilities
from subjective judgements (our employees won’t strike this year) with probabilities derived from prior
observations. (0.01% of our products are defective)

Bayesian logic : is a type of statistical analysis that can quantify an uncertain outcome by determining its
probability of occurrence using previously known related data.

Bayesian logic offers a way to measure things that were previously immeasurable, allowing us to test
hypotheses and predictions and thereby refine our conclusions and decisions.

Example: Horse race.

Lets say there are 10 horses in a race. If that’s the only information we have on which to base a decision,
then we could pick any horse on the basis that its chance of winning is 1 in 10 or 0.10.

Take that kind of mathematics to the track and you will lose (or you can win) The real world is more
complicated that this. In fact, each of the 10 horses has already run at least a few races and therefore there
is a history. If Lightning has won every race he has entered and Thunder has lost every race he has entered,
then we have got a real evidential basis on which to bet on Lightning instead of Thunder.

In fact there is a lot more information available about every horse in a race.

1. Lineage
Is the horse the offspring of a champion? How have his brothers and sisters performed.

2. Performance under different weather conditions.

If it rains in the morning and the track is soft, how does that affect his speed?

3. Position on the track

Is our horse next to the rail or on the outside. How does the horse react when he is in that position.

4. Length of time since last race.

When was the last time the horse has entered a race and how has been the practice sessions.

5. Distance of today’s race.

What is the distance of today’s race. Has he performed in a similar race before and how has he
furred

All of this information can help us make a better estimate of our horse’s chance of winning than the simplistic 1 out
of 10.
Analysing these factors is a Bayesian Process.

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1.3.5 Decision analysis using Decision Trees

Branched diagrams whose endpoints reflect various financial outcomes and whose branching points
represent choices (we build a new plant or we do not) or outcomes determined by probabilities. (there is a
40% chance that our workforce will strike)
The financial outcomes can be combined with the probabilities to yield expected value of a decision.

1.3.6 Modelling for Decision Making

The decision process is closely tied to the use of mathematical models and “quantitative analysis”.

There is need to understand the advantages and disadvantages of modelling. We use models to try to
represent the reality of a real system by duplicating its important features, appearance and characteristics.
Models are not a panacea: Indeed, most models are simplification of the real world.

You should know :-

 when a model is appropriate and what are its assumptions and limitations
 what purpose a model might serve in a particular problem
 how to use the model and produce results
 how to interpret, in management terms, the results of the model.

1.3.6.1 Advantages and Disadvantages of Using Models

1.3.6.1.1 Advantages
a) They are less expensive and disruptive than experimenting with the real-world system
b) They allow managers to ask, “what if” types of questions eg. What if my inventory cost increases
5 % next year – how will profits change?
c) They are built for management problems and encourage management input
d) They force a consistent and systematic approach to the analysis of problems
e) They require managers to be specific about constraints and goals relating to a problem
f) They can reduce the time needed in decision making

1.3.6.1.2 Disadvantages
a) They may be expensive and time consuming to develop and test
b) They are often misused and misunderstood (and feared) because of their mathematical complexity
c) They tend to downplay the role and value of non-quantifiable information
d) They often have assumptions that oversimplify the variables of the real world

1.3.7 Complex algorithms

1.3.8 Visualisation

1.3.9 Neural networks

1.3.10 Pattern recognition

1.3.11 Data mining, Data warehousing.

OR can be used to support an indefinite number of business decisions.

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1.4 Typical application of OR
 Capital Budgetting
 Asset allocation
 Fraud prevention, Anti money laundering
 Benchmarking
 Market channel optimisation
 Customer segmentation
 Direct market campaigns
 Predicting customer response
 Supply chain planning
 Distribution, Routing and Scheduling
 Traffic flow optimisation
 Resource allocation
 Staff allocation
 Inventory planning
 Product mix and blending.

1.5 The Analytic Decision Process

1.5.1 Phases of an OR project

An OR study can be separated into seven steps and the major steps are:

(1) Problem recognition and definition

The problem to be decided must be stated clearly and concisely, which in many cases is the
most important and difficult step.
 What is the problem?
 Diagnosis of the problem from its symptoms.
 Delineation of the sub-problem to be studied. Often we tend to ignore parts of the entire
problem.
 Establishment of specific and measurable objectives, limitations and requirements.

(2) Formulation as a mathematical model or relationship between goals and variables

Develop a representation of the situation - model
 Construction of the model
 Problems can be modelled in differing ways
 Choosing the appropriate model is crucial to the success of the OR analysis.
 Also consider availability and accuracy of the real world data required as input to the model.

(3) Data collection

 Data will be collected at the previous two stages, but to solve the problem much more data will be
required. The data required will also include the quantification of factors not always quantified,
such as risk and uncertainty.

(4) Model Validation (algorithm validation)

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 1. Running the algorithm for the model on the computer in order to ensure that :-
 The input data is free from errors
 The computer program is bug free
 The computer program correctly represents the model we are attempting to validate.
 The results from the algorithm seem reasonable.

(5) Solution of the model

The purpose of this step is to identify and evaluate alternatives. Many solutions are generated
and compared. The best alternative will be chosen.
Standard computer packages can be used to solve the model. In practice, an optimum solution involves
very many solutions under varying assumptions to establish sensitivity (process called sensitivity
analysis)

(6) Implementation
This phase may involve the implementation of the results of the study or the implementation of
the algorithm.

(7) Review and maintain

After implementation, the performance of the model should be carefully monitored to ensure
that it actually does work and fulfils its objectives. The review process should be at regular
intervals so that appropriate adjustments can be made to meet minor in condition or to
recognise promptly when major changes occur which render the implemented solution
inappropriate.

1.6 Typical Features of OR

The significant features of Operations Research include the following:
(i) Decision Making. Every industrial organization faces multifaceted problems to identify the best
possible solution. OR has techniques which aim to help the executives to obtain optimal solutions. It
also helps the decision maker to improve his creative and judicious capabilities to analyze and
understand the problem situation leading to better control, better coordination, better systems and
finally better decisions.

(ii) Scientific Approach. OR applies scientific methods, techniques and tools for the purpose of analysis
and solutions of the complex problems. In this approach there is no place for guess work and the
person bias of the decision maker.

(iii) Inter-disciplinary Team Approach. Basically the industrial problems are of complex nature and
therefore require team effort to handle them. These teams comprise of scientists, mathematicians and
technocrats who jointly use the OR tools to obtain optimal solutions to OR problems. They try to
analyse the cause and effect relationship between various parameters of the problem and evaluate the
outcome of various alternative strategies.

(iv)Systems Approach. This looks at an organization as consisting of subsystems; from a holistic

perspective then dissect. The main aim is to trace for each proposal, all significant and indirect effects
on all sub-systems of a system and to evaluate each action in terms of effects for the system as a
whole. The interrelationship and interaction of each sub-system can be handled with the help of
mathematical/analytical models of OR to obtain acceptable solutions.

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(v) Use of Computers. The models of OR needs a lot of computation and therefore, the use of computers
becomes necessary. With the use of computers, it is possible to handle complex problems requiring
large amount of calculations. However, computers work on the GIGO principle. Garbage In, Garbage
Out.

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2 Decision Theory

Decision Theory, an analytic approach to choosing the best alternative or course of action is one of the
most widely used and useful of all decision-making tools. Decision Theory can be separated into three
decision models and these are based on the degree of certainty of the possible outcomes or consequences
facing the decision maker. The three types of decision models are as follows:-

a) Decision making under certainty

Decision maker knows with certainty the consequences or outcome of any alternative or decision choice.
Eg. You know with complete certainty that a $100 deposit in a savings account will result in an increase
of $100 in the balance of the account.
b) Decision making under uncertainty
The decision maker does not know the probability of occurrence of the outcomes for each choice.
c) Decision making under risk
The decision maker knows the probability of occurrence of the outcomes or consequences for each
choice. Eg. Samsung may not know how many of its successful smart-phone products it will sell next
year, but the probability of selling more than 5 000 000 is 0.4

2.1 Fundamentals of Decision Theory

Regardless of the complexity of a decision, all decision makers are faced with alternatives and states of
nature.

An alternative is a course of action or a strategy that a decision maker might choose. Eg. An organization
has as an alternative to build a manufacturing plant in Zimbabwe.

A state of nature is an occurrence or a situation over which the decision maker has no control.

2.1.1 Decision Tables

These are charts that help define alternatives. For any alternative and a particular state of nature, there is a
consequence or outcome, which in business is usually expressed as a monetary value. This is called a
conditional value

Example 2.1
The XY Engineering Company is investigating the possibility of producing and marketing backyard
storage sheds. Undertaking this project would require the construction of either a large or a small
manufacturing plant. The market for the product produced – storage sheds – could be either favourable or
unfavourable. XY, of course, has the option of not developing the new product line at all. With a
favourable market, a large facility would give XY a net profit of $200,000. If the market is unfavourable,
a $180,000 net loss would occur. A small plant would result in a net profit of $100,000 in a favourable
market, but a net loss of $20,000 would be encountered if the market was unfavourable.

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The Table below shows the decision tables based on this information.

Table 2-1: Decision Table with Conditional Values for XY Products

States of Nature
Alternatives Favourable Market Unfavourable Market
Construct Large Plant $200,000 -$180,000
Construct Small Plant $100,000 -$20,000
Do Nothing $0 $0

2.1.1.1 Decision Making Under Certainty

Easiest situation a manager can face. If, for example, XY products, the company in the example above
knows that the market for storage sheds will be favourable, the firm will build a large plant. If the firm is
certain the market will be unfavourable, it will do nothing.

2.1.1.2 Decision Making Under Uncertainty

When there is complete uncertainty as to which state of nature in a decision table may occur (ie, when we
cannot even assess probabilities for each possible outcome), we rely on three decision methods.

1) Maximax – finds an alternative that maximizes the maximum outcome for every alternative. First,
we find the maximum outcome within every alternative, and then we pick the alternative with the
maximum number. Because this decision criterion locates the alternative with the highest possible
gain, is has been called an “optimistic” decision criterion.
2) Maximin – finds the alternative that maximizes the minimum outcome for every alternative. First,
we find the minimum outcome within every alternative, and then we pick the alternative with the
maximum number. Because this decision criterion locates the alternative that has the least possible
loss, it has been called a “pessimistic” decision criterion.
3) Equally Likely – finds the alternative with the highest average outcome. First, we calculate the
average outcome for every alternative, which is the sum of all outcomes divided by the number of
outcomes. We then pick the alternative with the maximum number. The equally likely approach
assumes that each state of nature is equally likely to occur.
Use of these approaches is shown in Example 1.2 below.

Example 2.2
Given XY’s decision table of Example 2.1, determine the maximax, maximin, and equally likely decision
criteria.

1) The Maximax choice is to construct a large plant. This is the maximum of the maximum number
within each row, or alternative.
2) The Maximin choice is to do nothing. This is the maximum of the minimum number within each
row, or alternative.
3) The Equally likely choice is to construct a small plant. This is the maximum of the average
outcome of each alternative. This approach assumes that all outcomes for any alternative are
equally likely.

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 Table 2-2 : Decision Table showing decision methods

States of Nature
Alternatives Favourable Unfavourable Maximum Minimum in Row
Market Market in Row Row Average
Construct Large $200,000 -$180,000 $200,000 -$180,000 $10,000
Plant
Construct Small $100,000 -$20,000 $100,000 -$20,000 $40,000
Plant
Do Nothing $0 $0 $0 $0 $0
Maximax Maximin Equally
Likely

2.1.1.3 Decision making under risk

Decision making under risk, a more common occurrence, relies on probabilities. Several states of nature
may occur, each with an assumed probability. Given a decision table with conditional values and
probability assessments for all states of nature, we can determine the Expected Monetary Value (EMV)
for each alternative. This figure represents the expected value or average return for each alternative if we
could repeat the decision a large number of times. Picking the alternative that has the maximum EMV is
one of the most popular decision criteria.

The EMV for an alternative is the sum of possible pay offs of the alternative, each weighted by the
probability of that payoff occurring.

EMV (Alternative i) = (payoff of 1st state of nature) x (probability of 1 st state of nature) + (payoff of
2nd state of nature) x (probability of 2 nd state of nature) + ........ + (payoff of
last state of nature) x (probability of last state of nature)

Example 2.3 Calculation of the EMV

XY Products’ P/OM Manager believes that the probability of a favourable market is exactly the same as
that of an unfavourable market. This is, each state of nature has a 0.50 chance. We can now determine the
EMV for each alternative

Table 2-3

States of Nature
Alternatives Favourable Market Unfavourable Market
Construct Large Plant $200,000 -$180,000
Construct Small Plant $100,000 -$20,000
Do Nothing $0 $0
Probabilities 0.50 0.50

1. EMV (Large Plant) = (0.5)(200,000) + (0.5)(-180,000) = $10,000

2. EMV (Small Plant) = (0.5)(100,000) + (0.5)(-20,000) = $40,000
3. EMV (Do nothing) = (0.5)(0) + (0.5)(0) = $0

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The maximum EMV is seen in the second alternative, constructing a small plant. Thus, according to the
EMV decision criterion, we would build the small facility.

2.1.1.4 Expected Value of Perfect Information (EVPI)

If a manager were able to determine which state of nature would occur, then he or she would know which
decision to make. Once a manager knows which decision to make, the payoff increases because the payoff
is now a certainty, not a probability. Because the payoff will increase if we know which state of nature
will occur, this knowledge, or “perfect information” has value. Therefore, we now look at how to
determine the value of this information. We call this difference between the payoff under certainty and the
payoff under risk the Expected Value of Perfect Information (EVPI).

EVPI = expected value under certainty – maximum EMV

To find the EVPI, we must first find the expected value under certainty, which is the average return
based on perfect information. In order to calculate this value, we choose the best alternative for each state
of nature and multiply its payoff by the probability for that state of nature.

Expected Value Under Certainty = (best outcome or consequence for 1st state of nature) x (probability
of 1st state of nature) + (best outcome for 2 nd state of nature) x
(probability of 2nd state of nature) + ......+ (best outcome for last
state of nature) x (probability of last state of nature)

In Example 2.4, we use the data and decision table in Example 2.3 to examine the expected value of
perfect information.

Example 2.4
Suppose XY Products’ P/OM Manager has been approached by a marketing research firm that proposed
to help him make the decision about whether or not to build the plant to produce storage sheds. The
marketing researchers claim that their technical analysis will tell XY Products with certainty whether or
not the market is favourable for the proposed product. In other words, it will change XY’s environment
from one of decision making under risk to one of decision making under certainty. This information could
prevent XY Products from making a very expensive mistake. The marketing research firm would charge
XY Products $65,000 for the information.
 What would you recommend to XY Products?
 Should the P/OM Manager fire the firm to make the marketing study?
 Even if the information from the study is perfectly accurate, is it worth $65,000?
 What would it be worth?

Determining the value of such perfect information can be very useful. It places an upper bound on what
XY Products would be willing to spend on information.

By referring to Table 2.3 in Example 2.3, XY Products’ Manager can calculate the maximum that he
would pay for information, ie, the EVPI. First, he computes the expected value under certainty. Then,
using this information, he calculates the EVPI. The following procedure is outlined.

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 1.) The best outcome for the state of nature “favourable market” is build a large facility” with a
payoff of $200,000. The best outcome for the state of nature “unfavourable market” is “do
nothing” with a payoff of $0.
Expected value under certainty = ($200,000)(0.50) + ($0)(0.50) = $100,000.
Thus, if we had perfect information, we would expect (on the average) $100,000 if the decision could
be repeated many times.

2.) The maximum EMV is $40,000, which is the expected outcome without perfect information.
EVPI = expected value under certainty – maximum EMV
= $100,000 - $40,000 = $60,000
Thus, the most XY Products should be willing to pay for perfect information is $60,000. This, of
course, is again based on the assumption that the probability of each state of nature is 0.50.

2.1.2 Decision Trees

Any decision that can be placed in a decision table can be placed in a decision tree. A Decision tree is a
graphic display of the decision process that indicates decision alternatives, states of nature and their
respective probabilities, and payoffs for each combination of alternative and state of nature. Decision trees
are most useful for problems that include sequential decisions and states of nature. When later decisions
depend on the outcomes of prior ones, decision tables are too difficult to structure.

Two main symbols are used in decision trees.

o A decision node from which one of several alternatives may be selected.

o A state of nature node out of which one state of nature will occur.

In constructing a decision tree, we must be sure that all alternatives and states of nature are in their correct
and logical places and that we include all possible alternatives and states of nature.

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 A state of nature node
Favourable market
A decision node
1
Unfavourable market

Favourable market

2
Unfavourable market

Figure 2-1 : Decision Tree using symbols

Although many decision criteria apply to decision trees, expected monetary value (EMV) is the most
commonly used and usually the most appropriate criterion for decision tree analysis. Early steps in the
analysis are to graph the decision tree and to specify the monetary consequences of all possible outcomes
on the tree for a particular situation.

Analysing problems with decision trees involve the following five steps.
1. Define the problem
2. Structure or draw the decision tree
3. Assign probabilities to the states of nature
4. Estimate payoffs for each possible combination of alternatives and states of nature.
5. Solve the problem by computing monetary values (EMV) for each state of nature node.
This is done by working backward, that is, by starting at the right of the tree and working
back to decision nodes on the left.

Example 2.6.
The following is an example of how to solve a problem using decision trees.

The payoffs are placed at the right hand side of each of the tree’s branches. The probabilities are placed in
parenthesis next to each state of nature. The expected monetary values for each state of nature node are
then calculated and placed by their respective nodes. The branch leaving the decision node with the
highest EMV will be chosen.

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 EMV for node 1 = (0.5)($200,000) + (0.5)(-$180,000)
= $10,000
Pay offs
Favourable market (0.5)
A decision node $200,000
1
Unfavourable market (0.5) -$180,000

Favourable market (0.5) $100,000

2
Unfavourable market (0.5) -$20,000

EMV for node 2 = (0.5)($100,000) + (0.5)(-$20,000)

= $40,000
$0

Figure 2-2 : Completed and solved Decision Tree for XY Products

In this case, a small plant should be built.

14
3 Linear Programming

LP is a deterministic mathematical procedure for allocating scarce resources while

ensuring some benefit cost. It is an important foundation for other OR tools such as
integer, stochastic, network flow, quadratic programming and other latest heuristics.

LP problems are optimisation problems in which the objective function and the
constraints are all linear.

LP are important because:

 Many practical problems can be formulated as LPs
 There exist an algorithm (Simplex algorithm) which enables us to solve LPs
numerically relatively easily.

3.1 Major application areas of LP

 Blending
 Production planning
 Oil refinery
 Distribution
 Financial and Economic planning
 Manpower planning
 Farm planning
 Blast furnace burdening.

3.2 Characteristics of LP

All LP problems have the following major properties in common

1. They seek to minimise or maximise some quantity (usually profit or cost). This is called
the Objective Function.
2. The presence of restrictions, or constraints, limits the degree to which we can pursue our
objective. For example, deciding how many units of each product in a firm’s product line
to manufacture is restricted by available labour and machinery. We want, therefore, to
maximize or minimize a quantity (the objective function) subject to limited resources
(the constraints).
3. There must be alternative courses of action to choose from. Eg. If a company produces
three different products, management may use LP to decide how to allocate among them
its limited production resources (labour, machinery etc). If there were no alternatives to
select from, we would not need LP.
4. The objectives and constraints are linear ie. Any term is either a constant or a constant
multiplied by an unknown.
5. All variables are continuous (i.e can take fractional values)

15
3.3 General LP Model Formulation

An LP model can be generalised as follows:

Maximise / Minimise, z = ∑ cj xj
J=1

Subject to z= ∑ aij xj ; ( ≥, =, ≤ ) bi , i=1, 2, ………., m

J=1

With xj ≥ 0
Here we are translating a verbal description of the problem into an equivalent mathematical
description.

In the above formulation there are: Variables, Constraints and Objective.

3.3.1 Illustration: The Two Mines Company

The Two Mines Company own two different mines that produce an ore which, after being
crushed, is graded into three classes: high, medium and low-grade. The company has contracted
to provide a smelting plant with 12 tons of high-grade, 8 tons of medium-grade and 24 tons of
low-grade ore per week. The two mines have different operating characteristics as detailed
below.

Mine Cost per day (Z$m) Production (tons/day)

High Medium Low
X 180 6 3 4
Y 160 1 1 6

How many days per week should each mine be operated to fulfill the smelting plant contract?

Note: this is clearly a very simple (even simplistic) example but, as with many things, we have to
start at a simple level in order to progress to a more complicated level.

3.3.1.1 Guessing

To explore the Two Mines problem further we might simply guess (i.e. use our judgement) how
many days per week to work and see how they turn out.

 work one day a week on X, one day a week on Y

This does not seem like a good guess as it results in only 7 tonnes a week of high-grade,
insufficient to meet the contract requirement for 12 tonnes of high-grade a week. We say that
such a solution is infeasible.

16
  work 4 days a week on X, 3 days a week on Y

This seems like a better guess as it results in sufficient ore to meet the contract. We say that such
a solution is feasible. However it is quite expensive (costly).

Rather than continue guessing we can approach the problem in a structured logical fashion as
below. Reflect for a moment though that really we would like a solution which supplies what is
necessary under the contract at minimum cost. Logically such a minimum cost solution to this
decision problem must exist. However even if we keep guessing we can never be sure whether
we have found this minimum cost solution or not. Fortunately our structured approach will
enable us to find the minimum cost solution.

3.3.1.2 Two Mines solution

What we have is a verbal description of the Two Mines problem. What we need to do is to
translate that verbal description into an equivalent mathematical description.

In dealing with problems of this kind we often do best to consider them in the order:

1. variables
2. constraints
3. objective.

We do this below and note here that this process is often called formulating the problem (or more
strictly formulating a mathematical representation of the problem).

(1) Variables

These represent the "decisions that have to be made" or the "unknowns".

Let

x = number of days per week mine X is operated

y = number of days per week mine Y is operated

Note here that x ≥ 0 and y ≥ 0.

(2) Constraints

It is best to first put each constraint into words and then express it in a mathematical form.

 ore production constraints - balance the amount produced with the quantity required
under the smelting plant contract

Ore
High 6x + 1y ≥ 12
Medium 3x + 1y ≥ 8

17
Low 4x + 6y ≥ 24

Note we have an inequality here rather than an equality. This implies that we may produce more
of some grade of ore than we need. In fact we have the general rule: given a choice between an
equality and an inequality choose the inequality.

For example - if we choose an equality for the ore production constraints we have the three
equations 6x+y=12, 3x+y=8 and 4x+6y=24 and there are no values of x and y which satisfy all
three equations (the problem is therefore said to be "over-constrained"). For example the
(unique) values of x and y which satisfy 6x+y=12 and 3x+y=8 are x=4/3 and y=4, but these
values do not satisfy 4x+6y=24.

The reason for this general rule is that choosing an inequality rather than an equality gives us
more flexibility in optimising (maximising or minimising) the objective (deciding values for the
decision variables that optimise the objective).

 days per week constraint - we cannot work more than a certain maximum number of days
a week e.g. for a 5 day week we have

x ≤ 5
y ≤ 5

Constraints of this type are often called implicit constraints because they are implicit in the
definition of the variables.

(3) Objective

Again in words our objective is (presumably) to minimise cost which is given by 180x + 160y

Hence we have the complete mathematical representation of the problem as:

minimise
180x + 160y
subject to
6x + y ≥ 12
3x + y ≥ 8
4x + 6y ≥ 24
x ≤ 5
y ≤ 5
x,y ≥ 0

There are a number of points to note here:

 a key issue behind formulation is that IT MAKES YOU THINK. Even if you never do
anything with the mathematics this process of trying to think clearly and logically about a
problem can be very valuable.

18
  a common problem with formulation is to overlook some constraints or variables and the
entire formulation process should be regarded as an iterative one (iterating back and forth
between variables/constraints/objective until we are satisfied).

 the mathematical problem given above has the form

o all variables continuous (i.e. can take fractional values)
o a single objective (maximise or minimise)
o the objective and constraints are linear i.e. any term is either a constant or a
constant multiplied by an unknown (e.g. 24, 4x, 6y are linear terms but xy is a
non-linear term).

 any formulation which satisfies these three conditions is called a linear program (LP).

3.3.1.3 Discussion

Considering the Two Mines example given above:

 this problem was a decision problem

 we have taken a real-world situation and constructed an equivalent mathematical

representation - such a representation is often called a mathematical model of the real-
world situation (and the process by which the model is obtained is called formulating the
model).

Just to confuse things the mathematical model of the problem is sometimes called the
formulation of the problem.

 having obtained our mathematical model we (hopefully) have some quantitative method
which will enable us to numerically solve the model (i.e. obtain a numerical solution) -
such a quantitative method is often called an algorithm for solving the model.

Essentially an algorithm (for a particular model) is a set of instructions which, when

followed in a step-by-step fashion, will produce a numerical solution to that model.

 our model has an objective, that is something which we are trying to optimise.

 having obtained the numerical solution of our model we have to translate that solution
back into the real-world situation.

3.3.2 Illustration : The Production Planning problem

A company manufactures 4 variants of the same product and in the final part of the
manufacturing process there are assembly, polishing and packing operations. For each of the
variant, the time required for these operations is shown below (in minutes) as is the profit per
unit sold.

19
 Table 3-4

Assembly Polishing Packing Profit $

(minutes)
Variant 1 2 3 2 1.5
Variant 2 4 2 3 2.5
Variant 3 3 3 2 3.0
Variant 4 7 4 5 4.5

Given the current state of the labour force, the company estimates that each year, they have 100
000minutes of assembly time, 50 000 minutes of polishing time and 60 000minutes of packing
time available. How many of each variant should the company make per year and what is the
associated profit.

Suppose now that the company is free to decide how much time to devote to each of the three
operations (assembly, polishing and packing) within the total allowable time of 210 000 (100
000+50 000+60 000) minutes. How many of each variant should the company make per year and
what is the associated profit.

3.3.2.1 Production planning solution

3.3.2.1.1 Variables

Let:

xi be the number of units of variant i (i=1,2,3,4) made per year

Tass be the number of minutes used in assembly per year
Tpol be the number of minutes used in polishing per year
Tpac be the number of minutes used in packing per year

where xi ≥ 0 i=1,2,3,4 and Tass, Tpol, Tpac≥ 0

3.3.2.1.2 Constraints

(a) operation time definition

Tass = 2x1 + 4x2 + 3x3 + 7x4 (assembly)

Tpol = 3x1 + 2x2 + 3x3 + 4x4 (polish)
Tpac = 2x1 + 3x2 + 2x3 + 5x4 (pack)

(b) operation time limits

The operation time limits depend upon the situation being considered. In the first situation,
where the maximum time that can be spent on each operation is specified, we simply have:

20
Tass ≤ 100000 (assembly)
Tpol ≤50000 (polish)
Tpac ≤ 60000 (pack)

In the second situation, where the only limitation is on the total time spent on all operations, we
simply have:

Tass + Tpol + Tpac≤ 210000 (total time)

3.3.2.1.3 Objective

Presumably to maximise profit - hence we have

maximise 1.5x1 + 2.5x2 + 3.0x3 + 4.5x4

which gives us the complete formulation of the problem.

21
3.4 The Simplex Method

There are LP problems that have more than 2 variables and that is where the Simplex Method is
used.

As each variable is represented by a separate axis on the graph, such situations give feasible
regions in multidimensional spaces.

NB: - We cannot construct diagrams in more than 3 dimensions and so graphical methods of
solution are impossible. Hence the SIMPLEX method is used.

3.4.1 Definition.
It is a step by step arithmetic method of solving LP problems whereby one moves from a
position of say zero production, and therefore zero contribution until no further
contribution can be made.

Each step produces a feasible solution and each step produces an answer better than the
one before.

3.4.2 Formulating the Simplex Model

1. State the problem in the standardized manner
2. Convert inequalities to equalities as it is difficult to perform arithmetic upon an
inequality.
3. Add a slack variable to make it an equality. The slack variable represents any unutilized
capacity in the constraint.
NB: Each constraint will have its own slack variable.

3.4.3 Simplex Maximising example

A company can produce 3 products A, B and C. The products yield a contribution of $8, $5 and
$10 respectively. The products use a machine which has 400hours capacity in the next period.
Each unit of the products uses 2,3 and 1hr respectively of the machine’s capacity.

There are only 150 units available in the period of a special component which is used singly in
products A and C, 200kgs only of a special alloy is available in the period. Product A uses 2kgs
per unit and product C uses 4kgs per unit.

There is an agreement with a trade association to produce no more than 50 units of product B in
the period. The company wishes to find out the production plan which maximizes contribution.

22
STEP 1

Express the problem in the standardized format.

Maximise 8x1 + 5x2 + 10x3

Subject to : 2x1 + 3x2 + x3 ≤ 400

x1 + x3 ≤ 150

2x1 + 4x3 ≤ 200

x2 ≤ 50

x1, x2, x3 ≥ 0

where x1 = number of units of Product A

x2 = number of units of Product B

x3 = number of units of Product C

STEP 2

Make the inequalities in the constraints into equalities by adding a “slack variable” in each
constraint.

Maximise 8x1 + 5x2 + 10x3

Subject to : 2x1 + 3x2 + x3 + x4 = 400

x1 + x3 + x5 = 150

2x1 + 4x3 + x6 = 200

x2 + x7 = 50

x4 – x7 are slack variables and represent the spare capacity in the limitations.

23
STEP 3

Set up the initial Simplex tableau

Initial Simplex tableau : TABLE 1

Solution Products Slack Variables Solution

Variabl Quantity
e X1 X2 X3 X4 X5 X6 X7

X4 2 3 1 1 0 0 0 400

X5 1 0 1 0 1 0 0 150

X6 2 0 4 0 0 1 0 200

X7 0 1 0 0 0 0 1 50

Z 8 5 10 0 0 0 0 0

NB : The tableau shows a feasible solution ie of nil production, nil contribution, maximum
unused capacity as represented by slack variables x4 to x7.

Now we need to improve on this status.

STEP 4

Improve on the previous feasible solution by making as many as possible of the product with the
most contribution. ie the Highest figure in the Z row.

Select the highest contribution in the Z row ie 10 under x3.

Divide the positive numbers in the x3 column into the solution quantity column.

400 ÷ 1 = 400

150 ÷ 1 = 150

200 ÷ 4 = 50

50 ÷ 0 = Ignore

Select the row that gives the lowest answer (x 6). Ring the element which happens in both the
identified column (x3) and the identified row (x6), this element is called the pivot element

24
 Initial Simplex tableau reproduced : Table 2

Solution Products Slack Variables Solution

Variabl Quantity
e X1 X2 X3 X4 X5 X6 X7

X4 2 3 1 1 0 0 0 400

X5 1 0 1 0 1 0 0 150

X6 2 0 4 0 0 1 0 200

X7 0 1 0 0 0 0 1 50

Z 8 5 10 0 0 0 0 0

NB : 4 in the shaded cell is the pivot element.

STEP 5

Divide all the elements in the identified row (x 6) by the value of the pivot element (4) and change
the solution variable to the heading of the identified column (x3)

Old row

X6 2 0 4 0 0 1 0 200

New row

X3 ½ 0 1 0 0 ¼ 0 50

Enter this row in a new tableau

Second Simplex tableau : Table 3

Row Solution Products Slack Variables Solution

No. Variable Quantity
X1 X2 X3 X4 X5 X6 X7

1 X4 2 3 1 1 0 0 0 400

2 X5 1 0 1 0 1 0 0 150

3 X3 1/2 0 1 0 0 1/4 0 50

4 X7 0 1 0 0 0 0 1 50

5 Z 8 5 10 0 0 0 0 0

25
This table is the same as Table 1 except for Row 3.

Row 3 means that 50 units of x3 are to be produced (Highest contribution)

STEP 6

As a consequence of producing 50 units of x3 it is necessary to adjust the other row so as to take

up the appropriate number of hours, components etc, used and to show the contribution produced
for the 50 units of x3.

This is done by row by row operations using Row 3 which makes all the other elements in the
pivot elements column into zeros.

Row 1 x4 2 3 1 1 0 0 0 400

Minus Row 3 x3 ½ 0 1 0 0 ¼ 0 50

Gives x4 1½ 3 0 1 0 -¼ 0 350

This new row will be inserted into a third tableau along with all the other altered rows and Row 3
from the second tableau.

Do the row by row operation for all the rows

STEP 7 : Produce the third tableau

Third Simplex tableau . Table 4

Row Soluti Products Slack Variables Solution

No. on Quantity
Varia X1 X2 X3 X4 X5 X6 X7
ble

6 (1-3) X4 1 1/2 3 0 1 0 - 1/4 0 350

7 (2-3) X5 1/2 0 0 0 1 -1/4 0 100

8 (3) X3 1/2 0 1 0 0 1/4 0 50

9 (4) X7 0 1 0 0 0 0 1 50

10 Z 3 5 0 0 0 -2 1/2 0 -500

(5-10x3)

NB : The (-500) in the Z row is the contribution earned by 50 units of x3 at 10 contribution.

26
Negative sign is merely a result of the Simplex method and the fact the contribution is shown as
a negative figure can be disregarded.

STEP 8

To produce subsequent tableaux and eventually an optimum solution, Steps 4 to 7 are repeated
until no positive numbers can be found in the Z row.

Repeating Step 4 :

From Row 10 it will be seen that the maximum contribution is 5

Therefore x2 column is chosen.

Repeating Step 5 :

The positive numbers in the x2 column are divided into the Solution quantities and
the lowest result selected.

Row 6 350 ÷ 3 = 116 2/3

Row 7 100 ÷ 0 = Ignore

Row 8 50 ÷ 0 = Ignore

Row 9 50 ÷ 1 = 50

Therefore Row 9 is selected and the pivot element identified and the Solution
variable altered to x2.

Row 9 x2 0 1 0 0 0 0 1 50

Resultant Fourth Simplex tableau . Table 5

Row Soluti Products Slack Variables Solution

No. on Quantity
Varia X1 X2 X3 X4 X5 X6 X7
ble

11 X4 1½ 3 0 1 0 - 1/4 -3 350

12 X5 ½ 0 0 0 1 -1/4 0 100

13 X3 ½ 0 1 0 0 1/4 0 50

14 X2 0 1 0 0 0 0 1 50

27
 15 Z 3 0 0 0 0 -2 1/2 -5 -750

This table shows that 50 units of Product B and C can be made.

Contribution will be 750 as Z = -750.

STEP 9

Because there is still a positive number in the Z row (3 under column x 1) the iterative process is
repeated in the same manner.

Resultant tableau ( Fifth Tableau)

Fifth Simplex tableau . Table 6

Row Soluti Products Slack Variables Solution

No. on Quantity
Varia X1 X2 X3 X4 X5 X6 X7
ble

16 X4 0 0 -3 1 0 -1 -3 50

17 X5 0 0 -1 0 1 -1/2 0 50

18 X1 1 0 2 0 0 1/2 0 100

19 X2 0 1 0 0 0 0 1 50

20 Z 0 0 -6 0 0 -4 -5 -1050

As there are no positive values in the Z row, the optimum solution has been reached.

STEP 10

All that is remaining is to obtain the maximum information from the fifth tableau

Optimum product mix

X1 = 100 ie produce 100 units of Product A

X2 = 50 ie produce 50 units of Product B

28
4 Transportation Problem

The aim of the transportation problem is to determine the best plan of assigning the units from
each origin to a specific destination so that the overall plan of transporting the goods minimizes
total cost. Here we consider operations whose costs are affected by the choice of which routes to
use on a map or plan.

A typical transportation problem deals with sources where a supply of some commodity is
available and destinations where the commodity is demanded. The classic statement of the
transportation problem uses a matrix with the rows representing sources and columns
representing destinations. The algorithms for solving the problem are based on this matrix
representation. The costs of shipping from sources to destinations are indicated by the entries in
the matrix. If shipment is impossible between a given source and destination, a large cost of M is
entered. This discourages the solution from using such cells. Supplies and demands are shown
along the margins of the matrix. As in the example, the classic transportation problem has total
supply equal to total demand.

4.1 Aim :
 Reduce the cost of transporting goods between towns or depots or warehouses.
 Minimise the total distance a salesman travels
 Find the shortest length of electrical cables needed to wire together the rooms of a house.

4.2 The transportation technique

1. It is an iterative, step by step process

2. It starts with a feasible solution and each succeeding solution is also feasible.
3. at each stage, a test is made to see whether transportation costs can be reduced
4. Optimum is reached when no further cost reductions are possible.

4.2.1 Transportation example.

A firm of office equipment suppliers has 3 depots located in various towns. It receives orders for
a total of 15 special filing cabinets from 4 customers. In total in the 3 depots there are 15 of the
correct filing cabinets available and the management wish to minimize delivery costs by
dispatching the filing cabinets from the appropriate depot for each customer.

29
Details of the availabilities, requirements and transport costs per filing cabinet are given in the
following table.

Table 4-5

Customer Customer Customer Customer Total

A B C D Required
Cabinets 3 3 4 5 15
Depot X 2 13 11 15 20
Depot Y 6 17 14 12 13
Depot Z 7 18 18 15 12
Total 15
Available

Step 1
Make an initial feasible allocation of deliveries. This is done by selecting the route with the
cheapest cost and allocating as much as possible to this route. The sequence is done in the order
of increasing cost until all the requirements are fulfilled.

Table 4-6

Requirements
A B C D
3 3 4 5
Available

X 2 2(1)
Y 6 1(4) 1 (3) 4(2)
Z 7 2(5) 5(2)

NB : The numbers in the table represent deliveries of cabinets and the numbers in brackets (1),
(2) etc, represent the sequence in which they are inserted, starting with the lowest cost first and
so on.

Step 2

Check solution obtained to see if it represents the minimum cost possible. This is done by
calculating what is called the “Shadow costs” ie the envisaged imputed cost of not using a
particular route. This is then compared to the real transportation cost to see whether a change of
allocation is desirable.
In this example, the routes that are not in use are X : A , X : C , X : D , Y : D , Z : B and Z : C.

30
 The calculation is done as follows :

Calculate the nominal “dispatch” and “reception” cost for each occupied cell. Assume that the
transport cost is capable of being split between dispatch and reception costs.

Letting D( ) denote dispatch costs and R( ) denote reception costs, the following can be
established.

D(X) + R(B) = 11
D(Y) + R(A) = 17
D(Y) + R(B) = 14
D(Y) + R(C) = 12
D(Z) + R(A) = 18
D(Z) + R(D) = 12

Where D(X), D(Y) and D(Z) are dispatch costs

And R(A), R(B) , R(C) and R(D) are reception costs.

By convention, the first depot is assigned the value of zero ie D(X) = 0

Substituting and establishing the values gives the following.

R(A) = 14 D(X) = 0
R(B) = 11 D(Y) = 3
R(C ) = 9 D(Z) = 4
R(D) = 8

Using these values, the shadow costs of the unoccupied cells can be calculated.

The unoccupied cells are X : A , X : C , X : D , Y : D , Z : B and Z : C.

Shadow costs.
D(X) + R(A) = 0 + 14 = 14
D(X) + R(C) = 0+9 = 9
D(X) + R(D) = 0+8 = 8
D(Y) + R(D) = 3+8 = 11
D(Z) + R(B) = 4 +11 = 15
D(Z) + R(C) = 4+9 = 13

Shadow costs are then compared with actual transport costs for those routes.

Cell Actual cost - Shadow cost + cost increase

or - cost reduction
X:A 13 - 14 = -1
X:C 15 - 9 = +6
X:D 20 - 8 = +12
Y:D 13 - 11 = +2

31
 Z:B 18 - 15 = +3
Z:C 15 - 13 = +2

On the above comparison, it is notable that on cell X:A, there is a negative on the
comparison of the actual and shadow costs. This means that total costs could be reduced
for every unit that can be transferred into cell X : A

As there is a cost reduction that can be made, the solution in table 2 is not optimum. We
then move on to the next step.

Step 3

Make the maximum possible allocation of deliveries into the cell where actual costs are less than
shadow costs using the occupied cells.

Cell X:A from step 2, the number that can be allocated is governed by the need to keep within
the row and column totals.

Table 4-7

Requirements
A B C D
3 3 4 5
X 2 + 2-

Y 6 1- 1+ 4
Available

Z 7 2 5

Reasons :
Cell X:A + Transfer in as many as indicated in Step 2
Cell X:B - Transfer out to balance Row X
Cell Y:B + Transfer in to balance column B
Cell Y:A - Transfer out to maintain Row Y and Column A totals.

The maximum number that can be transferred into Cell X:A is the lowest number in the
minus cells ie. Cells X:B and Y:A which is 1 unit.

Therefore 1 unit is transferred in the + and – sequence described above resulting in the
following table.

32
 Table 4-8

Requirements
A B C D
3 3 4 5
X 2 1 1
Available Y 6 2 4

Z 7 2 5

The total cost of this solution is :

Cell X:A 1 unit @$13 =13

Cell X:B 1 unit @$11 =11
Cell Y:B 2 units@$14 =28
Cell Y:C 4 units @$12 =48
Cell Z:A 2 units@$18 =36
Cell Z:D 5 units@12 =60
Total =$196

The new total cost is $1 less than the total cost established in Step 1.
N.B : Always commence the + and – sequence with a + in the cell indicated by the (actual cost –
shadow cost) calculation. Then put a – in the occupied cell in the same row which has an
occupied cell in its column. Proceed until a – appears in the same column as the original +.

Step 4

Repeat Step 2 ie check that solution represents minimum cost. Each of the processes in Step 2
are repeated using the latest solution (Table 4) as a basis.

Nominal dispatch and reception costs for occupied cells.

D(X) + R(A) = 13
D(X) + R(B) = 11
D(Y) + R(B) = 14
D(Y) + R(C) = 12
D(Z) + R(A) = 18
D(Z) + R(D) = 12

Setting D(X) at zero, the following values are obtained.

R(A) = 13 D(X) = 0
R(B) = 11 D(Y) = 3
R(C ) = 9 D(Z) = 5
R(D) = 7

33
 Using these values, the shadow costs of the unoccupied cells are calculated.
D(X) + R(C) = 9
D(X) + R(D) = 7
D(Y) + R(A) = 16
D(Y) + R(D) = 10
D(Z) + R(B) = 16
D(Z) + R(C) = 14

Compare with actual costs

Cell Actual cost - Shadow cost + cost increase

or - cost reduction
X:C 15 - 9 = +6
X:D 20 - 7 = +13
Y:A 17 - 16 = +1
Y:D 13 - 10 = +3
Z:B 18 - 16 = +2
Z:C 15 - 14 = +1
NB: All the answers are positive, therefore no further cost reduction and hence the optimum solution has been
reached.

Note also that only one iteration was necessary to produce an optimum solution mainly because a good initial
solution was chosen. It should be known that many iterations can be done for one to get to the optimum solution.

4.2.2 Unequal availability and requirements.

In the example dealt with here, there were equal quantities of units available and those required.
This in not always the case in real life. You find that there could be more available from depots
and less are required at destinations.

What do you do?

A slight adjustment is necessary in this case. On the initial table, you introduce a dummy
destination with zero transport cost. This dummy destination will absorb the surplus that is
available.
Thereafter, the transportation technique steps are followed until an optimum solution is gotten.

4.2.3 Maximization and the transportation technique.

Transportation problems are usually minimizing problems. On occasions problems are framed so
that the objective is to make the allocations from sources to destinations in a manner which
maximizes contribution or profit.

Steps involved.

34
Step 1

Make the initial feasible allocation on the basis of maximum contribution first, then next
highest and so on.

Step 2

For optimum, the differences between actual and shadow contributions for the unused
routes should be all negative.
If not, make allocation into cell with the largest positive difference.
Apart from the differences above, the transportation technique can be followed as usual.

35
 Outline of transportation method: Flow chart

Start

Do
re
q
ui
re
m
en
ts
NO

eq
u al
a
va
ilab
i
lit
y
Add dummy

?
YES
destination
Make initial
Feasible solution

Calculate total cost

Calculate nominal despatch

and
Reception costs

Calculate shadow costs of

unused routes
An tiv
Ne alu

NO
y e
ga es?
V

YES Optimum Solution

Put + into cell with

greatest negative value
and –s and +s to keep
row and column totals

Make largest possible

allocation into first +
cell and adjust other
cells. END
36
5 Assignment / Allocation Algorithm

This is a special form of the transportation problem. It is fundamentally concerned with the
process of planning an optimal allocation of resources. We require knowing a specification of the
resources available and their location, and the resources required and their destination.

It exists when there is only one item at each of the various sources and only one item is required
at each of the various destinations.
EG assigning service engineers to service requests so as to minimize millage.

5.1 The Assignment Technique for minimizing: Example

A company employs service engineers based at various locations throughout the country to
service and repair their equipment installed in customer’s premises. 4 requests for service have
been received and the company wishes to assign engineers to customers to minimize the total
distance to be traveled.

Distances traveled from Engineers to Customers are indicated in the table below.
Customers are W, X, Y and Z.

Table 5-9

W X Y Z
Alf 25 18 23 14
Bill 38 15 53 23
Charlie 15 17 41 30
Dave 26 28 36 29

Step 1

Reduce each column by the smallest figure in that column. The smallest figures are 15, 15, 23
and 14. Deducting these values from each element in the columns produces the following table

Table 5-10

W X Y Z
Alf 10 3 0 0
Bill 23 0 30 9
Charlie 0 2 18 16
Dave 11 13 13 15

37
Step 2

Reduce each row by the smallest figure in that row.

The smallest figures are 0,0,0 and 11.
Deducting these values gives the following table.

Table 5-11

W X Y Z
Alf 10 3 0 0
Bill 23 0 30 9
Charlie 0 2 18 16
Dave 0 2 2 4

NB : Where the smallest value in a row is zero, the row is of course unchanged.

Step 3

Cover all the zeros in Table 3 by the minimum possible number of lines. The lines may
be horizontal or vertical.

Table 5-12

W X Y Z
Alf 10 3 0 0
Bill 23 0 30 9
Charlie 0 2 18 16
Dave 0 2 2 4

Step 4

Compare the number of lines with the number of assignments to be made. (in this case there
are 3 lines and 4 assignments)
 If the number of lines equals the number of assignments to be made, go to Step 6.
 If the number of lines is less than the number of assignments to be made, then
a) Find the smallest uncovered element from Step 3, called T (in Table 4 this value
is 2)
b) Subtract T from every element in the matrix
c) Add back T to every element covered by two lines eg Alf : W in Table 4, T is
added twice.

38
 New table becomes

Table 5-13

W X Y Z
Alf 12 3 0 0
Bill 25 0 30 9
Charlie 0 0 16 14
Dave 0 0 0 2

Step 5

Repeat Step 3 and 4 until the number of lines covering the zeros equals the number of
assignments to be made.

Table 5-14

W X Y Z
Alf 13 3 0 0
Bill 25 0 30 9
Charlie 0 0 16 14
Dave 0 0 0 2

Here the number of lines equals the number of assignments

Step 6

When the number of lines equals the number of assignments to be made, the actual assignment
can be made using the following rules.

Rules for assigning

a) Assign to any zero which is unique to both a column and a row.
b) Assign to any zero which is unique to a column or a row.
c) Ignoring assignments already made repeat rule (b) until all assignments are made

In our example, applying the rules.

a) Zero unique to both a column and a row (Non in this example)
b) Zero unique to column or row
 Assign Bill to X and Alf to Z

c) Repeating rule (b) results in assigning Dave to Y and Charlie to W.

NB: Should the final assignment not be to a zero, then more lines than necessary were used
in Step 3
39
 If a block of 4 or more zeros is left for the final assignment, then a choice of assignment exist
with the same milage.

Step 7

Calculate the total milage of the final assignment

Table 5-15

Engineer Customer Milage

Alf Z 14
Bill X 15
Charlie W 15
Dave Y 36
TOTAL 80

5.2 The Assignment Technique for maximizing

To maximize, only step 1 from the above differs. The columns are reduced by the largest number
in each column.
From then on, the same steps as in the minimization technique apply.

40
6 Project Management and Network analysis

6.1 Introduction to Project Management

A project is different from operations work and this means that in organizations, there are
essentially two types of work.

1. Operations Work 2. Project Work

 Similar activities repeatedly performed  A temporary endeavour with a

by the same resource or group of beginning and an end date (non-
resources. ending projects not withstanding)
 Occurs continuously without a  Is unique producing a unique
specified beginning or end. product or service in differing
 Typified by its single-function focus. environments
Normally performed within the  Most are integrative & cross
confines of a functional unit. functional nature.
 have unknown elements, therefore
create risk

Because of the different nature of work involved in projects, the processes and techniques used
to manage operations work do not translate very well for use in managing project work.

6.2 Defining a Project

A project is :-
A project is a carefully defined set of interrelated activities that use resources to meet pre-defined
objectives. It has a definite starting and ending point and results in the accomplishment of a
unique, often major outcome. The resources are money, people, materials, energy, space,
provisions, communication, quality, risk, …

Examples of Project work are :-

 Building a bridge
 Making a boat
 Constructing a block of flats

6.2.1 Common characteristics for all projects

 A definite beginning and an end date.
 Unique.
o They may be similar to prior projects but they are unique in terms of timeframes,
resources, business environment, etc.
 Result in the creation of one or more deliverables.

41
  Have assigned resources (either full-time, part-time or both).

6.2.2 The Project Management Triangle

It is the relationship in a project that exists between resources, tasks and time. It is often referred
to as the triple constraint.

Scope / Quality

Referring to the diagram above, the Triple Constraint basically demonstrates in pictorial fashion,
the key attributes that must be handled effectively for successful completion and closure of any
project. For thoroughness, the key attributes of the Triple Constraint are itemized as follows:

Time – This refers to the actual time required to produce a deliverable. Which in this case,
would be the end result of the project. Naturally, the amount of time required to produce the
deliverable will be directly related to the amount of requirements that are part of the end result
(scope) along with the amount of resources allocated to the project (cost).

Cost – This is the estimation of the amount of money that will be required to complete the
project. Cost itself encompasses various things, such as: resources, labor rates for contractors,
risk estimates, bills of materials, et cetera. All aspects of the project that have a monetary
component are made part of the overall cost structure.

Scope – These are the functional elements that, when completed, make up the end deliverable for
the project. The scope itself is generally identified up front so as to give the project the best
chance of success. (Although scope can potentially change during the project life-cycle, a
concept known as ‘scope creep’) Note that the common success measure for the scope aspect of
a project is its inherent quality upon delivery.

The major take-away from the Triple Constraint, being that it is a triangle, is that one cannot
adjust or alter one side of it without in effect, altering the other sides. So for example, if there is a
request for a scope change mid-way through the execution of the project, the other two attributes
(cost and time) will be affected in some manner. How much or how little is dictated by the nature
and complexity of the scope change. As an added example, if the schedule appears to be tight
42
and the project manager determines that the scoped requirements cannot be accomplished within
the allotted time, both cost AND time are affected.

Based on the aforementioned definitions and examples, how does the project manager stay on
top of the triple constraint? What steps can one take to ensure successful project rollout knowing
how the three attributes affect each other?

Understand the Triple Constraint

For starters, the project manager MUST be fully cognizant of the fact that scope, time and cost
are fully inter-related and that the triple constraint dictates any adjustment to any of those items
MUST affect the other. In many cases, a project manager may be somewhat aloof about adding
scope to a project or accepting a budget cut without taking the effort to determine what the
consequences of that change will be. Denial of the potential repurcussions of adjustments to the
scope, time or cost of a project are only going to lead to issues down the road and may also cause
the project to fail.

Convey the Triple Constraint

Along with recognizing how the triple constraint functions, it is imperative that the project
manager convey that information to the project stakeholders. Making sure everyone who is
involved with the project recognizes the importance of the constraint will make discussions
regarding the scope, time and cost far easier. In many cases, the stakeholders are likely to be the
main reasons for scope creep or budget adjustments in a project. Having them aware up front of
what the ramifications might be for any requested or mandated changes will make dialog easier
in follow-up meetings and will also make them scrutinize their change requests more thoroughly
rather than assuming that any change will have no issue on the project release cycle. Note that
conveyance of the triple constraint to the stakeholders is best performed at the outset, likely
during the formation of the initial project plan.

Monitor the Triple Constraint

As the project manager, making sure that you stay on top of all the key attributes of the triple
constraint will make the likelihood of project success that much higher. So be cognizant of any
fluctuations to the key attributes, whether they be unexpected or requested. Never assume that
other attributes can be left un-changed if one attribute is known to be changing or fluctuating. As
noted earlier, one cannot simply dismiss a change to one without being fully aware of the fact
that it WILL affect the other two.

The Triple Constraint is one of the most well known and well respected mechanisms for
signifying the interaction of the key attributes of a project. By being fully aware of its function
and implications is an important aspect of the project manager’s role and responsibility. The
triple constraint is meant to be a asset to the project manager’s arsenal and should not be viewed
as a hinderance.

43
6.2.3 Defining Project Management
It is the discipline of organizing and managing resources in such a way that these resources
deliver all the work required to complete a project as planned (within defined scope, quality,
time and cost constraints).

Project Management can also be defined as the adept use of techniques and skills (hard and soft)
in planning and controlling tasks and resources needed for the project, from both inside and
outside of organisation, to achieve results.

The aim is to ensure the effective and efficient use of resources and delivery of the project
objectives within time, cost and resource constraints.

6.2.3.1 Phases of Project Management

Project Management is divided into 5 main phases that lead into each other. Each phase has
specific tasks that are associated with it. It is important to note these phase may however overlap.

The phases are :

 Define
 Plan
 Execute
 Manage
 Close

6.2.4 Skills required of a Project Manager

In order to overcome the challenges related to project triangle and meet the project objectives,
the project manager needs to have a range of skills, which includes:

 Leadership
 Managing people
 Negotiation
 Time management
 Effective communication
 Planning
 Controlling
 Conflict resolution
 Problem solving

Project management is very often represented on a triangle. A successful project manager needs
to keep a balance between the triple constraints so that the quality of the project or outcome is
not compromised.

There are many tools and techniques that are available in order to face the challenges related to
the three constraints. A good project manager will use appropriate tools in order to execute the
project successfully.

44
6.3 Network Analysis

Network analysis is a generic term for a family of related techniques developed to aid
management to plan and control projects.
 Techniques show the inter relationships of the various job tasks which make up the
overall project and clearly identify the critical paths of the project.
 Provide planning and control information on the time, cost and resource aspects of the
project.

It is a powerful tool in the management of projects.

Drawing a network provides a visual display of the relationships concerned and a way of
answering various questions about the project.

Network analysis is of value where projects are :

 Complex – many related and interdependent activities.
 Large – high capital investments, many personnel are involved.
 Where restrictions exists ie. Where projects have to be completed within
stipulated time or cost limits, or where some or all of the resources (material,
labour) are limited.

It is used in :
 Construction
 Engineering
 Manufacturing
 Management of administrative systems

Examples of the questions it helps answer are :-

 Which are the activities in the project which determine the time needed for its
completion?
 Is it financially desirable to allocate additional resources to some activities in order to
complete the project more quickly?
 Where are the peaks of manpower usage in the project, and can they be levelled out by
delaying the start of some activities?

6.3.1 Basic Network terminology

6.3.1.1 Activity

A task or job of work which takes time and resources eg. Dig foundation.

It is represented in a network by an arrow

45
Head of arrow indicates where the task ends.

6.3.1.2 Event
This is a point in time and indicates the start or finish of an activity or activities eg Wall built,
Foundation Dug.

An event is represented by a circle.

It will be noted that the establishment of activities automatically determines events because they
are the start and end of activities and represent the achievement of a specific stage of a project.

6.3.1.3 Dummy activity

This is an activity which does not consume time or resources. It is used merely to show clear,
logical dependencies between activities so as not to violate the rules for drawing networks.

Represented on a network by a dotted arrow.

6.3.1.4 Network

This is the combination of activities, dummy activities and events in a logical sequence
according to the rules for drawing networks.

46
6.3.2 Rules for drawing networks

1. A complete network should have one start event and one finish event.
2. Every activity must have one preceding and one succeeding. Note that many activities
may use the same tail event and many may use the head event.
 However an activity may not share the same tail event and the same head event
with any other activities, hence introduce a dummy.
3. No activity can start until its tail event is reached.
4. An event is not complete until all events leading to it are complete.
5. Loops , a series of activities which lead to the same event are not allowed because
essence of networks is a progression of activities always moving onwards in time.
6. All activities must be tied into the network ie they must contribute to the progression or
be discarded as irrelevant.

6.3.3 NETWORK ANALYSIS – TIME ANALYSIS

Assessing the time

Single time estimates for each activity – Based on individual judgement or using data from
similar projects.

Multiple time estimates for each activity

Usually use three estimates ie Optimistic (O), Most Likely (ML) and Pessimistic (P).
These three are combined to give an expected time and the accepted formula is :

47
 O + P + 4ML
Expected time =
6

Basic Time analysis

Critical Path

It gives the shortest time in which the whole project can be completed. It is the chain of
activities with the longest duration times. There may be more than one critical path in a
network and it is possible for the critical path to run through a dummy.

Earliest Start Time (EST)

Is the earliest possible time at which a succeeding activity can start.

Latest start time (LST)

It is the latest possible time at which a preceding activity can finish without increasing
the project duration

Activities along the critical path are vital activities which must be completed by their
ESTs / LSTs otherwise the project will be delayed..

The non critical activities have spare time or float available. If it is necessary to reduce
the overall project duration then the time of one or more of the activities on the critical
path must be reduced perhaps by using more labour, or more or better equipment or
some other method of reducing job times.

FLOAT

Total Float
The amount of time a path of activities can be delayed without affecting the overall project
duration.

Free Float
This is the amount of time an activity can be delayed without affecting the commencement of a
subsequent activity at its earliest start time, but may affect float of a previous activity.

Independent float

48
The amount of time an activity can be delayed when all preceding activities are completed as late
as possible and all succeeding activities completed as early as possible. Independent float
therefore does not affect the float of either preceding or subsequent activities.

6.3.4 NETWORK ANALYSIS – COST SCHEDULING

Cost analysis objectives

 To be able to calculate the cost of various project durations.

The normal duration of a project incurs a certain cost. This duration varied by :-
 Putting more labour
 Working overtime
 More equipment
But this is at the expense of more cost.

Penalties and Bonuses.

Penalty clause for delayed projects

Bonuses for earlier completion.

Normal cost

Cost at which the costs are associated with the normal time of completion which is associated
with the most efficient utilisation of resources.

Crash cost
The cost associated with the minimum possible time for an activity. Crash costs because of extra
wages, overtime premiums, extra facility costs are always higher than normal costs.

Crash time
The minimum possible time that an activity is planned to take. The minimum time is invariably
brought about by the application of extra resources eg. More labour or machinery.

Cost slope
This is the average cost of shortening an activity by one unit (day, week, month as appropriate)

Crash Cost – Normal Cost

Cost Slope =
Normal Time – Crash time

Least Cost scheduling or Crashing

The process which finds the least cost method of reducing the overall project duration, time
period by time period

49
6.3.5 NETWORK ANALYSIS – RESOURCE SCHEDULING

Project resources
 Men of varying skills
 All types of machines
 Materials
 Finance
 Space

These resources are subject to varying demands and loadings as the project proceeds.

Management need:
1. information on what activities and resources are critical to the project and the impacts of
any of those if they are limited.
2. they also wish to ensure as far as possible, constant work rates to eliminate paying
overtime at one stage of the project and having short time working at another stage.

Details required for resource scheduling.

a) Activity times, descriptions and sequences

b) Resource requirements for each activity showing the classification of the resource and the
quantity required.
c) Resources available to the project.
d) Any management restrictions that need to be considered eg. Which activities may or may
not be split or any limitations on labour mobility.

Resource scheduling steps

1) Draw the activity times on a Gantt chart based on their ESTs
2) Based on the time bar chart prepare a Resource aggregation profile ie. Total resource
requirements in each time period.
3) Examine the requirements and it may be noted that at times more resources are required
than are available. The ESTs and LSTs can show that there are some floats. Having
regard for these floats it is necessary to “smooth out” the resource requirements so that
the resource required do not exceed the resource constraint. ie. Delay the commencement
of activities (within their float) – This is called resource levelling.

6.4 Project Management Information Systems

Interest in the techniques and concepts of project management has exploded and this has resulted
in a parallel increase in project management software offerings. Jacobs & Chase (2008) notes
that there are over 100 companies offering project management software. They also say that two
of the leading companies are Microsoft with MS Project and Primavera with Primavera Project
Planner

6.4.1 Introduction to MS Project

50
MS Project comes with an excellent online tutorial, which is one reason for its overwhelming
popularity with project managers tracking mid-sized projects. The program includes features for
scheduling, allocating and levelling of resources, as well as controlling costs and producing
presentation quality graphics and reports.

Finally, for managing very large projects or programs having several projects, Primavera Project
Planner is often the choice. Primavera was the first major vendor of this type of software and has
possibly the most sophisticated capability.

51
7 Inventory Control

7.1 Introduction
Inventory is the stock of any item or resource used in an organization (Jacobs & Chase, 2008). It
is a major element of the working capital of many organisations. Hence its proper control is
crucial to the profitability of the organisation. Stock in organisations is found in the form of raw
materials, work in progress or of finished goods awaiting despatch.

It is surprising to note that each and every department in an organisation has stock in one way or
another. In much the same way, many departments think that inventory is only found in the
production department. It is against this background that all people in the organisation need to
know inventory in their departments and understand that its control is critical.

The overall objective of inventory control is to maintain stock levels so that the combined costs
are at a minimum.

7.2 Reasons for holding stocks

There are many reasons why organisations hold stock. These are varied and can be summarised
as follows.
a) To meet anticipated demand without experiencing a stock out.
b) To absorb variations in demand and production
c) To provide a buffer between production processes
d) To take advantage of bulk purchasing discounts
e) To meet possible shortages in the future
f) To absorb seasonal fluctuations in usage or demand
g) To enable production processes to flow smoothly and efficiently
h) As a necessary part of the production process eg. The maturing of whiskey
i) As a deliberate investment policy particularly in times of inflation or possible shortage.

The above are the logical ones based on deliberate decision. However, stocks accumulate for
other, less praiseworthy reasons, typical of which are the following;
a) Obsolete items are retained in stock
b) Poor or non-existent inventory control resulting in over-large orders, replenishment
orders being out of phase with production
c) Inadequate or non-existent stock records
d) Poor liaison between Production control, Purchasing and Marketing departments
e) Sub-optimal decision making, e.g the Production Department might increase WIP stocks
unduly so as to ensure long production runs.

All the above reasons may be important. The overall objective of Inventory control is to maintain
stock levels so that the combined costs are at a minimum.

52
Which of these is most important will depend on the type of business.

In deciding a stock control system, the fundamental choice is between having large orders
delivered infrequently or having small orders at frequent intervals. The factors in favour of these
respective possibilities are set out in the Table 7-16below.

Table 7-16

Factors in favour of large orders Factors in favour of small orders made

made infrequently frequently
 Economy of purchasing  Less cash tied up in stock
 Security of supply in cases of  Less space needed
delivery difficulty  Lower insurance costs
 Flexibility of production  Less chance of deterioration of
 Immediate availability of goods material
for sale  Less risk of obsolescence
 Ability to gain from price
increases.

7.3 Costs associated with Stock

Stocks represent an investment by an organisation. As with any other investment, the costs of
holding stock must be related to the benefits to be gained.

There are four categories of these costs.

1. Costs of holding stock

2. Cost of obtaining stock
3. Stockout costs
4. Cost of stock itself

7.3.1 Costs of Holding stock

These are the costs that are incurred in holding the stock and they include the following.
(i) Interest on capital invested in stock
(ii) Storage charges
a. Renting space
b. Lighting
c. Refrigeration for perishables
d. Air conditioning
(iii) Stores staffing, equipment maintenance and running costs.
(iv) Stock handling costs
(v) Auditing, stocktaking
(vi) Insurance, security

53
 (vii) Deterioration and obsolescence
(viii) Pilferage

7.3.2 Costs of obtaining stock.

These are costs associated with ordering or procuring the stock and they include the following.
(i) Clerical and administrative costs associated with the Purchasing, accounting and
Goods received departments.
(ii) Transportation costs
(iii) Set up and tooling costs for internally manufactured goods.

7.3.3 Stock out costs

These are the costs associated with running out of stock. The avoidance of these costs is the basic
reason why stocks are held in the first instance. Clearly costs under this category are difficult to
quantify, but they are often significant.
(i) Lost contribution through the lost sale caused by the stock out.
(ii) Loss of future sales because customers go elsewhere
(iii) Loss of customer goodwill.
(iv) Cost of production stoppages caused by stock outs of WIP or raw materials.
(v) Labour frustration over stoppages,
(vi) Extra costs associated with urgent, often small quantity, replenishment purchases.

7.3.4 Costs of Stock

These are the buying in prices or the direct costs of production. These costs need to be
considered when:-
(i) Discounts are available for bulk purchases
(ii) Savings in production costs are possible with longer batch runs.

7.4 Types of Control System

An inventory system provides the organizational structure and the operating policies for
maintaining and controlling goods to be stocked. The system is responsible for ordering and
receipt of goods: timing the order placement and keeping track of what has been ordered, how
much, and from whom.

There are two main inventory control systems and these are the Re-order level and the Periodic
Review system.

7.4.1 Re-order level system

It is also known as the two bin system and has the following characteristics.
(i) A predetermined re-order level is set for each item.
(ii) When the stock level falls to the re order level, a replenishment order is issued
(iii) The replenishment order quantity is invariably the EOQ.
(iv) The name “two bin system” comes from the simplest method of operating whereby
the stock is segregated into two bins. Stock is initially drawn from the first bin and a
replenishment order issued when it becomes empty.

54
7.4.2 Periodic Review
This system is sometimes called the constant cycle system and has the following
characteristics.
(i) Stock levels for all parts are reviewed at fixed intervals eg every fortnight.
(ii) Where necessary a replenishment order is placed.
(iii) The quantity of the replenishment order is not a previously calculated EOQ, but is
based upon; the likely demand until the next review, the present stock level and the
lead time.
(iv) The replenishment order quantity seeks to bring stocks up to a predetermined level.
(v) The effect of the system is to order variable quantities at fixed intervals as compared
with the re-order level system, where fixed quantities are ordered at variable intervals.

7.4.3 Hybrid systems

The two basic inventory control systems have been explained above but many variations
exist in practice. A company can develop a system to suit their organisation which contains
elements of both systems. In stable conditions of constant demand, lead times, and costs,
both basic approaches are likely to be equally effective.

7.5 The Simple Stock Control Model

It will be clear in real life that controlling stock is a complex matter and we will not be able to
take into account all the possible factors. What we will begin with is a simple model that has
assumptions in order to facilitate the understanding of stock control situations.

The simple stock control model is based on the following assumptions.

(i) Demand rate is constant
(ii) There is zero lead time on orders
(iii) The stockist does not choose to spend any non-zero time out of stock.
(iv) No discounts are available for large orders
(v) Orders arrive instantaneously and not gradually.
(vi) The variable overhead cost for each delivery is the same.
(vii) The cost of holding stock is constant (either in monetary terms or as a proportion of
item value)
(viii) No Discounted Cash Flow (DCF) considerations are applied to any costs.

These assumptions are rather simplistic and unlikely to be met in practice but the model is none
the less very useful.

55
 Stock Terminology
Average
Slopes indicate
Anticipated rates
Of demand
Stock Level

Maximum
EOQ

Safety Stock

Time

7.5.1 Derivation of the EOQ Formula

Let the delivery cost for each order be c

Let the demand rate (constant) be d items per year
Let the cost of holding stock for a year be proportion I of stock value.
Let the value of each item be p.
NB: The cost of holding one item for one year is ip.

We need altogether d items per year. Let there be Q in each delivery.

d
Then the number of deliveries needed is Q
cd
Each delivery costs c so the total delivery cost per year is Q
Q
Average stock level through the year is 2
pQ
Each item is worth p so the average value of stock through the year is 2
ipQ
Hence the annual stock holding cost is 2

56
The relationship between these costs and the batch size, Q, is shown in the graph below.

Total Cost
Cost

Stock Holding cost

Min
Cost

Delivery costs

EOQ Q

NB: the inclusion of any fixed costs (not depending on Q) would merely move the whole cost
curve upwards and would not affect the Q value at the minimum point.

Total Cost = Stock Holding cost + Delivery costs

cd ipQ
y= +
Given by : Q 2

Using Calculus, minimisation at the EOQ would give:

dy cd ip
=− +
dQ Q2 2

dy ip cd
=0 = 2
Then dQ Gives 2 Q

So
Q2 =
2cd
ip and we have
Q=
2 cd
ip √
Therefore the Economic Order Quantity (EOQ) is
Q=
√ 2 cd
ip

57
It is possible, and more usual, to calculate the EOQ using the above formula. The formula
method gives an exact answer, but do not be misled into placing undue reliance upon the precise
figure. The calculation is based on estimates of costs, demands, etc which are, of course subject
to error.

58
8 Tutorials

8.1 Network Analysis

Question 1
The Bulawayo City council intends to carry out a capital project using direct labour. Table 1 below shows
for each activity needed to complete the project the normal time, the shortest time in which the activity
can be completed and the cost per day for reducing the time of each activity. The cost of reduction
remains the same per day irrespective of the number of days involved.

Activity Normal Time (Days) Shortest Time (Days) Cost of reduction

per day
1-2 6 4 80
1-3 8 4 90
1-4 5 3 30
2-4 3 3 -
2-5 5 3 40
3-6 12 8 200
4-6 8 5 50
5-6 6 6 -

The cost of completing the eight activities in normal time is 5 800, excluding site overhead. The overhead
cost of general site activities is 160 per day.

You are required to :

1.) Calculate the normal duration of the project, its cost and the critical path;
2.) Calculate and plot on a graph the cost/time function for the project and state
(a) the lowest cost and associated time.
(b) The shortest time and the associated cost.

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Question 2

You are the Production Manager at TS Machines LTD. You have been asked to present information about
the times and costs for the development of a new machine that the company may choose to manufacture.
The Managing Director requires accurate time and cost estimates since the project will involve a fixed-fee
contract offering no provisions for later renegotiation, even in the event of modifications.

Activity Preceding Duration(weeks) Cost ($)

activities
A Obtain engineering quotes I 1 4
B Sub-contract specifications A, J 4 8
C Purchase raw materials - 3 24
D Construct prototype I 5 15
E Final drawings I 2 6
F Fabrication H 6 30
G Special machine study - 4 12
H Sub-contract work B, E 8 40
I Preliminary design G 2 8
J Vendor evaluation C, D 3 3

You have been asked to identify the critical activities, to determine the shortest possible project duration
and to provide a week by week cost schedule.

Required :
(a) Draw a network to represent the inter-relationships between the activities indicated, and insert
earliest and latest event times throughout.
(b) Determine the critical path and the shortest possible duration of the project.
(c) Assuming each activity commences at the earliest start date, and that for each activity the cost is
incurred evenly over its duration, construct a week by week schedule of cash flows.
The project is to be financed by Z$50m available initially, a further Z$50m available at the start of
week 9 and the final Z$50m available from week 20.
Identify any particular problems and suggest solutions.

Question 3

Project Manpower requirements

Table below shows the durations of the various activities involved in a certain project, and the logical
relationships between those activities.

Table :

Activity A B C D E F G H I J
Duration(days) 9 10 4 10 5 9 7 8 7 8
Preceding - - B A A A E D C, F G, H, I
activity

(a) Draw the network and determine the activities on the critical path
(b) If the number of men used each day on each activity is as follows :

60
 A B C D E F G H I J
7 3 6 5 7 6 6 5 7 8

(i) assuming that each activity begins as soon as possible, draw a bar chart showing the combination of
activities in progress at each stage of the project

(ii) a graph showing the number of men used each day over the life of the project. State what is the
maximum manpower requirement during the project and indicate a way of reducing this peak by
rescheduling the starts of some activities. What is the total number of man days in the project?

Solutions to tutorial questions.

Solution to Question 1

Network

3
12
8
1 5
4 8 6
6
3 6

2 5 5

The normal duration of the project is seen to be 20 days

Critical path is 1-3 and 3-6.

Cost of completing this in normal time is 5 800 + 20x160 = 9 000

Of the two critical activities the cheaper to speed up is 1-3 at 90 per day. Saving 3 days on 1-3 reduces the
total project time to 17days.

New total cost = Original cost – Overhead for 3 days + 3 day’s saving on 1-3

= 9 000 – 3x160 +3x90 = 8 790

All activities are now critical except 1-4 on which the float has been reduced to 4 days. This has happened
because the total time available to get from node 1 to 6 on all paths has been reduced by 3 days.

For dealing with such problems, it is important that you keep track of what is happening with the float as
this information is very critical.

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Redrawing the network yield the following.

3
12
5
1 5
4 8 6
6
3 6

2 5 5

By considering the network above, we see that there is no need in just saving the one remaining day
available on 1-3. This will not reduce the total project time below 17 days, and thereby save any money,
because paths 1-2-4-6 and 1-2-5-6 will both still require 17 days. In order to achieve any further saving it
is necessary to reduce the time along all critical paths simultaneously.

The cheapest way this can be done in an example is to save one day on 1-3 and 1-2 simultaneously. This
is adequate because 1-2 is part of the two critical paths and so saving on these two activities reduces all
three critical paths. The total time for the project is reduced to 16 days. The cost of this saving is 90 +80 =
170.

Since this is the cheapest saving that can be made and it costs more than the 160 overhead saved, we see
that 17 days at 8 790 is the minimum cost completion. All further time savings made in this case will
increase total cost. New total cost = 8790 – 160 + 170 = 8 800.

All activities are critical except 1-4, on which the float has been reduced to 3 days. Activity 1-3 is now
reduced to its minimum duration of 4 days so any further time reductions must involve 3-6 in order to
shorten the time on the critical path 1-3-6. Activity 1-2 still has one day that can be saved, so the cheapest
reduction is using 3-6 and 1-2, which reduces total time to 15 days. The cost saving is 200+80 = 280. So
the new total cost = 8800 – 160 + 280 = 8920.

All the activities are critical except 1-4, on which the float has been reduced to 2 days. Activity 1-2 is
now reduced to its minimum time and no reductions at all are possible on 2-4 and 5-6. Hence the only
remaining combination of activities which can be reduced is 3-6 with 4-6 and 2-5. It is possible to save
two days on this combination before 2-5 is reduced to its minimum time of 3 days. This reduces the total
time to 13 days.
The cost of this saving is = 2x(200+50+40) = 580

So the new total cost is

8920 – 2 x 160 + 580 = 9180

All the activities are now critical.

This time of 13 days, with associated cost of 9180 is the minimum time completion of the project because
no further time reduction is possible on the critical path 1-2-5-6

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For the cost/time graph we summarise the costs and durations of the project normally and after the
various time reductions described.
Cost Duration(days)
9000 20
8790 17
8800 16
8920 15
9180 13

THEN PLOT THE GRAPH.

In some instances the primary interest when completing a project is to get it done in the least possible
time even if this does not mean the least possible cost. EG. If the equipment being used for the project
were urgently needed for profitable work elsewhere. Many other examples can be thought of.

Solution to Question 2.

(a) The network

J
3

B
C 4
3 A
D 1 H F
5 8 6

G E
4 I 2
2

(b). Critical path GIDJBHF

Duration 32 weeks

(c). The start and finish times for each activity (assuming each starts at the EST) are :

Activity Start Finish Cost/week

A 6 7 4
B 14 18 2
C 0 3 8
D 6 11 3
E 6 8 3
F 26 32 5
G 0 4 3
H 18 26 5
I 4 6 4
j 11 14 1

63
A week by week schedule is provided by :

Time Activities Cost /

week
0-3 C, G 11
3-4 G 3
4-6 I 4
6-7 D, A, E 10
7-8 D, E 6
8-11 D 3
11-14 J 1
14-18 B 2
18-26 H 5
26-32 F 5

The cash outflows, week by week, are shown below.

Wee 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
k
Cost 11 11 11 3 4 4 10 6 3 3 3 1 1 1 2 2

Wee 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32
k
Cost 2 2 5 5 5 5 5 5 5 5 5 5 5 5 5 5
The cash outflow in the first eight weeks amounts to 60 000 which is more than the 50 000 available for
these weeks; that is, the budget would have been exceeded in week 7. However, it is possible to defer
activities A and E until week 9 without prolonging the overall project duration. The final 50 000 available
in week 20 is in time for all subsequent cash outflows.

8.2 Inventory Control

Question 1

The simple stock control model leads to the formula

Q=
√ 2 cd
ip for the optimum batch size.
This model includes among its assumptions that no stock-outs are permitted. In many situations
it is possible to accumulate orders received, when there is no inventory to satisfy them, and
deliver the accumulated orders immediately the product is received from the supplier. There may
be a variety of costs associated with this situation and in the following calculations you should
assume that these costs are equal to £2.
Other data, from which you should select those which are relevant includes: annual uniform
demand 24 000 units per annum; the cost of placing an order is £20, of receiving, inspecting and
checking a delivery is £70, the cost of carrying stock is £3 per unit per annum; lead time is 1/24 th
of a year, interest paid by the company, on average, for funds employed is 12% per annum, and
the cost of extra storage facilities would be £500 per annum.

64
You are required to :
(a) Calculate the Economic Batch Quantity (EBQ) and the reorder point if no stock outs are
permitted. (10)
(b) Calculate the EBQ and reorder point when stock-outs are permitted. (10)

Question 2

The forecast annual demand for a particular product sold by a retail store is 600 units; the cost is
$60 per unit. The cost of ordering and receiving delivery is $15 on each occasion. Stockholding
costs are 20% per annum of stock value.

You are required to:

(a) Derive the basic economic batch quantity (EBQ) formula defining any symbols used
and stating clearly the assumptions you have made.
(b) Calculate the optimum order quantity if there is to be instantaneous delivery of an
order.
(c) Explain how the various stock related costs balance up to be economic.

65
9 Bibliography

Beasley, J., n.d. Operations Research. [Online]

Available at: http://people.brunel.ac.uk

Heizer, J., Render, B., Neufeld, J. & Forman, E., 1996. Production and Operations
Management : Customised Edition for The George Washington University. 4th ed. New Jersey:
Simon & Schuster Company.

Jacobs, R. & Chase, R., 2008. Operations and Supply Chain Management: The Core. New York:
McGraw-Hill Irwin.

Lucey, T., 1982. Quantitative Techniques. Hampshire: DP Publications.

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