Topic 5 – Operations Management

Production Planning

Learning Objectives

To understand why businesses hold stocks and the costs of stock holding

Analyse the advantages and disadvantages of traditional stock-control systems

Discuss and compare the just-in-case approach and just-in-time (JIT) stock management system

Stock / Inventory

• Materials and goods required to allow for the production of and supply of products to the customer

• All businesses hold stock of some kind• Manufacturing businesses will hold stocks in three

distinct forms– Raw materials and components – held until they are used

in the production process– Work in progress– Finished goods – held until despatched to customers

Stock holding costs

• Three costs associated with stock holding1. Opportunity cost – the working capital which is

tied up in stocks could be put to a better alternative use

2. Storage costs3. Risk of wastage and obsolescence – Is stock is

held for too long there is a risk of goods deteriorating or becoming outdated

Costs of NOT holding stocks

• There are risks of holding very low stock levels• Often called ‘stock-out’ costs

1. Lost sales – unable to supply customers from stock2. Idle production resources – If stocks of raw materials

and components run out, production will have to stop

3. Special orders could be expensive – urgent order given to a supplier – extra costs may be incurred

4. Small order quantities – missing out on economies of scale

Optimum stock level

0Quantity of stock held

Cost

s ($

)

Total costs

Optimum

Stock holding costs

Out of stocks costs

Optimum order size

• Managers may be tempted to order huge quantities of stock in order to gain EoS and to ensure they don’t run out

• But holding too much stock can cause problems too– Out of date stock Economic order quantity

The optimum or least-cost quantity of stock to re-

order taking into account delivery costs and stock

holding costs

Controlling stock levels – a graphical approach

Terms to know• Buffering stocks – minimum stock to hold so production can

continue to take place (higher with reorder uncertainty)• Re-order quantity – number ordered each time• Lead time – normal time between order and delivery• Re-order stock level – level that triggers a new order to be sent to

the supplier

‘perfect world situation’

‘real world situation’

Shipment delayed

Holiday sale Holiday sale

Just-in-time Just-in-caseAvoid holding stock by Holding high stock levelsrequiring stock arrive “just-in-case” there is a just as they are needed production problem,in production & completed unexpected rise in demand,products are produced to or delivery problemorder

STOCK MANAGEMENT SYSTEMS

Just-in-Case

Important JIT factors:• Excellent supplier relationship so supplier can work quickly to fulfill

order• Multi-skilled production staff that can switch jobs on short notice• Flexible set up of equipment and machinery (usually expensive,

computer-controlled machinery)• Accurate demand forecasting• Latest IT equipment allows for more success (data base)• Excellent employer-employee relations to avoid production break• Quality of utmost importance (no time for mistakes)

JIT is not suitable for all firms:• Not good if cost of production stoppage from when supplies

don’t arrive far exceed the costs of holding buffer stock of key components

• IT systems needed may be too expensive for small firms• Rising global inflation makes holding extra stock more

beneficial, but storage may be difficult. (less delivery charge, less chance of raw material price increasing, more storage space)

Just in Time