COURSE MANUAL

C4: Operations Management

MCP1604
Module 2

The Open University of Sri-Lanka

Faculty of Humanities and Social Sciences
Department of management Studies
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© Commonwealth of Learning, 2011

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without prior permission in writing from:

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The Open University of Sri Lanka

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Department of Management Studies
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Acknowledgements
The Commonwealth of Learning (COL) wishes to thank those below for their contribution to
the development of this course:

Course author David Gardiner

Gardiner Consulting Group
Operations Management Consultants
Christchurch, New Zealand

Course content specialist: Olga Kaminer, PhD

Professor, Supply Chain/Logistics/Operations Management
Faculty of Business
Sheridan Institute of Technology and Advanced Learning,
Canada

Subject matter experts: Fook Suan Chong

Wawasan Open University, Malaysia

Maurice Fletcher
University College of the Caribbean, Jamaica

ArabaIntsiful
Kwame Nkrumah University of Science and Technology,
Ghana

S. A. D. Senanayake
Open University of Sri Lanka, Sri Lanka

Educational designers: Symbiont Ltd.

Paraparaumu, New Zealand

Course editor: Symbiont Ltd.

Paraparaumu, New Zealand

Course formatting: Kathryn Romanow

Commonwealth of Learning

COL would also like to thank the many other people who have contributed to the writing of
this course.
 Contents

Contents
Module 2 1
Balancing supply with demand..........................................................................................1
Unit 3
Demand management and forecasting...............................................................................2
Activity 2.1......................................................................................................................10
Activity 2.2......................................................................................................................11
Activity 2.3......................................................................................................................13
Activity 2.4......................................................................................................................15
Activity 2.5......................................................................................................................15
Activity 2.6......................................................................................................................16
Activity 2.7......................................................................................................................17
Activity 2.8......................................................................................................................18
Activity 2.9......................................................................................................................20
Activity 2.10....................................................................................................................21
Unit summary 22
Readings for further study 23
Unit 4
Capacity planning and management................................................................................24
Activity 2.11....................................................................................................................35
Activity 2.12....................................................................................................................41
Activity 2.13....................................................................................................................42
Unit summary 42
Assignment......................................................................................................................43
References 45
Further Readings 45
Activity feedback.............................................................................................................46
Module 2
Balancing supply with demand
Introduction
This module examines at a strategic level, the balancing of demand
with supply. An economist would argue that prices adjust to
balance supply with demand. This is great in theory, but the
operations manager gains no comfort from this statement. Excess
demand means lost revenue and excess supply means wasted
resources. The balancing of supply with demand in the real world is
very difficult. If organisations can (somehow) get it right, then they
should be very effective and very successful.
Upon completion of this module you will be able to:
 Explain the nature of demand.
 Understand the strategic role of forecasting.
 Distinguish between qualitative and quantitative forecasting
and perform basic quantitative calculations.
Outcomes  Outline how capacity is measured and appreciate the
dilemma faced by management in matching variable
demand with variable capacity.
 Calculate various aggregate planning scenarios.
 Identify various strategies for balancing supply with
demand.
 Evaluate the application of yield management.
 Evaluate queues and waiting lines.

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Unit 3
Demand management and
forecasting
Introduction
Operations managers spend money on the inputs to the
transformation process. These inputs may be raw materials, human
resources, buildings, machines, processes, energy and operating
supplies, to name a few. A major decision is what to buy, but
equally important decisions include when to buy and how much to
buy. To answer these questions we need to know, with some level
of accuracy, how much output from the transformation process we
will need. That is where forecasting and demand management enter
the picture.
Operations management personnel use forecasts to make decisions
about process selection, capacity planning, facility layout,
production planning, scheduling and inventory. Forecasting is
essential in operations management.
One thing we can be reasonably certain about is that any forecast is
most likely to be different from what eventually happens. Many
managers are discouraged from making forecasts simply because
they know they will be “wrong”. The essence is to somehow agree
on a set of numbers and plan around those numbers and to develop
a contingency plan in case the real numbers are too high or too low.
This unit starts by defining demand management and distinguishing
between short-range, medium-range and long-range forecasting.
This leads to a discussion on the strategic role of forecasting and
the differences between dependent and independent demand.
We perform some forecasting deviation calculations and interpret
the answers. This is followed by some more calculations in
quantitative forecasting. The intention is to show the types of
calculations that can be performed and therefore the mathematics is
quite basic.
We decompose a time series into components so we can understand
where the data is coming from and this places us in a better
position to determine future data. One of the demand components
is seasonality, so we develop the seasonality index and perform
detailed calculations using seasonal indices and regression analysis.
We conclude with a discussion on alternative approaches to
forecasting.

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 Upon completion of this unit you will be able to:
 Define demand management.
 Explain the nature of demand.
 Understand the strategic role of forecasting.
 Distinguish between qualitative and quantitative
Outcomes forecasting.
 Explain forecast accuracy.
 Define forecast value added.
 Perform basic quantitative calculations on forecasting.
 Define and calculate seasonal indices.
 Use regression analysis to develop long-term trends.
 Discuss other approaches to forecasting.

Cyclical A component of demand that occurs in a cycle

component greater than one year. Examples of cycles
include economic, political and/or business.
Terminology
Decomposition A method of forecasting where the time series
data is split into components of demand
(trend, seasonal and cyclical). Trend measures
the general upwards or downwards direction,
seasonal indicates the effect of different
seasons and cyclical shows the effect of a
longer repeating non-seasonal period cycle.
Each separate component is projected into the
future and the sum of the projections becomes
the new forecast.

Delphi method A qualitative forecasting method that uses a

group of experts to arrive at a consensus about
the future.

Demand A need for a particular product or service. At

the finished-goods level demand may not
equate to sales. Demand is what the customer
wants, while sales represent the ability to
deliver. In demand forecasting there are four
components of demand:trend, seasonal,
cyclical and random.

Dependent The demand for all lower-level items

demand calculated from the product structure of the
end item. Dependent demand should be
calculated and not forecast.

Forecast An estimate of future demand. A forecast can

be constructed using quantitative methods,

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 qualitative methods or a combination of both.
The four components of demand are: trend,
seasonal, cyclical and random.

Forecast The difference between the actual (eventual)

deviation demand and the forecast value.

Independent The demand for an item that is unrelated to the

demand demand for other items. Examples include
demand for finished items and spare parts.

Random Random component in demand forecasting has

component no predictable pattern. For example, sales data
may vary around a forecast value with no
specific pattern forming and no way of more
accurately determining the actual demand
other than by the forecast.

Seasonal A component of demand describing the

component variation that occurs because of the time of
year, month or week. A seasonal component
generally repeats itself at least once a year
whereas a cyclical component usually takes
longer than one year.

Seasonal index A number used to adjust data to seasonal

demand.

Trend A component of demand showing an increase

component or decrease of demand over time.
Terminology sourced from Gardiner (2010).

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What is demand management?
Demand is the need for a particular product or service. When
customers need a product or service they approach their supplier
and demand sufficient quantity of that product or service to satisfy
their demand.
Without a need to satisfy demand, firms and organisations have
little reason to exist. Production firms make tangible products that
can be consumed by customers and service firms deliver services
that are experienced by customers. It is up to the organisation to
decide how much of that demand they will deliver.
It is a strategic decision for organisations to decide how much of
that demand they want to supply. When a production firm stores
products in a warehouse, they are anticipating future demand.
When a service organisation occupies a facility and employs and
trains staff, they are anticipating future demand.
Demand occurs at all stages in a supply chain and at all stages in a
service chain. Raw materials are demanded by the manufacturer,
fabricated and component parts are demanded by the assembler,
finished products are demanded by the wholesaler/distributor,
finished products are also demanded by the retail customer, and
services are demanded at all stages of the supply chain as well as
the service chain.
Predicting the future is an art as well as a science. It does not really
matter how specific firms and organisations arrive at their forecast.
What does matter, however, is exactly what the organisation does
with the forecast. The predictions are useful for organisations
before they make decisions which may give them a competitive
advantage in the market place.
A forecast is an estimate of future demand and it can be developed
using quantitative methods, qualitative methods or a combination
of both. The forecasting process is the business process that
attempts to predict demand for products and services so that
capacity, resources and materials are available in time to meet the
need.
It will cost money to buy capacity; it will cost money to occupy a
facility; it will cost money to buy raw materials and components; it
will cost money to train and educate employees to perform
production and service activities; and it will cost money to deliver
products and services to customers.
Depending on how much money is spent and when it is spent will
determine how well, or how poorly, the organisation is able to
satisfy customer demand. If the organisation spends the right
amount of money, the organisation will satisfy customer demand at

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 the minimum cost. If the organisation spends too much, the
organisation may find it has under-utilised resources.

Short-, medium- and long-range forecasting

Demand forecasting operates within three time horizons, short-,
medium- and long-range.
Long-range forecasting
Long-range forecasting generally covers the period required to
replace major resources. These forecasts are strategic in nature and
cover applications such as facility and capacity planning,
technology and design planning, research and development, and
process planning.
Forecasting is aggregated into total groups of similar products and
should indicate trends and resource imbalances. So a steel producer
might forecast tonnes of output per year, an airline might forecast
the number of passengers and tonnes of freight per route per month
and an electricity producer might forecast megawatt hours (MW.h
= 106 watt hours) of electricity per month.
Forecast data for long-range forecasting should be bracketed in
months, quarters or even years. If you were planning the electricity
generation requirements for a significant region you might examine
closely the peak seasons for the next 10 or 20 years. Daily
requirements would not be important, but possible daily peak loads
would be important. The actual day that the peak load will occur
will not be considered, but the year that the new peak level is
achieved would be important.
The forecasts at this level need to be in the “ballpark”. In other
words, absolute accuracy is not relevant as long as it is relatively
close and clearly provides the trend data and resource requirements
that will be required.
Medium-range forecasting
Medium-range forecasting applications include sales planning,
operations planning, budgeting, yield management and aggregate
staffing plans.
Medium-range forecasting models use some aggregation. A
hospital, might group all patients into the type of care they are to
receive, for example: maternity, paediatric, psychiatric, elective
surgery or accident and emergency.
The level of detail is greater than with long-range forecasting and
the required accuracy is also greater. An organisation planning in
this time frame usually will not have the capability of acquiring
additional resources in time to meet any significant changes in
demand. This should have been highlighted in the long-term plans.

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 Peak periods such as holidays, special events and changes in shift
capacity will, however, need to be considered.
Short-range forecasting
Short-range forecasting usually involves detailed planning and
scheduling for purchasing, job scheduling and staffing rosters as
well as production allocations.
Planners and operators working with short-range data will be
endeavouring to resolve short-term demand and capacity issues.
These issues will be current and have to be resolved immediately.
Planning is performed by named personnel for individual tasks at
specific times on given days. This can become very detailed and
this level of detail is required to make the tactical decisions of the
organisation.

Strategic role of forecasting

Forecasting demand for some products is more difficult than
forecasting the demand for others. New products do not have
established patterns of demand; fashion items are influenced by
intangible forces such as perceived desirability; and commodity
products are sold on a regular basis. This, however, does not make
forecasting any less worthwhile.
One thing certain about forecasting is that it will almost always be
wrong. It may deviate from actual performance by only a small
margin, but it will be different. This is enough to put some
organisations off the concept of forecasting. They wonder why they
should put valuable resources into an activity that is always wrong.
In a strategic sense, each organisation should understand the
dynamics of the demand patterns and be prepared for whatever
happens. Sudden demand changes may occur because of external
factors such as natural disasters, terrorist activities, weather
patterns, major events and accidents. Gradual changes may occur
as a result of social, demographic, political, legal and
environmental change.
Some of these changes can be expected and some are unexpected.
One could argue that the unexpected should, in fact, be expected
and that it is the magnitude and timing of the occurrence that is in
doubt. Organisations should be prepared for whatever happens to
their demand patterns. This does not mean that they should be able
to react satisfactorily to all changes in demand. They may, for
instance, elect as a matter of policy not to service demand. They
may have in their planning a statement suggesting that should
demand exceed a certain value then they will choose to reject it and
not attempt to satisfy it. This is not a statement that says that all
demand must be satisfied. Rather, it is a statement that says that the

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 firm can handle certain deviations from expected demand but only
up to a limit, at which point the excess is unsatisfied.
Organisations should consider the consequences of the forecast
being too optimistic or too pessimistic. What would happen to the
business if the forecast figures were not achieved? Or the forecast
figures were exceeded? What are the choices of action?

Reflection 1
Excluding the changing behaviours demonstrated by the customer,
what factors would influence demand?

Reflection

Activity feedback can be found at the end of this module.

Dependent and independent demand

Dependent demand is the demand for all lower-level items
calculated from the product structure of the end item. Dependent
demand should be calculated and not forecast. Independent demand
is the demand for an item that is unrelated to the demand for other
items. Examples include demand for finished items and spare parts.
Demand forecasting processes should be applied to independent
demand items and groups of independent demand items. Most
products and services sold exhibit independent demand as these can
be sold independently of all other sales. Occasionally, an item is
sold in association with another item. For example, bread and
butter, socks and shoes, motor vehicles and petrol, fish and chips,
and paint and a paint brush. The demand for these types of items is
still considered to be independent since the quantity of each is not
directly related to the other item in the pairing.
Dependent demand relates to the component items of a product
structure where the component items are in relatively fixed
quantities of the parent item. For example, the meat and vegetables
of a restaurant meal, the purchased and fabricated items of a
refrigerator and the quantity of steel and concrete in a building.
Dependent demand should be calculated by multiplying the
quantity per parent by the number of parent items being demanded.

Forecast deviation calculations

Forecast deviation is the difference between the actual (eventual)
demand and the forecast value. Organisations use the output of
forecasting for spending decisions. It must be obvious that if the
actualdemand differs from the forecast values then spending will
not be at the optimum level. A forecast deviation would suggest the
firm is about to either spend too much and have excess products

8
 and capacity available, or not spend enough and be unable to
satisfy demand for its products and services.
Most organisations plan their supply chains assuming forecasts will
actually happen. They start with this assumption and express regret,
or blame market conditions, when they end up with product
shortages or surpluses. Instead, they should start with a range that
represents the likely upper and lower bounds and plan the demand
and supply risk of those limits.
While it is not necessary (or even practical in all cases) for the
forecast to be 100 per cent accurate, it would benefit the whole
forecasting process if the reasons for the variation were understood
and if a learning process took place. This allows the forecasting
process to improve and, in turn, allows the organisation to aim for
the optimum expenditure of resources.

Reflection 2
Think of three or four reasons why a forecast value would be
inaccurate.

Reflection

Activity feedback can be found at the end of this module.

There are two types of forecast deviation, bias and random. Bias
deviations occur when a consistent mistake such as always too high
or always too low is made. Random deviations simply cannot be
explained; they just happen and are sometimes referred to as
“noise”.
We can measure forecast deviation in various ways. Most
measurements examine the difference between the actual demand
and the forecast value. Sometimes we look at the algebraic
difference which allows for high values to cancel out low values
with a net summation of close to zero. It is possible to have wildly
fluctuating forecast values and still conclude that a good forecast
model is being used.
An absolute difference allows the magnitude of the over- or under-
forecast to be measured. Whether the forecast value is over or
under does not matter; the absolute measurement examines the
relative distance of the actual demand from the forecast value.
The algebraic deviation and the absolute deviation are very popular
measurements but the significance of the deviation relative to the
actual observation quantity is required. A deviation of 50 when
forecasting demand in hundreds is significantly different from a
deviation of 50 when forecasting demand in millions.

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 Mean absolute deviation (MAD)
The mean absolute deviation (MAD) measures the absolute
dispersion of the deviation. It is calculated as the mean of the sum
of the absolute differences between the actual demand values and
the forecast values. An absolute value does not have any sign. If the
difference is negative, it is written just as a number; similarly, if it
is positive it is written just as a number. The mean absolute
deviation measures the average distance of demand values from
forecast values. The formula for mean absolute deviation (MAD)
is:
mean absolute deviation

MAD=
∑|D−F|
n
where D is the actual demand value for each period
F is the forecast value for each period
n is the number of periods or observations

Activity 2.1
Use the data in the following table to calculate mean absolute
deviation MAD.

Activity

Demand Forecast Deviation

Month
D F (D-F)

Jan 500 550 -50

Feb 550 600 -50
Activity feedback can be found at the end of this module.

Bias
Bias indicates whether a method of forecasting tends to favour a
higher or lower value. It is calculated as the sum of the algebraic

10
 differences between the actual demandvalues and the forecast
values divided by the sum of the demand values. Thus, the pluses
may offset the minuses. It is a useful measure especially when
expressed as a percentage of actual demand.
The formula for bias is:

bias=
∑ ( D−F ) x 100
∑D
where D is the actual demand for each period
Activity 2.2 F is the forecast for each period

Use the data in the following table to calculate bias.

Activity
Demand Forecast Deviation
Month
D F (D-F)

Jan 500 550 -50

Feb 550 600 -50
Activity feedback can be found at the end of this module.

Mean absolute percentage deviation (MAPD)

Mean absolute percentage deviation (MAPD) is the mean of the
absolute deviation between actual demand value and forecast value
divided by the mean of the demand values expressed as a
percentage. This is similar to mean absolute deviation (MAD) but
considers the significance by dividing by mean demand.
The MAPD is described as a mean value but the formula does not
divide by the number of observations. This is simply because n, the
number of observations, is the divisor for both numerator and
denominator and cancels itself out. The formula could be written as
mean absolute deviation divided by mean demand.
The formula for mean absolute percentage deviation MAPD is:

mean absolute percentage deviation

MAPD=
∑|D-F|x 100
∑D 11
where D is the actual demand value for each period
F is the forecast value for each period
 Mean absolute percentage variation (MAPV)
Mean absolute percentage variation (MAPV) is the average of the
absolute deviation between actual demand value and mean demand
value divided by the mean demand expressed as a percentage. The
MAPV is described as a mean value, but the formula in total does
not divide by n, the number of observations. This is simply because
n, the number of observations, is the divisor for both numerator and
denominator and cancels itself out. MAPV measures the variability
in the demand.
The formula for mean absolute percentage variation (MAPV) is:
mean absolute percentage variation

∑|D−∑
D
|x 100
n
MAPV=
∑D
where D is the actual demand value for each period
n is the number of periods or observations
Mean absolute percentage deviation (MAPV), on its own, is not
strictly a forecasting measure. The usefulness of MAPV comes
when comparing the forecast deviation with the volatility of the
actual demand. A dynamic demand pattern is considerably more
difficult to forecast than a stable commodity demand pattern.

Activity 2.3

12
 Use the data in the following table to calculate mean absolute
percentage deviation MAPD and mean absolute percentage
variation MAPV.
Activity

Abs
Demand Forecast
Month deviation
D F
|D-F|

Activity feedback can be found at the end of this module.

Forecast value added

Forecast value added is the change in forecast accuracy due to an
activity in the forecasting process. The forecasting process starts
with demand history. This is usually quite difficult to obtain since
most organisations have sales history but not demand history. The
difference is in the detail of quantities, products and timings. The
customer demands products in certain quantities and certain times,
and the organisation supplies quantities of products at certain times.
The demand may not equal the supply, but it is the supply that is
measured. Supply is the firm’s ability to deliver.
The quantitative forecast is now examined by various functions and
individuals in the organisation for their qualitative inputs. These
functions and individuals may represent sales, marketing, product
development, finance, production and anyone else who can make a
meaningful contribution to the forecast output. Additionally,
executive management would almost certainly want to have some
inputs.
This is where the forecast value added analysis becomes effective.
All the inputs supplied by these functions and individuals are noted
and a consensus forecast is developed by a consensus process.
Power, influence, hierarchy, knowledge, lack of knowledge,
history, experience and politics all play their part in developing the
consensus forecast. Often, in power politics, it is the chief
executive that has the strongest voice, since few employees
reporting below the chief executive actually stand up and argue

13
 strongly against the chief executive. Yet, it could conceivably be
that the inputs from the chief executive are making the forecast
worse.
When actual observations are available they are compared to the
consensus forecast. Ideally, the consensus forecast should mirror
the actual observations. If it does not, and this outcome would
normally be expected, then each of the inputs to the consensus
process is examined to see the effect each input had in modifying
the statistical forecast. In other words, each modification to the
quantitative forecast is noted and analysed to see if it added value
to the forecast or made it worse.
If, for example, the marketing function is able to exert pressure
during the consensus process and this results in a positive
contribution to the consensus, then marketing will assume a
stronger position in the next consensus round. If a function, or an
individual, contributed to the consensus and made it worse, their
inputs will be discounted in future and may even be ignored.

Quantitative forecasting
Quantitative forecasting assumes the history of past data about the
item being forecast can, in some way, be used to predict the future.
Quantitative techniques include time series models such as simple
moving average, weighted moving average, exponential smoothing,
decomposition of a time series and regression analysis.
When using past data one assumes the demand pattern will be
repeated. If it is known that the demand patterns will not be
repeated, then the historical data must be changed. This may occur,
for example, when a supplier is unable to deliver raw materials
resulting in no sales of finished products. In this example, demand
is occurring but the sales are not and most firms record sales (and
not demand). Other examples of when past data becomes unreliable
include changes in legislation and known changes in the
environment.
Firms often struggle with this concept of changing the actual data
to reach a better forecast. They argue that the past data is history
and the forecast should be based on history. The analyst response
should be that it does not matter how the forecast is developed.
What does matter is that the forecasting process is improved.

Simple moving average

The simple moving average forecast is a forecasting method that

adds together the most recent actual observations and divides by
the number of observations.
The formula to calculate the forecast using simple moving average
is:

14
 sum of actual demand values for the chosen number of periods
Ft=
chosen number of periods
D +. .. . ..+Dt−2 +D t−1 ∑ D
F t = t−n =
n n
where F is the forecast
D is the demand value for each period
t is the period number
n is the chosen number of periods
Using simple moving average, the forecast for a period is the
average of the actual demand for the n most recent periods. The
choice for the number of periods, n, is arbitrary and is usually an
odd number of periods such as 3, 5, 7 or 9. Greater numbers of
periods makes the forecast less responsive as this tends to smooth
out any temporary ups and downs in the demand pattern.

Activity 2.4
Calculate the forecast for month six using a three-month simple
moving average given historical demand for months one to five
as follows: 120, 130, 110, 135 and 145.
Activity

Activity feedback can be found at the end of this module.

Activity 2.5
Calculate the forecast for month six using a five-month simple
moving average given historical demand for months one to five
as follows: 120, 130, 110, 13, and 145.
Activity

Activity feedback can be found at the end of this module.

15
 Weighted moving average
The weighted moving average is an averaging technique that
assigns varying weights according to their significance to selected
data values.
The formula for weighted moving average is:

sum of (each period©s demand value xeach period©s weight )

Ft= A
sum of the weights
Dt−n w t−n +.. . ..+Dt−2 w t−2 +Dt−1 w t−1
Ft=
w t−n +.. . ..+wt−2 +w t−1
where F is the forecast
D is the demand value for each period
w is the weight applied to each period
t is the period number
n is the chosen number of periods
weighted moving average allows any weighting (or influence) to be
placed on the demand for each of the n most recent periods. This
method recognises that all periods should not be treated equally.
Assume, for example, that the forecast covers nine months. It might
be unreasonable to allow the same emphasis (weight) to be applied
to the first period (most distant) as is used with the last period
(most recent).
The simple moving average treats all periods equally and applies an
even weighting to each period. Weighted moving average does not
treat all periods equally. The sum of all weights usually adds up to
one.

Activity 2.6
Calculate the forecast for month six using a three-month weighted
moving average given historical demand for months one to five
as follows: 120, 130, 110, 135 and 145. Apply weights of 0.2, 0.3
and 0.5. (In other words, apply weights of 20 per cent, 30 per cent
Activity
and 50 per cent.)

Activity feedback can be found at the end of this module.

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 Exponential smoothing
Exponential smoothing is a time series forecast that adjusts a
previous forecast by a percentage of the forecast deviation. The
method is called exponential because data points are weighted in
accordance with an exponential function of their age.
The formula for exponential smoothing is:

F t = Ft−1 + α ( Dt−1 − F t−1 )

where F is the forecast
D is the demand value for each period
t is the period number
α is the smoothing constant 0<α<1
For this method, only three pieces of data are required — namely
the most recent forecast, the actual demand that occurred for that
period, and a smoothing constant, alpha (). Alpha is given a value
between 0 and 1. This method gives the weight of  to the demand
of the most recent period; (1-) to the demand one time period
older; (1-)2 to the demand two time periods older; and so on.
Thus the method applies exponential weighting such that each
increment in the past is decreased by (1-).
For stable demand, a small alpha is desirable for lessening the
effects of random changes. For increasing or decreasing demand, a
large alpha is desirable. Adaptive smoothing refers to approaches
for controlling the value of alpha.

Activity 2.7
Calculate the forecast for month six using exponential smoothing
given historical demand for months one to five as follows: 120,
130, 110, 135 and 145. Use an alpha factor  equal to 0.2 and you
are given a forecast for month five equal to 130.
Activity

Activity feedback can be found at the end of this module.

Regression analysis
Regression analysis enables us to determine the relationship
between a variable of interest, called a dependent variable, and one
or more independent variables. The equation that describes a
straight line, or linear function, takes the form ŷ = a + bx.

17
 ^y is the best estimate of y=a+bx
n ∑ xy−( ∑ x ∑ y)
b=
n ∑ x 2 −( ∑ x )2

a=
∑ y −b ∑ x
n n
where y is the dependent variable
x is the independent variable
a is a constant where the line on the graph cuts the y -axis (the y intercept )
b is a constant giving the gradient, or slope, of the line

Simple linear regression provides a mathematical way of estimating

a and b. It is also known as the line of best fit or least squares linear
regression.
Simple linear regression defines the trend line by determining the
values of a and b from the past data such that the sum of squares of
the vertical differences between actual values (y) and values
obtained from the line (ŷ) is a minimum.
In demand forecasting, a trend line using linear regression is
derived by fitting a straight line through the time series demand
data, with time on the x-axis and demand on the y-axis.

Activity 2.8
Given the six months sales data in the following table, develop a
trend line using least squares regression analysis. Use the trend
line to forecast the next three months.
Activity
Month Demand x y
January 115 1 115
February 123 2 123
March 132 3 132

Activity feedback can be found at the end of this module.

18
Decomposition of a time series
Decomposition of a time series occurs when the time series data is
split into the components of demand (trend, seasonal and cyclical).
The trend component measures the general upwards or downwards
direction, the seasonal component shows the effect of different
seasons, and the cyclical component shows the effect of a longer
repeating non-seasonal period cycle. Each separate component is
projected into the future and the sum of the projections becomes
the new forecast.

Seasonal index
The seasonal index is a number used to adjust data to seasonal
demand.
The seasonal index for each season is derived as the average of all
the demands for that period divided by the average demand for all
periods.
The formula to calculate the seasonal index is:
period average demand
seasonal index =
average demand for all periods
The deseasonalised demand is calculated by dividing the observed
demand for the period by the seasonal index for the period.
The formula for deseasonalised demand is:

observed demand for the period

deseasonalised demand =
seasonal index for the period

Activity 2.9
Using the observed demand data for two years is shown in the
following table; perform a regression analysis on deseasonalised
demand to forecast demand for the winter season in year three.
Activity

Observed Seasonal
Activity feedback can be found at the end of this module.
Year Season x
Alternative approaches to forecasting demand index
Modern technology allows firms to improve their internal and
1 autumn 205 1 0.7391
external processes, to change behaviours and subsequently arrive at
a better forecast of future demand. Most forecasting systems accept

winter 140 2 0.4457

19
 the customer demand as given when it is quite feasible for firms to
be proactive and influence demand.
Four very effective alternative approaches to forecasting are:

1. customer collaboration

2. supply chain engineering

3. demand smoothing

4. proactive collaboration.

With customer collaboration, it is possible for suppliers and

customers to work together and share information relating to
demand. If a customer is planning on increasing demand for a short
period by promoting and advertising a product, then it would make
sense to have sufficient supply arrangements in place before the
demand increases.
Supply chain engineering uses standard operations management
techniques to improve the effectiveness of the supply chain.
Techniques such as building flexibility into processes, shortening
set-up times, minimising lead time, minimising safety stock, using
pull replenishment systems and postponement tend to reduce the
reliance on forecasts by shortening the forecast horizon.
Demand smoothing is a proactive approach that recognises the
volatility of inherent demand caused by normal consumption of the
product or service and the artificial volatility created by the
organisation’s own policies and procedures. End-of-period push,
sales contests, trade promotions, channel-stuffing, bulk discounts,
trading terms favouring start-of-month orders and pricing changes
all contribute to a pattern of demand variability beyond the normal
variability of consumption. This is artificial and is all within the
managerial control of the organisation.
The inherent volatility of demand can be measured using the
coefficient of demand variation (CDV). This is the standard
deviation of demand divided by the mean demand. The value
calculated for both supplier and customer should be the same. If
they are not the same then artificial volatility exists.
Proactive collaboration is similar to customer collaboration but
operates proactively. Business partners work together to smooth
demand and make demand patterns predictable. This results in an
effective supply chain which should lower total supply chain costs.

20
Activity 2.10
Work through the following questions. You may need to go back
and reread the unit to help you.

Activity

1. Describe the four components of demand.

2. Explain the difference between qualitative and quantitative
forecasting.
3. Describe the strategic importance of forecasting.
4. Describe the use of MAPD and MAPV.
5. Explain how forecasting performance might be measured.
6. Explain the expression, “Forecasting is about understanding
variation”.
7. What is the difference between seasonal variation and cyclical
variation?
8. Discuss seasonal variation of demand and how an organisation
can respond.
9. Explain how the seasonal index is calculated.
10. What strategies are used by airlines, hotels and rental car
companies to influence demand?

Unit summary
In this unit you learned how to define demand management, to
explain the nature of demand, to understand the strategic role of
forecasting, to distinguish between qualitative and quantitative
Summary forecasting, to explain forecast accuracy, to define forecast value
added, to perform basic quantitative calculations on forecasting, to
define and calculate seasonal indices, to use regression analysis to
develop long-term trends and to discuss other approaches to
forecasting.

21
Readings for further study
Armstrong, J. S. (2001). Standards and practices for forecasting. In
J. S. Armstrong (Ed.), Principles of forecasting: A
handbook for researchers and practitioners. Norwell, MA:
Reading Kluwer Academic Publishers.
Fitzsimmons, J. A.& Fitzsimmons, M. J. (2008). Service
management: Operations, strategy, and information
technology (6th ed.). New York, NY: McGraw-Hill Irwin.
Gardiner, D. (2010). Operations management for business
excellence (2nd ed.) (pp. 39–78).Auckland, New Zealand:
Pearson Education.
Gilliland, M. V. (2002, July–August). Is forecasting a waste of
time? Supply Chain Management Review, 16–23.
Gilliland, M. V. (2004). New metrics of forecasting performance.
APICS 2004 International Conference Proceedings (pp. A–
04). Alexandria,VA: APICS.
Hanke, J. E.& Wichem, D. W. (2009). Business forecasting (9th
ed.). Upper Saddle River,NJ: Pearson Prentice Hall.
Heizer, J.& Render, B. (2010). Operations management(10th ed.).
Upper Saddle River, NJ: Prentice Hall.
Johnson, R.& Clark, G. (2008). Service operations management:
Improving service delivery (3rd ed.). Harlow,England:
Prentice Hall.
Katsaros, J.& Christy, P. (2005). Getting it right the first time: How
innovative companies anticipate demand. Westport, CT:
Praegar.
Lapide, L. (1998–99, winter). Forecasting is about understanding
variations. Journal of Business Forecasting, 29–30.
Savage, S. L. (2009). The flaw of averages: Why we underestimate
risk in the face of uncertainty. Hoboken, NJ: John Wiley &
Sons.

22
 Unit 4

Capacity planning and

management
Introduction
Today, providing service in a competitive world has uncovered
issues relating to what service actually is and how to measure it in
the minds of most managers, how service is perceived by the
customer and how the customer’s future purchasing decisions may
be affected by the service experiences they currently encounter.
To provide a service, management must first anticipate the level
and nature of customer demand. For instance, airlines must
anticipate the level of demand in order to purchase aircraft and
support staff. If customer demand is low, profits will be lower
because expensive resources such as aircraft are not utilised. If
demand is high it may be that customers will be dissatisfied by not
getting the seats advertised and may opt for a competitor’s offering.
There is a need to anticipate demand and provide resources and —
at the same time — maximise profit. This requires management to
take decisions. How many customers a day can a restaurant
service? How long should a customer wait before being answered
by a telephone hotline? How many firefighters and appliances
should a city employ?
Manufacturing companies may create inventory buffers in order to
supply goods from stock even if the factory is idle. This is not so
with service products which are intangible and often consumed and
supplied simultaneously. Service can rarely be inventoried although
there are exceptions such as in emergency services where fire
engines are essentially inventoried in case they are required. Also,
most product offerings come bundled with services. When you
purchased a car,was it presented in a showroom? Did you require
finance to pay for the car? Was your old car traded in as part of the
new purchase arrangement?
Manufactured products are often sold “off the shelf”, which means
customer demand had been anticipated and resources organised to
make, assemble, ship and store the product. Services cannot be
managed in a similar fashion. Errors or the mismatches between
actual demand for services and the resources needed to provide
those services must be managed without the ability to keep stock.
Hence better managerial approaches are necessary. How well
competing companies manage resources may have a significant

23
 impact on both their competitive position in the market and their
profitability.
This unit focuses on answering difficult, often strategic resource
questions and explains the significance of managing capacity and
providing customer service. It begins by considering the problems
facing both manufacturing and service organisations in meeting
their respective customer demand. It considers the nature of
variability and the significance of different resources and their part
in balancing supply with demand. The study unit then investigates
yield management (or revenue maximisation) which attempts to
maximise revenue from (relatively) fixed capacity and is practised
by airlines, hotels and rental companies.
This is followed by a short discussion on flexibility and an analysis
of queues and waiting lines.

Upon completion of this unit you will be able to:

 Outline how capacity is measured and appreciate the
dilemma faced by management in matching variable
demand with variable capacity.
 Calculate various aggregate planning scenarios.
Outcomes  Discuss the strategic planning process.
 Identify various strategies for balancing supply with
demand.
 Evaluate the application of yield management.
 Discuss flexibility.
 Appreciate the customers psychology in relation to queuing.
 Discuss queues and waiting lines.

Aggregate Aggregate planning is the process used to

planning develop tactical plans to support the
organisation’s business plan. In the capacity
Terminology planning process hierarchy, aggregate
planning follows strategic capacity planning
and is performed before short-term capacity
planning. Aggregate planning is performed for
families or groups of products and usually
includes an analysis of the plans for total sales,
total production, targeted inventory and
targeted customer backlog. The result of the
process is the production plan.

Capacity Capacity is the capability to produce output

for a time period. Capacity required represents
the process capability needed to make a given
product mix or deliver a given service mix

24
 (assuming technology, product
specificationand so on). The capacity available
and the capacity required can be measured in
the short, medium and long term.

Capacity Capacity planning is the process of

planning determining the amount of capacity required
to meet market demand for products and
services.

Chase capacity Chase capacity strategy is a production

strategy planning method that varies production to
meet demand. Production resources are added
and removed as required and this maintains a
stable inventory level or a stable backlog
(queue). This suits firms that experience
significant changes in demand and can add
and removeresources easily and effectively.

Demand Demand management strategy is a production

management planning strategy that attempts to modify
strategy demand to meet available capacity. It is used
in conjunction with either a level capacity
strategy or a chase capacity strategy. Methods
employed include pricing to promote “off-
peak”, restricted service at peak times,
advertising, promotion, reservations and
appointments.

Diseconomies of Diseconomies of scale refer to the situation

scale when this reduction in average unit cost is no
longer possible through further increases in
facility size because co-ordination of material
flows and personnel becomes so expensive
that new sources of capacity must be found.

Economies of Economies of scale refer to the drop in the

scale average cost for each unit of output as a plant
gets larger and each succeeding unit absorbs
part of the fixed costs. Economies of scale are
important to capacity decisions. The best
operating level is the capacity for which the
average unit cost is a minimum.

Level production Level production strategy is a production

strategy planning method that maintains resources at a
constant level resulting in a relatively level
production rate. This strategy suits a firm with
scarce or expensive resources or when steadily

25
 building up stock levels in anticipation of
seasonal demand.

Master Master production schedule is a line on the

production master schedule grid that reflects the
schedule anticipated build schedule for items assigned
to the master scheduler. The master scheduler
maintains this schedule, and in turn, it
becomes a set of planning numbers that drives
the material requirements planning. It
represents what the company can build and
will build expressed in specific product
configurations, quantities and dates.

Master schedule Master schedule is a report that shows by time

period the forecast, customer orders, projected
available balances, available to promise and
the master production schedule. It takes into
account the forecast, the production plan and
other things such as backlog, capacity,
material availability and management policies.

Production plan Production plan is the agreed plan that comes

from the aggregate planning process,
specifically the overall level of production
output planned to be produced, usually stated
as a monthly rate for each product family
(group of products).

Sales and Sales and operations planning is a business

operations process that helps companies keep demand
planning and supply in balance. It does that by focusing
on aggregate volumes (product families and
groups) so that mix issues (individual products
and customer orders) can be handled more
readily.

Supply Supply is the actual or planned replenishment

quantity created in response to a demand for a
product or a component in anticipation of such
demand.

Yield Yield management is the application of

management or discriminatory pricing to various market
revenue segments so that relatively fixed capacity can
management be utilised to satisfy customer requirements
and simultaneously maximise revenue.
Terminology sourced from Gardiner (2010).

26
Capacity and capacity planning
Capacity is the capability to produce output over a time period.
Capacity required represents the process capability needed to make
a given product mix or deliver a given service mix (assuming
technology, product specification and so on.). The capacity
available and the capacity required can be measured in the short-,
medium- and long-term.
Capacity planning is the process of determining the amount of
capacity required to meet market demand for products and services.
The term capacity planning has traditionally been used in
production industries where the capacity requirements of open
manufacturing orders were calculated at a very detailed level.
Production scheduling attempted to schedule jobs through the
factory at minimum cost and minimum lead time.
More recently, the term capacity planning has been used by
information and communications technology organisations since
they need to have sufficient resources available to meet current and
future demand.
Forecast demand is not completely predictable and available
capacity is not completely predictable. There are elements of
predictability in demand and capacity but the summation includes
variation and unpredictability. The real significance of capacity
planning is realised when organisations appreciate the variations of
demand and capacity.
Set-up time variations, production rate variables, unavailability of
resources at planned times, unexpected machine breakdowns and
transport disruptions all contribute to the variations of output that
govern capacity decisions.

The importance of capacity

Long-range capacity planning ensures that sufficient resources are
available to meet the long-range demand. For most organisations
this is 18 months and beyond.
Medium-range capacity planning uses aggregate sales and
operations plans. The time horizon can range from six months to a
year and a half depending on the organisation. Capacity increments
(or decrements) have to be in place to meet the medium-range
demand.
Short-range capacity planning determines the required capacity
from current time out to about six months but can extend up to a
year. Twenty or 30 years ago, capacity requirements were planned

27
 in great detail at this level. Today’s business systems do not require
that level of detailed capacity planning since modern methods of
lean thinking and flexibility reduce the need for intense detailed
reports, provided the capacity planning has been performed at the
long-range (resource) level and at the medium-range (aggregate)
level.

Strategic capacity planning

The objective of strategic capacity planning is to specify the overall
capacity level of resources —facilities, equipment and labour —
that best supports the organisation’s long-range competitive
strategy.
If capacity is inadequate, the organisation may lose customers
through slow service or by allowing competitors to enter the
market.
If capacity is excessive, the organisation may have to reduce prices
to stimulate demand or else underutilise its workforce, carry excess
inventory, or seek additional, less-profitable products to stay in
business.

Reflection 3
Imagine you are about to launch a new venture. It may be a factory,
a restaurant, a medical centre, a retail store, a transport company, a
school or a hospital (to name a few examples).
Reflection
All production and service organisations usually occupy one or
more facilities at one or more locations. For this new venture, the
following strategic decisions need to be resolved:

1. Where will each facility be located?

2. How large, or small, will each facility need to be?

3. What process technology will be installed at each location?

4. Will the physical size of the facility be sufficient in the short-,

medium- and long-term?

5. When should capacity increments be installed?

6. What happens if the available capacity is too much?

7. What happens if it is too small?

28
 Activity feedback can be found at the end of this module.

Aggregate planning – matching capacity and demand

Aggregate planning seeks to find the combination of sales,
production, labour requirements, inventory levels (production) and
customer backlog (services) that minimises total production-related
costs over the planning period. An aggregate plan could be a formal
report in one company and an informal directive in another.
Capacity policy decisions could also limit demand requests which,
for example, are in excess of current capacity limits.
The planning process at the aggregate level considers families or
groups of products. Typically, a firm should have 6–12 families or
groups of products. This number is quite significant. A number less
than six suggests that the firm is approaching a full consolidation of
the total plans for the business and this would suit a business
planning exercise. A number greater than 12 would make the
evaluation of the aggregate plans a very lengthy exercise. Assume
aggregate plans are discussed at a senior executive meeting and 30
minutes is allocated to discuss each family or group. If the
organisation has, say, 20 groups, then the meeting has a 10-hour
duration and the whole purpose of the meeting may be lost and
irrelevant.
Sales are matched with the overall level of production output to
best meet general business objectives of profitability, productivity
and competitive customer lead times consistent with the overall
business plan. The sales and production capabilities are evaluated
and a sales plan, production plan, financial budget statements, and
supporting plans for materials and workforce requirements are
developed.
This plan affects most functions of the firm and requires inputs
from marketing, sales, production, finance, new product and
service development, service and distribution.
The master production schedule disaggregates the aggregate
production plan and specifies the amount and need dates for the
production of specific end products. It is a statement of what can
and will be built.

Facilities and capacity

Design capacity is the amount a firm would like to produce under
normal circumstances and for which the system was designed. It is
the rate of production the facility was designed to accommodate
over the long-term.

29
 Best operating level is the level for which the process was designed
and is thus the volume of output at which the average unit cost is at
a minimum.
Economies of scale refer to the drop in the average cost for units of
output as a plant gets larger and each succeeding unit absorbs part
of the fixed costs. Economies of scale are important to capacity
decisions. The best operating level is the capacity for which the
average unit cost is a minimum.
Diseconomies of scale refer to the situation when this reduction in
average unit cost is no longer possible through further increases in
facility size because co-ordination of material flows and personnel
becomes so expensive that new sources of capacity must be found.
Economies of scale occur as the average cost per unit decreases and
diseconomies of scale occur as the average cost per unit increases.
The best operating level occurs at the transition from decreasing
unit cost to increasing unit cost.
Having sufficient capacity available is a strategic decision for any
organisation. For manufacturing industries, capacity can be stored
in inventory. Service organisations do not have that option. Some
assessment of the required capacity has to be made in advance of
requirements.
Finding the right capacity in service industries has more cost
implications simply because the output cannot be stored.
Underutilised resources, including staff, do not generate as much
incoming revenue and become a serious cost to the firm. Over-
utilised resources also increase costs and impact on flexibility and
lead time.

Strategic capacity planning process

Master planning of resources
Master planning of resources is the group of business processes that
includes demand management (forecasting sales, planning
distribution, servicing customer orders) sales and operations
planning (sales planning, production planning, inventory planning,
backlog planning and resource planning), master scheduling
(preparation of master production schedule and rough-cut
planning).
Sales and operations planning
Sales and operations planning is a business process that helps
companies keep demand and supply in balance. It focuses on
aggregate volumes (product families and groups) so that mix issues
(individual products and customer orders) can be handled more
readily.

30
 It usually occurs on a monthly cycle and displays information in
quantity and monetary units. The organisation’s strategic plan is
linked to its detailed processes. When this process is used properly
it enables the organisation’s managers to view the organisation
holistically and gives them a window into the future.
Master schedule
The master schedule is a report that shows by time period the
forecast, customer orders, projected available balances, available to
promise and the master production schedule. It takes into account
the forecast, the production plan and other things such as backlog,
capacity, material availability and management policies.
Once the preliminary demand numbers have been presented, the
capacity choices are balanced to arrive at what is achievable in
terms of capacity. This may result in agreeing that the planned
demand can be produced with existing resources or it may require a
modification of demand to create the rate of sales consistent with
existing capacity.
If there is a shortfall in available capacity, the organisation may
increase capacity, to obtain temporary resources, to outsource
production capacity or simply to not deliver the forecast demand.
If there is an excess of capacity, the organisation may decide to sell
excess capacity or close down some resource.

Strategies for balancing supply with demand

It is difficult to say which should come first —supply or demand.
An organisation that can look forward and visualise a demand
pattern based on history or their perception of what is about to
happen is in a strong position to determine the required capacity or
supply. This can be determined on the basis of the quantity and the
timing required.
Organisations use production planning strategies to develop the
overall production output to meet customer demand by setting
production levels, inventory levels and backlog levels. The main
methods used are chase capacity strategy, level production strategy
and demand management strategy.
The chase capacity strategy varies production to meet demand.
Production resources are added and removed as required and this
maintains a stable inventory level or a stable backlog (queue). This
strategy would suit firms that experience significant changes in
demand and can add and removeresources easily and effectively.
The level production strategy maintains resources at a constant
level, resulting in a relatively level production rate. This would suit
a firm with scarce or expensive resources or when steadily building
stock levels in anticipation of seasonal demand.

31
 Demand management strategy attempts to modify demand to meet
available capacity. It is used in conjunction with either a level
capacity strategy or a chase capacity strategy. Methods employed
include pricing to promote “off-peak”, restricted service at peak
times, advertising, promotion, reservations and appointments.

Reflection 4
For the most part, the production planner is given a sales forecast
and has to use a pure strategy or a combination of strategies.

Reflection Think of three or four capacity or supply planning decisions that

the production planner could use to increase/decrease the available
capacity.

Activity feedback can be found at the end of this module.

Level production strategy

A level production schedule focuses on holding production and the
work force constant over a period of time. Any difference between
the constant rate of production and the varying rate of demand is
made up by allowing inventory levels to rise or fall, increasing or
decreasing the number of orders in the backlog, or changing the
length of the queue of customers.
Operations managers often prefer this method since production
rates are usually dependable, quality of outputs tend to be
consistently high, and operating costs tend to be low. The emphasis
is on production efficiency and service goals are secondary. Staff
levels can be kept constant and supply lines can be arranged to
deliver at a steady rate.
The disadvantage is that inventory levels do change and this
requires substantial warehousing arrangements to handle periods of
low demand. If a queue of customers is being managed, a process
for handling lengthy queues has to be implemented.
Examples of a level production strategy can be found in electronics
and home appliance assembly plants when high volumes of
common products are produced.
Packaging companies will often build up packaging supplies before
the season for which the packaging is required. This applies to
seasonal produce such as apples, pears, kiwifruit and some
vegetables where the seasonal demand of the product is higher than
the production capability at the time for the packaging. Therefore
the companies manufacture the packaging before it is needed and
are able to meet demand when it happens.

32
Chase capacity strategy
The chase capacity strategy allows the production capacity to vary
each period to exactly match the forecast aggregate demand in that
time period. Workers are employed and terminated to adjust the
level of the workforce. Overtime and temporary staff are used to
fill short periods of high demand. Often a subcontractor is used to
add additional capacity during peak periods.
The main advantage of this method is that the level of finished
goods inventory can be maintained at a relatively low level.
Customer queues, if present, are held at a constant length.
However, labour and material costs are much higher because of the
disruptions caused by frequently scaling the work force up and
down and adjusting capacity of materials suppliers. Essentially, the
demand is being matched with available supply.
Examples of this strategy occur in most agricultural and
horticultural seasonal harvesting activities where the production
requirement occurs for a very short time. To have staff permanently
on the payroll just for the seasonal activity would be an ineffective
use of resources.

Demand management strategy

Some organisations have the ability to modify demand to suit their
available capacity.
One obvious way is to alter prices. A firm that increases the price
would normally expect demand to fall; likewise a firm that
decreases the price would normally expect demand to rise. Pricing
can be an effective tool to promote off-peak demand.
Telephone companies, airlines, hotels and rental car companies all
practise changing the price of their service to promote off-peak
demand. The net effect, though, is to level the supply.
Restaurants may offer a restricted service at peak periods. This is
not presented as a negative offering on their part. Rather they
usually promote the restriction as a positive. They may offer, for
example, a special low-priced breakfast menu until 10:30 am each
day allowing the restaurant to focus production activities on a
narrow range of choices rather than the full range. The customer
benefits by having a cheaper breakfast option prepared in a very
short lead time. Other restaurants may display a “specials” board
which sounds like it is offering something extra and “special” when
in fact it just means that the chefs have sufficient quantities of those
food items and can prepare them quickly and easily.

33
Production planning model
Production planning considers the forecast demand, the available
capacity, the required capacity, cost of production, cost of regular
and overtime labour, cost of hiring and training new staff, cost of
making employees redundant or laying off, cost of holding
inventory, cost of backlogging, cost of managing the queue and
subcontracting costs.

Activity 2.11
The data in the following table represents the demand forecast for
12 months commencing January for an organisation.

Activity

Jul 4000 Demand

Aug 3000 Inventory
Sep 4800
Oct 6400
The organisation currently employs 25 employees. For planning
purposes, each employee is capable of making 200 units a month.
The cost of hiring additional staff is $600 per employee and the
cost of making an employee redundant is $300. A storage charge
of $1 per unit is made for inventory on hand at the end of each
month. This is to cover the cost of warehousing.
(Please note that the dollar amounts are nominal amounts for
planning purposes and no attempt has been made to quantify the
actual costs in this example.)

Plan 1: Develop a production plan using a level production

strategy.

Plan 2: Develop a production plan using a chase capacity strategy.

34
 Plan 3: Develop a production plan using six months at 4800 and
six months at 5200.

Activity feedback can be found at the end of this module.

Yield management
Yield management is the application of discriminatory pricing to
various market segments so relatively fixed capacity can be used to
satisfy customer requirements and simultaneously maximise
revenue.
The objective of yield management (also known as revenue
management) is to increase revenues for organisations that operate
with relatively fixed capacity.
The concept of yield management was first applied in the airline
industry during the late 1970s but has since been applied across a
number of industries including hotels, rental cars, retail,
advertising, electricity generation and transmission, tour operators,
passenger transport and freight carrying. Even restaurants are
learning how to use yield management to their advantage.
The application of yield management is well practised in the airline
industry with airlines offering flights for as low as one dollar.
Airlines may offer discounted fares on lightly loaded sectors and
these bookings usually have to be paid in full, are non-transferrable
to another person, and non-refundable. In some cases they are
changeable but with the payment of a change penalty fee and by
paying any applicable fare adjustment. Peak-hour flights are
unlikely to have many fares at lower rates since the airlines have
little trouble selling these at higher rates.
Hotels practise yield management by offering lower rates at
weekends and during an off-season. They have to be aware of both
predictable, seasonal factors and unpredictable, individual customer
demand by using a systematic approach with a combination of
knowledge, experience, understanding and forecasting. This
combines predictability and uncertainty.
Yield management is most effective when the following exist:

 Relatively fixed capacity and the same unit of capacity

can be used in variety of ways. There would be no need to
manage yield when capacity is flexible. With relatively
fixed capacity such as an airline seat or a hotel room, the
organisation cannot easily change the capacity and yet
demand fluctuates widely.

 Demand can be segmented by market and each segment

has varying needs, behaviour and willingness to pay.

35
 Airlines segment their market into general classifications of
business class, full economy fares and discount fares.
Business travellers are time sensitive and are likely to book
late and require maximum flexibility. For that flexibility
they pay a higher-priced fare.

 Demand is highly variable (seasonal fluctuations) and

uncertain. In periods of low demand (winter for the
tourism industry), demand needs to be stimulated and in
periods of high demand (summer in the tourism industry),
revenues need to be maximised.

 Inventory is perishable (hotel room by night, airline seat

by flight). If an airline seat is not sold by the time the flight
departs, the revenue from that seat is lost and can never be
recovered. Similarly, the revenue from an empty hotel room
for the night can never be obtained.

 Product can be sold in advance. Customers choose to buy

at different times, either well in advance or at the last
minute. Suppliers can take advantage of this buyer
behaviour and they also have an opportunity to influence
that buyer behaviour. When the same price applies
regardless of booking time, the only driver that would
encourage customers to buy earlier would be a fear of
unavailability of supply.

 Product can be forecast with relatively high accuracy.

The organisation will dynamically adjust pricing and will
hold back on some capacity to be sold at the last minute at a
premium. The company needs to know how much to hold
back. If it holds back too much, it may miss out on any
revenue. If it holds back too few, it misses out on the high
revenue-generating last-minute sales.

 Fixed costs are high and marginal costs of selling one

extra unit are low. The cost of adding an additional aircraft
with additional seats to the fleet is high. The cost of adding
an additional hotel room requires a new hotel to be
constructed and this is relatively expensive. The cost of
adding one more passenger to the passenger list is relatively
low. The airline has to handle the reservation, handle the
check-in, carry the luggage and make sure the passenger
arrives at their destination.

 Price is not an indicator of quality. Price should not be

seen as a status symbol and should not be an indicator of
quality. Using airline pricing as an example, most
customers realise that if they pay a high price for their seat

36
 they will not get a higher quality flight when compared to a
discount purchaser who purchases the same class of seat.
The difference is in the timing of the purchase, not the
delivery of the service.

 Producers are profit-oriented and have freedom of

action. Yield management assumes that the supplier of the
service is profit-oriented. A hotel can charge different rates
for each room and can hold back some rooms in
anticipation of receiving higher revenue later. This
approach would not be feasible in an emergency ward of a
public hospital.

Yield management process

The yield management process starts by determining how far in
advance the system will look ahead. Airlines typically use 300
days.
The market is segmented, based on future purchasing behaviour.
Airlines have a clear segmentation between leisure and business
travellers. Hotels have short-term, long-term, leisure, business and
conference guests. Rental car firms have similar segments to hotels.
The supplier predicts customer demand based on forecast demand
and capacity at each product/price level and attempts to optimise
the price by mathematically determining capacity availability and
price that maximises expected profit.
This attempts to allocate the right capacity to the right customer at
the right time and simultaneously maximises revenue or yield. It
relies on being able to predict the expected behaviour of specific
market segments within the overall market demand. Successful
implementation of yield management requires the organisation to
be capable of continually monitoring and forecasting changes in
demand patterns.
The supplier dynamically recalibrates and continually monitors
performance and reacts to the updated market response. It is a
continuous process keeping surveillance on response to the pricing,
competitor reactions and making adjustments.
The management of demand attempts to influence buyer behaviour
so that it fits in with available capacity. Options to influence
demand include:

 Partitioning demand or segmenting the market based on

purchasing behaviour, not just current or past
classifications. The most common example is the
partitioning of business and leisure travel and
accommodation.

37
  Offering off-peak pricing incentives. When off-peak
services are priced at a lower rate than full-peak services,
customers will deliberately delay their demand for the
service until the price incentive takes effect.

 Promoting off-peak demand. This is similar to the off-

peak option but relates to promoting activities and
advertising that promotes off-peak demand almost to the
exclusion of promoting on-peak activities.

 Developing reservation systems. Customers know that

they have to make a reservation or an appointment so they
are encouraged to book early to avoid disappointment. This
has an added effect of controlling demand to the capacity
limit.

The options to manage supply are:

 Share capacity with another supplier. This capacity

sharing occurs with airline companies when they fly one
aircraft on a particular route and it carries two or more
airline flight numbers.

 Increase customer participation. This may occur at all

times or just in peak periods or off-peak periods. On-line
banking and automatic teller machines allow customers to
conduct banking business without the need for bank
personnel to be present while the transaction is occurring.
This allows the fixed capacity of the banking system to be
used for longer periods without needing additional staff.

 Cross-train employees. If demand shifts from one area of

the business to another, trained staff can be directed to meet
that demand. If cross-training were not in place the
organisation may not be able to offer the full range of
services at all times.

 Employ part-time. This allows staff numbers to be

increased and decreased almost at will to meet whatever
demand is placed on the organisation.

 Create adjustable capacity. This occurs when

organisations do not normally use all available capacity and
they open up the additional capacity only in peak periods
and close it in quiet times. Tourist destinations often operate
in this manner with some hotels closing completely for the
off-season.

38
Capacity flexibility
Capacity flexibility essentially means having the capability to
deliver what the customer wants within a shorter lead time than
competitors can offer. Such flexibility is achieved through flexible
plants, processes, workers and through strategies that use the
capacity of other organisations.
The actual capacity is the level of output for a process or activity
over a period of time. The effective capacity is the output rate that
managers expect for a given activity or process. The demonstrated
capacity is the proven capacity calculated from actual performance
data.
Capacity control is the process of measuring production output and
comparing it with the capacity plan, determining if the variance
exceeds pre-established limits, and taking corrective action to get
back on plan if the limits are exceeded.
Set-up time is one of the determinants of capacity flexibility. Set-
up occurs at the start of a production run and total set-up time is a
function of the number of production runs executed. A machine is
set up and the run size quantity is produced. The machine is then
set up for the next product. Organisations often look at the
production rate to determine capacity. Capacity, though, needs to
consider set-up time as a non-productive period as well as the
processing speed to determine capacity of a machine.
A production facility works best when it focuses on a fairly limited
set of production objectives because a firm should not expect to
excel in every aspect of production performance —cost, quality,
flexibility, new product introductions, reliability, short lead times,
and low investment.
Service capacity must be available to produce a service at the time
it is needed. Empty airline seats, for example, cannot be transferred
from an off-peak flight to a full-peak flight.
Service capacity must be located near the customer or at least be
available to the customer before the service can be delivered.
Having empty hotel rooms in one city does not help a shortage of
hotel rooms in another city.
Customers interact with the service production system and as a
result the processing time required for each delivery may vary.
Services experience off-peak and on-peak as well as in-season and
off-season demands and this is caused by customer behaviour
influencing demand.
Service providers must consider the day-to-day relationship
between service utilisation and service quality. A good operating
point is near 70 per cent of the maximum. This is enough to keep
servers busy but allows time to serve customers individually and

39
 keep enough capacity in reserve so as not to create too many
managerial headaches.
Low rates are appropriate when both the degree of uncertainty and
the stakes are high, such as an accident and emergency department
at a hospital and fire services. Sporting events and concerts prefer
sell-out crowds that use the maximum capacity.

Queues and waiting lines

Queues are a natural consequence of service delivery. In many
ways a queue in a services environment is equivalent to buffer
inventory in manufacturing.
In production industries, the inventory acts as a buffer to allow the
rate of inputs to be different from the rate of outputs.
In services, the queue acts as the buffer between the arrival rate of
customers and the supply and delivery rate of the actual service.

Activity 2.12
When you are waiting in a queue, it often feels like you are
waiting for a very long time. Make a list of possible reasons why
a customer perceives the wait time is longer than it actually is.

Activity
Activity feedback can be found at the end of this module.

Queuing theory
Queuing theory is used to manage processes. A queue can be
studied in terms of the source of each customer, how frequently
customers arrive, how long they can or should wait, whether some
customers should jump ahead in the queue, how multiple queues
might be formed and managed, and the number of servers required.
The design of a call centre provides an excellent example of
queuing theory in practice. Call centre performance is typically
measured by the cost per call, the resolution rate or fulfilment rate
and customer satisfaction.
When customers are in the queue they may leave and be lost to the
system. They may call back or they may hold one line and use
another telephone to join the queue again. An increase in the
average call duration increases the queue.

40
Activity 2.13
1. What does the term “capacity” mean?
2. How does capacity differ from capability?
3. Why is capacity management strategically important?
Activity
4. The management of capacity for services is more difficult than
for manufacturing. Why?
5. Describe the capacity considerations for a hospital and identify
how this is different from a manufacturing unit.
6. What are the possible consequences of demand rate being
different from design capacity rate?
7. What is yield management?
8. What industries use yield management and why?
9. Describe three strategies for expanding capacity.

Unit summary
In this unit you learned how capacity is measured, and appreciated
the dilemma faced by management in matching variable demand
with variable capacity. We developed various aggregate planning
Summary scenarios and discussed the strategic planning process and
developed various strategies for balancing supply with demand

We explored the application of yield management (or revenue

management) and discussed flexibility.

We concluded with a section on the customers’ psychology in

relation to queuing, queues and waiting lines.

41
 Assignment

Assignment
There are three questions in this assignment.

Question 1 40 marks
Assignment
a. Lowering prices can increase demand for products or services,
but it also reduces profit margins if the product or service
cannot be produced at lower cost. Briefly discuss how an
operations manager should approach his or her job when
competing on cost.

b. Quality is a dimension of a product or service that is defined by

the customer. Today, more than ever, quality has important
market implications. Briefly discuss how an operations
manager should approach his or her job when competing on
quality.

c. As the saying goes, “time is money.” Some companies do

business at “Internet speed,” while others thrive on consistently
meeting delivery promises. Briefly discuss how an operations
manager should approach his or her job when competing on
time.

d. Flexibility is a characteristic of a firm’s operations that enables

it to react to customer needs quickly and efficiently. Some firms
give top priority to flexibility. Briefly discuss how an
operations manager should approach his or her job when
competing on flexibility.

Question 2. 30 marks

a. Provide three questions that should be considered when

developing the objectives of a forecast.

b. Name three different models that could be developed and tested

during the forecasting process.

c. What does “applying the model” mean?

d. Explain, using an example, the forecasting step “considering

real-world constraints on the model’s application”.

e. Explain how one might “revise and evaluate the forecast”.

f. What is the most important rule of forecasting and what should

42
 C4: Operations Management

we be trying to achieve?

Question 3: 30 marks
The number of guests staying at an exclusive lodge has been:

a. Calculate seasonal indices using the above data.

b. Deseasonalise the above data, and determine the regression

equation.

c. Using the regression equation, determine the forecasts for year

four.

43
 Assignment

References
Gardiner, D. (2010).
Operations
management for
business excellence
(2nd ed.). England,
New Zealand:
Pearson Education.
Johnson, R. & Clark, G.
(2008).Service
operations
management:
Improving customer
service (3rd ed.).
Harlow, England:
Prentice Hall.

Further Readings

44
 C4: Operations Management

Fitzsimmons, J. A.&
Fitzsimmons, M. J.
(2008). Service
Reading management:
Operations,
strategy, and
information
yechnology (6th
ed.). New York,
NY: McGraw-Hill
Irwin.
Gardiner, D. (2010),
Operations
management for
business excellence
(2nd ed.) (pp. 79–
118). Auckland,
New Zealand:
Pearson Education.
Heizer, J.& Render, B.
(2010). Operations
management (10th
ed.). Upper Saddle
River, NJ: Prentice
Hall.
Johnson, R.& Clark, G.
(2008). Service
operations
management:
Improving service
delivery (3rd ed.).
Harlow, England:
Financial
Times/Prentice
Hall.
Netessine, S.& Shumsky,
R. (2002).
Introduction to the
theory and practice
of yield
management.
Retrieved from
INFORMS
Transactions on
Education, 3(1), 34–

45
 Assignment

44. Available online

at
[Link]
[Link].
Shy, O. (2008). How to
price: A guide to
pricing techniques
and yield
management.
Cambridge, NY:
Cambridge
University Press.
Talluri, K. T.& Van Ryzin,
G. J. (2005). Theory
and practice of
revenue
management
(International series
in operations
research and
management
science). New York,
NY: Springer
Science and
Business Media.
Wallace, T. F. (1999). Sales
and operations
planning: The how-
to handbook.
Cincinnati, OH: T.
F. Wallace.

46
 C4: Operations Management

Activity feedback
Reflective activities
Reflection 1
A number of factors influence demand such as changes in
technology, competitor initiatives or pricing levels. Forecasting
helps firms to focus on the factors that influence demand and
establish a relationship between those factors and actual demand.
Reflection 2
Forecast inaccuracy can be attributed to the following causes:

 The forecasting model or method employed may not be

suitable for the demand being monitored.

 The information in the forecasting process may arrive too

late to be of significant value.

 True demand is not being captured and it is being confused

with sales data.

 Appropriate data is not being used. This feature develops

when individuals are left to source information for
themselves and then this data is consolidated in some way
at an organisational level.

 Forecasts are calculated from the past data that may not
hold for projected data points.

Reflection 3
All of these questions have a major bearing on the success, or
otherwise, of the organisation. If you are capable of getting it right,
you will find yourself in an enviable position of being able to
capitalise on every opportunity that comes your way (assuming you
want to take it) and thus maximise revenues and profits. If you get
it wrong, you may find yourself searching for additional capacity at
a premium price or being left with excess capacity that you are
unable to sell.
Reflection 4
 Hiring additional staff and making staff redundant.
 Working variable days per week.
 Working overtime.
 Varying the level of inventory.

47
 Assignment

 Varying the number of orders in the backlog.

 Varying the length of the queue of customers.

 Using subcontractors to supply additional capacity.

 Outsourcing parts of the business to free up resources.

 Adding or removing temporary capacity.

 Adding or removing permanent capacity.

These are reactive measures and the controllability of these factors

depends on union agreements, employment contracts, employment
legislation, short-term constraints on physical capacity levels,
customer requirements and preferences, and the amount of money
that can be tied up in inventories.
Activities
Activity 2.1
Calculate the absolute deviation between demand values and
forecast values for each month. Add them up and find the average
(mean) value. This is the mean absolute deviation (MAD).

MAD=
∑|D−F|= 450 =45
n 10
Thus the actual demand is, on average, 45 units from the forecast
value.

Activity 2.2
Bias is found by calculating the algebraic difference between
demand value and forecast value for each period. To make sure that
the algebraic sign is correct, ensure you subtract forecast from
demand (D – F). The sum of the algebraic differences is divided by
the sum of the demand values and expressed as a percentage.

bias=
∑ ( D−F ) x 100
∑D
( 6000−5950 ) x 100
=
6000
=0. 833 %

Thus the forecasting model has a bias in favour of demand of 0.833

per cent.

48
 C4: Operations Management

Activity 2.3
MAPD is the mean of the absolute deviation between actual
demand value and forecast value divided by the mean of the
demand values expressed as a percentage. In this formula
description, both numerator and denominator calculate average
values using the number of observations. In the formula, the
number of observations, n, could appear in numerator and
denominator and cancels each other out.

MAPD=
∑|D-F|x 100 = 450 x 100 =7. 5 %
∑D 6000

Mean absolute percentage variation (MAPV) is the average of the

absolute deviation between actual demand value and mean demand
value divided by the mean demand expressed as a percentage.

∑D
∑|D− n |x 100 860 x 100
MAPV= = =14 .33 %
∑D 6000

Thus the mean absolute deviation is 7.5 per cent of the mean
demand (MAPD) and the variability of demand (MAPV) is 14.33
per cent.

Activity 2.4
In this example n = 3 and t = 6.

n=3 , t=6
sum of actual demand values for the chosen number of periods
Ft=
chosen number of periods
Dt−n +. . .. ..+Dt−2 +D t−1
¿
n
D3 + D4 +D5
¿
3
110+135+145
¿
3
¿ 130

Thus, the forecast for month six using a three-month simple

moving average is 130.

49
 Assignment

Activity 2.5
In this example n = 5 and t = 6.
n=5 , t=6
sum of actual demand values for chosen number of periods
F t=
chosen number of periods
Dt−n +. . .. ..+Dt−2 +D t−1
¿
n
D1 +D 2 +D3 +D 4 + D5
¿
5
120+130+110+135+145
¿
5
¿ 128
Thus, the forecast for month six using a five-month simple moving
average is 128.

Activity 2.6
In this examplen = 3, t = 6.

n=3 , t=6 , w3 =0 .2, w 4 =0 . 3, w5 =0 . 5, sum of the weights =1

In sum of (each period©s demand value x each period©s weight )
Ft=
sum of the weights
D w +.. . ..+Dt−2 w t−2 +Dt−1 w t−1
F t = t−n t−n
w t−n +.. . ..+wt−2 +w t−1
F 6 =( D3 x W 3 )+(D 4 x W 4 )+( D5 x W 5 )
F 6 =(110 x 0 .2 ) + (135 x 0 .3 ) + (145 x 0. 5 )
¿ 135
this example, the sum of the weights adds up to 1. Thus, the
forecast for month six using a three-month weighted moving
average is 135 units.

50
 C4: Operations Management

Activity 2.7
t=6 , F 5=130 , D 5=145 , α=0 .2
F t = Ft−1 + α ( Dt- 1− F t−1 )
¿ 130+0 . 2 x (145−130)
¿ 133
Thus, the forecast for month six using exponential smoothing with
 equal to 0.2 is 133.

Activity 2.8
The data as supplied has demand data for six months. The monthly
demand is the independent variable and is assigned to the x-axis.
The months in the x-axis are numbered 1 through 6. The y-axis is
for the dependent variable and this is the observed demand.
In order to calculate a,b and the trend line, the values for xy and
x2are required as shown in the table above.

n=6 , ∑ xy=2877 , ∑ x=21 , ∑ y=790 , ∑ x 2 =91

n ∑ xy−( ∑ x ∑ y ) By
b=
n ∑ x 2 −( ∑ x )2
6 x 2877−21 x 790
¿
6 x 91−212
¿6.4

n=6 , ∑ xy=2877 , ∑ x=21 , ∑ y=790 , ∑ x 2 =91

a=
∑ y −b ∑ x
n n
¿ 131 .67−6 . 4 x 3. 5
¿ 109 .27

^y =109 . 27+6 . 4 x trend line equation

using Excel the calculations can be automated. The Excel software
requires the data analysis add-in and the calculation is initiated
using the Data menu followed by Data Analysis and then
Regression. For the Input Y Range select the column of y-values
and for the Input X Range select the column of x-values. The
output report contains more data than is immediately required and
the pertinent values are shown below.

SUMMARY OUTPUT
Coefficients
Intercept 109.27
x 6.4
51
 Assignment

Substituting x=7, x=8 and x=9 into the trend line equation provides
the forecast values as shown below.

Month Demand x y
January 115 1 115
February 123 2 123
March 132 3 132

Activity 2.9
Start by calculating the seasonal indices for autumn, winter, spring
and summer.
The period average demand for autumn is (205 + 475) / 2= 340
The period average demand for winter is (140 + 270) / 2 = 205
The period average demand for spring is (375 + 685) / 2 = 530
The period average demand for summer is (570 + 960) /2 = 765
The average demand for all periods can be calculated as 3680/8 and
is given as 460.

period average demand

seasonal index =
average demand for all periods
340
seasonal index for autumn= =0 .7391
460
205
seasonal index for winter= =0 . 4457
460
530
seasonal index for spring= =1. 1522
460
765
seasonal index for summer = =1. 6630
460

Calculate the deseasonalised demand for each season by dividing

the observed demand by the seasonal index for that period as
shown in the following table. Then calculate the extended fields for
xy and x2 as shown in the following table.

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 C4: Operations Management

Observed Seasonal
Year Season x
demand index
1 autumn 205 1 0.7391
winter 140 2 0.4457

n=8, ∑ xy=18880.8616, ∑ x=36, ∑ y=3679.9423, ∑ x2=204

n ∑ xy−(∑ x ∑ y)
b=
n ∑ x −( ∑ x)
2 2

8 x18880.8616−36 x3679.9423
¿ 2
8 x204−36 =211.308+55.2648 x ¿
¿55.2648

a=
∑ y −b ∑ x
n n
¿460−55.2648 x 4.5
¿211.308 {^y

Now calculate b, a and the best estimate of ŷ= a + bx.

Thus the trend line for deseasonalised data isŷ = a + bx = 211.308
+ 55.2648x.
Now substitute x= 10 corresponding to winter in the third year to
get the deseasonalisedvalue for that period.

when x=10 , the deseasonalised value for winter in the third year is
By ^
y =211. 308+55 . 2648 x
=211. 308+55 . 2648 x 10
=763 . 956
using a program such as Excel, the calculations to get the
regression line can be automated. The Excel software requires the
data analysis add-in and the calculation is initiated using the Data
menu followed by Data Analysis and then Regression.

53
 Assignment

For the Input Y Range select the column of y-values and for the
Input X Range select thecolumn of x-values. The output report
contains more data than is immediately requiredand the pertinent
values are shown in the following table.
SUMMARY OUTPUT
Coefficients
Intercept 211.308
x 55.2648

The deseasonalised forecast for winter in the third year is:

^y =211. 308+55 . 2648 x=763 .956

Now multiply the deseasonalised forecast by the seasonal index to
calculate the seasonalised forecast for winter in the third year:
763.956 x 0.4457 = 340.4952 = 340 (0 dp)

Activity 2.10
All answers are in the learning material.

Activity 2.11
Plan 1: Develop a production plan using a level production strategy.
Start this plan by calculating the level production rate. The annual
demand is 60,000 and there are 12 monthly periods so that makes
5000 units a month.
In January, the beginning inventory is zero, the production is 5000
and demand is 4400, therefore the ending inventory is 600 units.
In February, the beginning inventory (following on from January)
is 600, the production is 5000 and demand is 3200, therefore the
ending inventory is 2400 units.
In March, the beginning inventory (following on from February) is
2400, the production is 5000 and demand is 4000, therefore the
ending inventory is 3400 units.

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 C4: Operations Management

Continue like this for the rest of the year.

Month Demand forecast

Jan 4400

The inventory storage cost is $28,000, the cost of employing new

staff is zero, and the cost of terminating staff is zero to give a total
cost for this plan of $28,000.
Plan 2: Develop a production plan using a chase capacity strategy
In this plan the production rate varies to match the demand pattern
and the number of employees is increased or decreased to match
the production rate.
In January, the demand forecast is 4400, so production is set to
match that rate. Beginning inventory on hand is zero, production
matches demand forecast, so the ending inventory on hand is zero.
To produce 4400 we need 22 staff (200 units per employee per
month) so three employees are made redundant. Their employment
contract would specify the temporary nature of their employment.
In February, the demand forecast is 3200, so production is set to
match that rate. Beginning inventory on hand is zero, production
matches demand forecast, so the ending inventory on hand is zero.
To produce 3200 we need 16 staff (200 units per employee per
month) so six employees are made redundant.

55
 Assignment

In March, the demand forecast is 4000, so production is set to

match that rate. Beginning inventory on hand is zero, production
matches demand forecast, so the ending inventory on hand is zero.
To produce 4000 we need 20 staff (200 units per employee per
month) so four employees are hired.
The remaining months are calculated in a similar fashion.

Beginnin
g
Month
inventory
on hand
Jan 0
The inventory storage cost is zero, the cost of employing new staff
is $22,200, the cost of terminating staff is $9,300 to give a total
cost for this plan of $31,500.
Plan 3: Develop a production plan using six months at 4800 and six months
at 5200.
The calculations for this strategy follow the same pattern as plan
one and two except that the production rate is set at 4800 for the
first six months, then increases to 5200 for the rest of the year. This
represents a starting position in trying to optimise the plan. The
number of employees is increased or decreased to match the
production rate.

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 C4: Operations Management

Demand
Month forecast
Jan 4400

The inventory storage cost is $20,800, the cost of employing new

staff is $1,200, the cost of terminating staff is $300 to give a total
cost for this plan of $22,300.

Activity 2.12
Johnson and Clark (2008) identified that the customer often
perceives that the time in the queue is longer than it really is. They
observed the following:

 Unoccupied time feels longer than occupied time.

 Pre-process waits feel longer than in-process waits.

 Anxiety makes the wait seem longer.

 Uncertain waits are longer than known, finite waits.

 Unexplained waits seem longer than explained waits.

 Unfair waits are longer than equitable waits.

 The more valuable the service, the longer the customer

waits.

 Solo waiting feels longer than group waiting.

 Uncomfortable waits feel longer than comfortable waits.

 New or infrequent users feel they wait longer.

57
 Assignment

Activity 2.13
All answers are in the learning material.

58