OPERATIONS RESEARCH

Development of Operations Research

Pre-World War II

No science has ever been born on a specific day. There is no exception for
OR also. Its roots are as old as science and society. Though the roots of OR
are extended to early 1800s, Charles Babbage (Father of OR) has done his
research into the cost of transportation and sorting of mail led to England’s
University Penny Post in 1840. In 1885 Ferderick W Taylor emphasised the
application of scientific analysis to the methods of production, that the real
star took place. Taylor conducted an experiment in connection with a simple
shovel. His aim was to find the weight load of the ore moved by shovel with
minimum fatigue. After many experiments with varying weights he obtained
optimum weight load.

Another man of early scientific management era was Henry L Gantt worked
on Job scheduling methods. A job for instance may be processed on a
machine without trouble but it might wait for days for acceptance by the
other machine. Gantt mapped each job from machine to machine in such a
way that it minimizes the delay.

In 1917 A K Erlang a Danish mathematician published his work on the

problem of congestion of telephone traffic. The difficulty was that during the
busy periods telephone operators were unable to handle the calls the
moment they were made, resulting in delayed calls. Erlang has developed
the formulae for waiting time which is fundamental importance to the theory
of telephone traffic.

However it was the first industrial revolution ( Replacement of man by

machine as a source of power, improved means of transportation) which
contributes mainly towards the development OR.

World War II

During World War II the military management in England called a team of

scientists to study the strategic and tactical problems of air and land
defence. This team was under the direction of Prof P M S Blackett of
university of Manchester. This team consists of Blackett and three
physiologists, two mathematical physicists, one astrophysicist, one army
officer, one surveyor, one general physicist and two mathematicians. The
objective was to find out the most effective allocation of limited military
resources to the various military operations. It includes the effective use of
newly invented radar, British air force planes to missions and the
determination of best patterns for searching submarines.

The name of Operations Research was apparently coined in 1940 because

the team was carried out research on military operations.
Post-World War II
Immediately after World War-II the success of military teams attracted the
attention of industrial mangers who were seeking solutions to their
problems. Industrial operations research in UK and USA developed along
different lines. In UK critical economic situation requires drastic increase in
production efficiency and creation of new markets. Nationalization of a few
key industries further increased the potential field of OR. Consequently OR
spread from military to government, industrial, social and economic
planning.

The progress of industrial Operations Research in USA was due to the

advent of Second Industrial Revolution (Automation). This new revolution
begins around 1940s when electronic computers having tremendous
computational speed and information storage became commercially
available.

In 1950 OR was introduced as a subject for academic study in American

Universities.

OR in India

In India OR came into existence with the opening of OR unit in 1949 at the
Regional Research Laboratory in Hyderabad. At the same time another OR
unit was set up at the Defence Science Laboratory in New Delhi. An OR unit
was established under Prof P C Mahalonobis in Kolkata in 1953 to apply OR
method in national planning and survey. Operations Research Society of
India was formed in 1957 and its first conference was held in Delhi in 1959.
Some of Indian organizations using OR techniques are Indian Airlines,
Railways, Defence Organisations, Fertilizer Corporation of India, Hindustan
Steel ltd, Tata iron and steel, TELCO, BHEL, SAIL etc.

Definition

Operations research is the scientific method of providing executive

departments with a quantitative basis for decisions regarding the
operations under their control.

CHARACTERISTICS OF OPERATIONS RESEARCH

1. It is a system orientation: One of the most important characteristics of

OR study is its concern with problems as a whole or its system
orientation.
2. The use of inter disciplinary teams: OR study is performed by a team
of scientists whose individual members have been drawn from
different scientific and engineering departments.
3. Application of scientific method: OR problems should be solved by
using a scientific method.
4. Uncovering of new problems: Solution of an OR problem is obtained
by taking all the existing problems in to consideration. But it may
uncover number of new problems.
 5. Improvement in the quality of decisions: Application of scientific
method to OR problem can improve the quality of the solution but it
may not be able to give perfect solution.
6. Use of computers: OR problem needs a computer to solve the complex
mathematical model.
7. Quantitative solutions: OR approach provides the management with a
quantitative basis for decision making.
8. Human factors: While deriving the quantitative solutions OR problem
does not consider the human factors.

NECESSITY OF OR IN INDUSTRY

OR is needed in the industry due to the following reasons

a. Complexity: In industry there is huge number of factors influence the

decision. Due to the involvement of these factors which are interacting
with each other in complex manner it becomes difficult to take a
decision. For example consider a factory production schedule. It has
to take the following factors into account
i. Customer demand
ii. Requirement of raw material
iii. Equipment capacity and its possible failures
iv. Restriction on manufacturing process
Evidently it is not easy to prepare a schedule which is both
economical and realistic. This needs OR models.
b. Scattered responsibility and authority: In a big industry responsibility
and authority of decision making is scattered throughout the
organization and if the organization is not conscious, it leads to
inconsistent goals. Mathematical quantification of OR overcomes this
difficulty.
c. Uncertainty: There is a great uncertainty in decision making about
economic and general environment. With economic growth
uncertainty also increases. This makes each decision costlier and time
consuming. So OR is essential from reliability point of view.
d. Knowledge explosion: Majority of the industries are not up to date
with the latest knowledge and it is the disadvantage. OR teams
collects latest information and hence this disadvantage can be
overcome.

SCOPE OF OPERATIONS RESEARCH

The scope aspect of any subject indicates the limit of application of

the subject matter/techniques of the subject to the various fields to solve
the variety of the problems. Different fields in which OR is used are
discussed below
(i) In Defence Operations

In modern warfare the defence operations are carried out by number of

different agencies like Army, Navy and Air force. The activities performed by
each of them are further divided into sub activities like operations,
intelligence, administration and training. Then it needs to coordinate all the
activities involved in order to arrive an optimum strategy which needs OR
techniques.

(ii) In Industry

In the field of industrial management there is a chain of problems starting

from the purchase of raw materials to the dispatch of finished goods.
Generally the management is interested in having an overall view of the
method of optimizing the profits. In order to take decision the OR team has
to consider different alternative methods of production like change of
machinery, introduce of more automation processes etc. Techniques of
operations research can be conveniently applied to solve these problems. In
fact decision trees, inventory model, Linear Programming model,
Transportation model, Sequencing model, Assignment model and replacement
models are helpful to the managers to solve various problems, they face in
their day to day work.

(iii) In Planning For Economic Growth

In India we have five year planning for steady economic growth. Every state
government has to prepare plans for balanced growth of the state. Various
secretaries belonging to different departments has to co-ordinate and plan
for steady economic growth. For this all departments can use Operations
research techniques for planning purpose.

(iv) In Agriculture

The demand for food products is increasing day by day due to the increase
in population. But the land available for agriculture is limited. We must find
newer ways of increasing agriculture yield. So the selection of land area for
agriculture and the seed of food grains for sowing must be meticulously
done so that the farmer will not get loss and at the same time the users will
get what they desire at the desired time and desired cost.

(v) In Public utilities

OR models can be applied in big hospitals to reduce waiting time of outdoor

patients and to solve the administrative problems.

Monte Carlo methods can be applied in the area of transport to regulate the
train arrivals and their running times.

OR techniques can be applied in insurance offices to decide the premium

rates of various policies. It can also be applied in petroleum, chemical,
paper, mining and textile industries.

OR approach is equally applicable for big and small organizations. For

example whenever departmental store faces a problem like employing
additional sales girls etc., techniques of OR can be applied to minimize cost
or maximize profit.
TYPES OF MODELS IN OR

Models are also categorized depending on number of factors such as

structure, purpose, nature of environment, behaviour, by method of solution
and by use of digital computers etc.

(a) Classification by Structure

Based on structure the OR models are classified in to three categories.
Those are Iconic models, Analogue models, Symbolic models.

(i) Iconic Models: These models are scaled version of the actual object. For
example a toy of a car is an iconic model of a real car. In your laboratory,
you might have seen Internal Combustion Engine models, Boiler models etc.
All these are iconic models of actual engine and boiler etc.

(ii) Analogue Model: In this model one set of properties are used to represent
another set of properties. Many times we represent various aspects on graph
by different colours or different lines all these are analog models.

(iii) Symbolic Models or Mathematical Models: In these models the variables of

a problem are represented by mathematical symbols, letters etc. To show
the relationships between variables and constraints we use mathematical
symbols.

(b) Classification by function

Depending on the use of the model or purpose of the model, the models are
classified as Descriptive, Predictive and normative models.

(i) Descriptive model: The descriptive models explain various operations in

non mathematical language and try to define the functional relationships
and interactions between various operations. They simply describe some
aspects of the system on the basis of observations, survey or questionnaire.

(ii) Predictive model: These models basing on the data collected, can predict
the approximate results of the situation under question.

(iii) Normative models: If the predictions of these models are successful, then
it can be used conveniently to prescribe the courses of action to be taken. In
such case we call it as Normative or Prescriptive model.

(c) Classification by nature of environment

Depending on the environment in which the problem exists and the
decisions are made, and depending on the conditions of variables, the
models may be categorized as Deterministic models and Probabilistic models.

(i) Deterministic Models: In this model the operations research analyst

assumes complete certainty about the values of the variables and the
available resources and expects that they do not change during the planning
horizon. All these are deterministic models and do not contain the element
of uncertainty or probability.
(ii) Probabilistic or Stochastic Models: In these models, the values of
variables, the pay offs of a certain course of action cannot be predicted
accurately because of element of probability. It takes into consideration
element of risk into consideration. The degree of certainty varies from
situation to situation.

(d) Classification by the time horizon

Depending on the behaviour of the variables and constraints of the problem
they may be classified as Static Models or Dynamic models.

(i) Static Models: These models assume that no changes in the values of
variables given in the problem for the given planning horizon due to any
change in the environment or conditions of the system. All the values given
are independent of the time.

(ii) Dynamic Models: In these models the values of given variables goes on
changing with time or change in environment or change in the conditions of
the given system.

(e) Classification by degree of abstraction

By degree of abstraction the models are classified as mathematical models

and language models.

(i) Mathematical Models: Mathematical models are the most abstract type
since it requires not only mathematical knowledge but also great
concentration to get the idea of the real life situation they represent.
Problem is represented by mathematical equations.

(ii) Language Models: Least abstract since they instantaneously suggest the
shape or characteristics of the modelled entity. Cricket commentary is the
example for language model.
(f) Classification by generality

(i) General models: The model that can be used in number of functions or
departments of an organization is called general model.

(ii) Specific models: Model that can be used in only one department like sales
response curve used in marketing is called specific model
Objective of OR

The industrial growth has brought with it the need for division of
management functions within the organisation. Thus every organisation has
number of departments in it. Every department is having its own policy
which is the part of the organisation. Finally the total cost or process
parameters of the organisation should be optimized.

With economic growth uncertainty is also growing. This makes each decision
costlier and time consuming. However in the competitive world today, one
has to take quick decisions because any delay may only help the
competitors. The decision has to be quick as well as sound. This requires a
rigorous and scientific approach to the problem.

Two business realities a manager has to face are change and uncertainty.
The market demand fluctuates, raw materials and spares become scarce,
production equipment fails or the change in government policies may affect
the company’s policy drastically. Under such situations past experience or
past data and future trends help the manager in taking decisions. OR can
help the managers here.

To summarise the OBJECTIVE of the OR is “To provide a scientific basis to

the managers of an organisation for solving problems involving interaction of
the components of the system by employing a system approach by a team of
scientists drawn from different disciplines for finding a solution which is in
the best interest of the organisation as a whole”

Phases of OR (or) Methodology of OR

Operations research, like all scientific research is based on scientific

methodology which proceeds along the following lines.
1. Formulating the problem
2. Constructing the model
3. Deriving the solution from the model
4. Testing the model and solution derived from it
5. Establishing the controls over the solution
6. Implementation or Putting the solution to work

Advantages of a Good Model

1. A model provides logical and systematic approach to the problem.
2. It provides the analyst a base for understand the problem and
solution
3. The model will avoid the duplication work in solving the problem.
4. Models fix the limitation and scope of an activity.
5. Models help the analyst to find newer ways of solving the problem.
6. Models saves resources like money, time etc.
7. Model helps analyst to make complexities of a real environment
simple.
8. Risk of tampering the real object is reduced.
9. Models provide distilled economic descriptions and explanations of the
operation of the system they represent.

Limitations of OR Model

1. OR models does not take all influencing factors which are real in to
consideration
2. Mathematical models are applicable to only specific categories of
problems.
3. Considerations of all the factors and establishing the relation between
them requires large calculations.
4. Being a new field there is a resistance from the employees to the new
proposals.
5. Management also offer a lot of resistance due to convensional thinking.
 LINEAR PROGRAMMING

INTRODUCTION

A model, which is used for optimum allocation of scarce or limited resources

to competing products or activities under such assumptions as certainty,
linearity, fixed technology, and constant profit per unit, is linear
programming.

PROPERTIES OF LINEAR PROGRAMMING MODEL

Any linear programming model (problem) must have the following properties:

(a) The relationship between variables and constraints must be linear.

(b) The model must have an objective function.
(c) The model must have structural constraints.
(d) The model must have non-negativity constraint.

Assumptions in LPP

The following are some important assumptions made in formulating a linear

programming model:
1. It is assumed that the decision maker here is completely certain (i.e.,
deterministic conditions) regarding all aspects of the situation, i.e.,
availability of resources, profit contribution of the products,
technology, courses of action and their consequences etc.
2. It is assumed that the relationship between variables in the problem
and the resources available exhibits linearity. Here the term linearity
implies proportionality and additivity.
3. We assume here fixed technology. Fixed technology refers to the fact
that the production requirements are fixed during the planning period
and will not change in the period.
4. It is assumed that the profit contribution of a product remains constant,
irrespective of level of production and sales.
5. It is assumed that the decision variables are continuous. It means that
the companies manufacture products in fractional units.
6. It is assumed that only one decision is required for the planning
period.
7. All variables are restricted to nonnegative values
 TRANSPORTATION
COMPARISON BETWEEN TRANSPORTATION MODEL AND GENERAL
LINEAR PROGRAMMING MODEL

Similarities
1. Both have objective function.
2. Both have linear objective function.
3. Both have non - negativity constraints.
4. Both can be solved by simplex method.
5. A general linear programming problem can be reduced to a
transportation problem if the coefficients of the structural variables in
the constraints are restricted to the values 0 or 1 and there exists
homogeneity of units among the constraints.

Differences
1. Transportation model is basically a minimization model; whereas
general linear programming model may be of maximization type or
minimization type.
2. The resources, for which, the structural constraints are built up is
homogeneous in transportation model; where as in general linear
programming model they are different.
3. The transportation problem is solved by transportation algorithm;
whereas the general linear programming problem is solved by simplex
method.
4. The values of structural coefficients are not restricted to any value in
general linear programming model, where as it is restricted to values
either 0 or 1 in transportation problem.

DEGENERACY IN TRANSPORTATION PROBLEM

The basic feasible solution of a transportation problem must have (m +

n – 1) basis variables or allocations. This means to say that the number of
occupied cells or loaded cells in a given transportation problem is 1 less
than the sum of number of rows and columns in the transportation matrix.
Whenever the number of occupied cells is less than (m + n – 1), the
transportation problem is said to be degenerate.

Degeneracy in transportation problem can develop in two ways. First,

the problem becomes degenerate when the initial programme is designed by
northwest corner or inspection or VAM, i.e. at the stage of initial allocation
only.

To solve degeneracy at this stage, we can allocate extremely small

amount of goods (very close to zero) to one or more of the empty cells
depending on the shortage, so that the total occupied cells becomes m + n –
1. The cell to which small element (load) is allocated is considered to be an
occupied cell. In transportation problems, Greek letter ‘∈’ represents the
small amount.
 One must be careful enough to see that the smallest element epsilon
is added to such an empty cell, which will enable us to write row number ‘ui’
and column number ‘vj’ without any difficulty while giving optimality test to
the basic feasible solution by MODI method. That is care must be taken to
see that the epsilon is added to such a cell, which will not make a closed
loop, when we move horizontally and vertically from loaded cell to loaded
cell.

Secondly, the transportation problem may become degenerate during

the solution stages. This happens when the inclusion of a most favourable
empty cell i.e. cell having highest opportunity cost results in simultaneous
vacating of two or more of the currently occupied cells. Here also, to solve
degeneracy, add epsilon to one or more of the empty cells to make the
number of occupied cells equals to (m + n – 1).
 ASSIGNMENT

COMPARISION BETWEEN TRANSPORTATION PROBLEM AND

ASSIGNMENT PROBLEM

Similarities
1. Both are special types of linear programming problems.
2. Both have objective function, structural constraints, and non-
negativity constraints. And the relationship between variables and
constraints are linear.
3. The coefficients of variables in the solution will be either 1 or zero in
both cases.
4. Both are basically minimization problems. For converting them into
maximization problem same procedure is used.
 SEQUENCING
Assumptions Made in Sequencing Problems

Principal assumptions made for convenience in solving the sequencing

problems are as follows:

a. The processing times Ai and Bi etc. are exactly known to us and they
are independent of order of processing the job on the machine.
b. The time taken by the job from one machine to other after processing
on the previous machine is negligible.
c. Each job once started on the machine, we should not stop the
processing in the middle. It is to be processed completely before
loading the next job.
d. The job starts on the machine as soon as the job and the machine
both become idle.
e. No machine may process more than one job simultaneously.
f. The cost of keeping the semi-finished job in inventory when next
machine on which the job is to be processed is busy is assumed to be
same for all jobs or it is assumed that it is too small and is negligible.
g. While processing, no job is given priority i.e. the order of completion of
jobs has no significance.
h. There is only one machine of each type.
 REPLACEMENT

TYPES OF REPLACEMENT PROBLEMS

One must remember that the study of Replacement of items is a field of
application rather than a method of analysis. The study involves the
comparison of alternative replacement policies. Various types of replacement
problems we come across are
(a) Replacement of Capital equipment, which loses its operating efficiency
due to aging or due to continuous usage. Examples are: Machine tools,
Transport and other vehicles, etc. In this case the deterioration process is
predictable and is represented by an increased maintenance cost and de
creased in scrap cost and increased production cost per unit. In such cases
the optimum life of the item is determined on the assumption that increased
age reduces efficiency. These types of problems are solved by two methods.
i. By calculating the cost per unit of time, without considering the
money value. Here we calculate the total cost up to the period and
divide by time unit to find the average cost to decide the period of
replacement.
ii. By taking the money value into consideration using present value
concept to compare on a one number basis.

(b) Replacement of items that fail completely all in a sudden in a random

nature. We use Group replacement or Preventive maintenance
technique for these items and these are expensive to replace individually.
Examples are: Electric bulbs, Transistors, Electronic components etc. Here
replacement of items is done in anticipation of failure, which is known as
preventive maintenance.

(c) Replacement of human beings in organizations, known as Staffing

problem, or known as Human resource planning or Mortality and
Staffing problem. This problem requires the knowledge of life distribution
for service of staff in a system.

(d) Miscellaneous problems such as replacement of existing units due to

availability of more effective and new and advanced technology. In these
problems replacement will become necessary due to research of new and
advanced and more effective technology and old technology becomes out of
date.
 INVENTORY CONTROL

DEFINITION OF INVENTORY AND INVENTORY CONTROL

The word inventory means a physical stock of material or goods or

commodities or other economic resources that are stored or reserved or kept
in stock or in hand for smooth and efficient running of future affairs of an
organization at the minimum cost of funds or capital blocked in the form of
materials or goods.

The function of directing the movement of goods through the entire

manufacturing cycle from the requisitioning of raw materials to the
inventory of finished goods in an orderly manner to meet the objectives of
maximum customer service with minimum investment and efficient plant
operation is termed as inventory control.

Classification of Inventories
Inventories may be classified as those which play direct role during
manufacture or which can be identified on the product and the second one
are those which are required for manufacturing but not as a part of
production or cannot be identified on the product. The first type is labelled
as direct inventories and the second are labelled as indirect inventories.
Further classification of direct and indirect inventories is as follows:

(A) Direct inventories

(i) Raw material inventories: The inventory of raw materials is the

materials used in the manufacture of product and can be identified on the
product. In inventory control manager can concentrate on the
(a) Bulk purchase of materials to save the investment,
(b) To meet the changes in production rate,
(c) To plan for buffer stock or safety stock to serve against the delay in
delivery of inventory against orders placed and also against seasonal
fluctuations.
(ii) Work-in -process inventories or in process inventories: These
inventories are of semi-finished type, which are accumulated between
operations or facilities. As far as possible holding of materials between
operations to be minimized if not avoided. This is because; as we process the
materials the economic value and use value are added to the raw material,
which is drawn from stores. Hence if we hold these semi finished material
for a long time the inventory carrying cost goes on increasing, which is not
advisable in inventory control. These inventories serve the following
purpose:
(a) Provide economical lot production,
(b) Cater to the variety of products,
(c) Replacement of wastages,
(d) To maintain uniform production even if sales varies.
(iii) Finished goods inventories: After finishing the production process
and packing, the finished products are stocked in stock room. These are
known as finished goods inventory. These are maintained to:
(a) To ensure the adequate supply to the customers,
(b) To allow stabilization of the production level and
(c) To help sales promotion programme.
(iv) Spare parts inventories: Any product sold to the customer, will be
subjected to wear and tear due to usage and the customer has to replace the
worn-out part. Hence the manufacturers always calculate the life of the
various components of his product and try to supply the spare components
to the market to help after sales service. The use of such spare parts
inventory is:
(a) To provide after sales service to the customer,
(b) To utilize the product fully and economically by the customer.
(iv) Scrap or waste inventory: While processing the materials, we may
come across certain wastages and certain bad components (scrap), which
are of no use. These may be used by some other industries as raw material.
These are to be collected and kept in a place away from main stores and are
disposed periodically by auctioning.

(B) Indirect Inventories

Inventories or materials like oils, grease, lubricants, cotton waste and such
other materials are required during the production process. But we cannot
identify them on the product. These are known as indirect inventories. In
our discussion of inventories, in this chapter, we only discuss about the
direct inventories. Inventories may also be classified depending on their
nature of use. They are:
(i) Fluctuation Inventories: These inventories are carried out to safeguard
the fluctuation in demand, non-delivery of material in time due to extended
lead-time. These are sometimes called as Safety stock or reserves. In real
world inventory situations, the material may not be received in time as
expected due to trouble in transport system or some times, the demand for a
certain material may increase unexpectedly. To safeguard such situations,
safety stocks are maintained. The level of this stock will fluctuate depending
on the demand and lead-time etc.
(ii) Anticipation inventory: When there is an indication that the demand
for company’s product is going to be increased in the coming season, a large
stock of material is stored in anticipation. Some times in anticipation of
raising prices, the material is stocked. Such inventories, which are stocked
in anticipation of raising demand or raising rises, are known as anticipation
inventories.
(iii) Lot size inventory or Cycle inventories: This situation happens in
batch production system. In this system products are produced in economic
batch quantities. It sometime happens that the materials are procured in
quantities larger than the economic quantities to meet the fluctuation in
demand. In such cases the excess materials are stocked, which are known
as lot size or cycle inventories.
(iv) Transportation Inventories: When an item is ordered and purchased,
they are to be received from the supplier, who is at a far of distance. The
materials are shipped or loaded to a transport vehicle and it will be in the
vehicle until it is delivered to the receiver. Similarly, when a finished product
is sent to the customer by a transport vehicle it cannot be used by the
purchaser until he receives it. Such inventories, which are in transit, are
known as Transportation inventories.
(v) Decoupling inventories: These inventories are stocked in the
manufacturing plant as a precaution, in case the semi finished from one
machine does not come to the next machine, this stock is used to continue a
production. Such items are known as decoupling inventories.

COSTS ASSOCIATED WITH INVENTORY

While maintaining the inventories, we will come across certain costs
associated with inventory, which are known as economic parameters. Most
important of them are discussed below:

(A) Inventory Carrying Charges, or Inventory Carrying Cost or Holding

Cost or Storage Cost (C1)
This cost arises due to holding of stock of material in stock. This cost
includes the cost of maintaining the inventory and is proportional to the
quantity of material held in stock and the time for which the material is
maintained in stock. The components of inventory carrying cost are:

(i) Rent for the building in which the stock is maintained if it is a rented
building. In case it is own building, depreciation cost of the building is taken
into consideration. Sometimes for own buildings, the nominal rent is
calculated depending on the local rate of rent and is taken into
consideration.
(ii) It includes the cost of equipment if any and cost of racks and any special
facilities used in the stores.
(iii) Interest on the money locked in the form of inventory or on the money
invested in purchasing the inventory.
(iv) The cost of stationery used for maintaining the inventory.
(v) The wages of personnel working in the stores.
(vi) Cost of depreciation, insurance.
(vii) Cost of deterioration due to evaporation, spoilage of material etc.
(viii) Cost of obsolescence due to change in requirement of material or
changed in process or change in design and item stored as a result of
becomes old stock and become useless.
(ix) Cost of theft and pilferage i.e. indenting for the material in excess of
requirement.

(B) Shortage cost or Stock - out - cost- (C2)

Sometimes it so happens that the material may not be available when
needed or when the demand arises. In such cases the production has to be
stopped until the procurement of the material, which may lead to miss the
delivery dates or delayed production. When the organization could not meet
the delivery promises, it has to pay penalty to the customer. Such type of
cost is called shortage cost. The cost is generally represented as so many
rupees and is represented by C2.

(C) Set up cost or Ordering cost or Replenishment Cost (C3)

For purchase models, the cost is termed as ordering cost or procurement
cost and for manufacturing cost it is termed as set up cost and is
represented by C3.
(i) Set up cost: The term set up cost is used for production or
manufacturing models. Whenever a job is to be produced, the machine is to
set to produce the job. That is the tool is to be set and the material is to be
fixed in the jobholder. This consumes some time. During this time the
machine will be idle and the labour is working. The cost of idle machine and
cost of labour charges are to be added to the cost of production.

(ii) Ordering Cost or Replenishment Cost: The term Ordering cost or

Replenishment cost is used in purchase models. Whenever any material is
to be procured by an organization, it has to place an order with the supplier.
The cost of stationary used for placing the order, the cost of salary of
officials involved in preparing the order and the postal expenses and after
placing the order enquiry charges all put together, is known as ordering
cost.
(iii) Procurement Cost: These costs are very much similar to the ordering
cost / set up cost. This cost includes cost of inspection of materials, cost of
returning the low quality materials, transportation cost from the source of
material to the purchaser‘s site. This is proportional to the quantity of
materials involved.

(D) Purchase price or direct production cost

This is the actual purchase price of the material or the direct production
cost of the product. It is represented by ‘p’. i.e. the cost of material is Rs. ‘p’
per unit. This may be constant or variable.

PURPOSE OF MAINTAINING INVENTORY OR OBJECTIVE OF

INVENTORY COST CONTROL

The purpose of maintaining the inventory or controlling the cost of inventory

is to use the available capital optimally (efficiently) so that inventory cost per
item of material will be minimum. The objective of controlling the inventories
is to enable the materials manager to place and order at right time with the
right source at right price to purchase right quantity.

The benefits derived from efficient inventory control are:

(i) It ensures adequate supply of goods to the customer or adequate of
quantity of raw materials to the manufacturing department so that the
situation of stock out may be reduced or avoided.
(ii) By proper inventory cost control, the available capital may be used
efficiently or optimally, by avoiding the unnecessary expenditure on
inventory.
(iii) In production models, while estimating the cost of the product the
material cost is to be added. The manager has to decide whether he has to
take the actual purchase price of the material or the current market price of
the material. The current market price may be less than or greater than the
purchase price of the material which has been purchased some period back.
Proper inventory control reduces such risks.
(iv) It ensures smooth and efficient running of an organization and provides
safety against late delivery times to the customer due to uncontrollable
factors.
(v) A careful materials manager may take advantage of price discounts and
make bulk purchase at the same time he can keep the inventory cost at
minimum.
(vi) It enables a manager to select a proper transportation mode to reduce
the cost of transportation.
(vi) Avoids the chances of duplicate ordering.
(vii) It avoids losses due to deterioration and obsolescence etc.
(viii) Causes of surplus stock may be controlled or totally avoided.
(ix) Proper inventory control will ensure the availability of the required
material in required quantity at required time with the minimum inventory
cost.

Procedure for ABC analysis

1. List out all items in stores along with their unit price and annual
consumption.
2. Calculate the annual consumption cost of each item, which is given by
multiplying the quantity consumed in the time period and the unit cost. If ‘q’
is the quantity consumed in the time period and ‘p’ is the unit price then
annual consumption value = q × p = qp.
3. Rearrange the list in the descending order of the annual consumption
cost. i.e. highest cost at the top and next highest is the second and so on
and the last item is the lowest consumption value item.
4. Calculate the cumulative total of annual consumption value.
5. Find the parentage of each cumulative value with respect to the total cost
of inventory.
6. Mark a line at 70%, 90% and at 100%. All the items covered by 70% line
are ‘A’ class items, those which are covered between 70% line and 90% line
are ‘B’ class items and those are covered by 90% and 100 % are ‘C’ class
items.
 QUEUING THEORY

QUEUING SYSTEM OR PROCESS

One thing we have to remember is that when we speak of queue, we have to

deal with two elements, i.e. Arrivals and Service facility. Entire queuing
system can be completely described by:
(a) The input (Arrival pattern)
(b) The service mechanism or service pattern,
(c) The queue discipline and
(d) Customer behaviour.

CUSTOMER BEHAVIOUR

The length of the queue or the waiting time of a customer or the idle time of
the service facility mostly depends on the behaviour of the customer. Here
the behaviour refers to the impatience of a customer during the stay in the
line. Customer behaviour can be classified as:

(i) Balking: This behaviour signifies that the customer does not like to
join the queue seeing the long length of it. This behaviour may
effect in losing a customer by the organization. Always a lengthy
queue indicates insufficient service facility and customer may not
turn out next time. For example, a customer who wants to go by
train to his destination goes to railway station and after seeing the
long queue in front of the ticket counter, may not like to join the
queue and seek other type of transport to reach his destination.
(ii) Reneging: In this case the customer joins the queue and after
waiting for certain time loses his patience and leaves the queue.
This behaviour of the customer may also cause loss of customer to
the organization.
(iii) Collusion: In this case several customers may collaborate and only
one of them may stand in the queue. One customer represents a
group of customer. Here the queue length may be small but service
time for an individual will be more. This may break the patience of
the other customers in the waiting line and situation may lead to
any type of worst episode.
(iv) Jockeying: If there are number of waiting lines depending on the
number of service stations, for example Petrol bunks, Cinema
theatres, etc. A customer in one of the queue after seeing the other
queue length, which is shorter, with a hope of getting the service,
may leave the present queue and join the shorter queue. Perhaps
the situation may be that other queue which is shorter may be
having more number of Collaborated customers. In such case the
probability of getting service to the customer who has changed the
queue may be very less. Because of this character of the customer,
the queue lengths may goes on changing from time to time.
 GAME THEORY
Assumptions in game theory

1. There is finite number of competitors called Players. This is to say

that the game is played by two or more number of business
houses. The game may be for creating new market, or to increase
the market share or to increase the competitiveness of the product.
2. A list of finite or infinite number of possible courses of action is
available to each player. The list need not be the same for each
player. Such a game is said to be in normal form.
3. A play is played when each player chooses one of his courses of
action. The choices are made simultaneously, so that no player
knows his opponent's choice until he has decided his own course
of action.
4. All players act rationally and intelligently.
5. Each player is interested in maximizing his gains or minimizing
his losses. The player on the left side of the matrix always tries to
maximize his gains and is known as Maximin player. The player
who is at the top of the matrix, a loser always tries to minimize his
losses and is known as Minimax player
6. Each player makes individual decisions without direct
communication between the players.
7. It is assumed that each player knows complete relevant
information.

Classification of Games

Game theory models can be classified in a number of ways, depending on

such factors as the:
(i) Number of players,
(ii) Algebraic sum of gains and losses
(iii) Number of strategies of each player, which decides the size of matrix.

Rules of dominance can be formulated as below

1. If all the elements of a column (say ith column) are greater than or equal
to the corresponding elements of any other column (say jth column), then
ith column is dominated by jth column.
2. If all the elements of rth row are less than or equal to the corresponding
elements of any other row, say sth row, then rth row is dominated by sth
row.
3. A pure strategy of a player may also be dominated if it is inferior to some
convex combinations of two or more pure strategies, as a particular case,
inferior to the averages of two or more pure strategies.
 DYNAMIC PROGRAMMING
Principle of Optimality: Bellman’s Principle of optimality states that ‘‘An
optimal policy (a sequence of decisions) has the property that whatever the
initial state and decision are, the remaining decisions must constitute an
optimal policy with regard to the state resulting from the first decision.’’

CHARACTERISTICS OF DYNAMIC PROGRAMMING

The basic features, which characterize the dynamic programming problem,
are as follows:
(i) Problem can be sub-divided into stages with a policy decision required at
each stage. A stage is a device to sequence the decisions. That is, it
decomposes a problem into sub-problems such that an optimal solution to
the problem can be obtained from the optimal solution to the sub-problem.
(ii) Every stage consists of a number of states associated with it. The states
are the different possible conditions in which the system may find itself at
that stage of the problem.
(iii) Decision at each stage converts the current stage into state associated
with the next stage.
(iv) The state of the system at a stage is described by a set of variables,
called state variables.
(v) When the current state is known, an optimal policy for the remaining
stages is independent of the policy of the previous ones.
(vi) To identify the optimum policy for each state of the system, a recursive
equation is formulated with ‘n’ stages remaining, given the optimal policy for
each stage with (n – 1) stages left.
(vii) Using recursive equation approach each time the solution procedure
moves backward, stage by stage for obtaining the optimum policy of each
stage for that particular stage, still it attains the optimum policy beginning
at the initial stage.