Merged SMB110!1!6

Project & Operations Management
Block
I
PROJECT MANAGEMENT AN OVERVIEW
UNIT 1
Introduction to Project Management 1-25
UNIT 2
Project Idea Generation and Screening 26-51
UNIT 3
Market and Technical Analysis of Projects 52-78
UNIT 4
Financial Analysis of Projects 79-120
UNIT 5
Project Selection 121-149
Expert Committee
Dr. J. Mahender Reddy Prof. S. S. George
Vice Chancellor Director, ICMR
IFHE (Deemed to be University) IFHE (Deemed to be University)
Hyderabad Hyderabad

Prof. Y. K. Bhushan Dr. 0. P. Gupta
Vice Chancellor Vice Chancellor
IU, Meghalaya IU, Nagaland

Prof. Loveraj Takru Prof. D. S. Rao
Director, IBS Dehradun Director, IBS, Hyderabad
IU, Dehradun IFHE (Deemed to be University)
Hyderabad

Course Preparation Team

Prof. Vivek Gupta
IFHE (Deemed to be University)
Hyderabad

Prof. Ramalingam Meenakshisundaram
Hyderabad

Ms. Smita Singh
IU, Sikkim

Mr. Ch Syamala Devi
IU, Meghalaya

Ms. Pushpanjali Mikkilineni
Hyderabad

Mr. Mrinmoy Bhattacharjee
IU, Mizoram
Aizawal

Prof. Tarak Nath Shah
IU, Dehradun

Mr. Manoj Kumar De
IU, Tripura
Agartala

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Course Introduction
Project management plays an important
strategy. Projects enable organizations to convert their strategies into actions,
and their objectives into reality. Although many of the project management
tools are derived from other management disciplines, project management is a
specialized field, with unique management techniques such as critical path
analysis and work breakdown structures. In the present scenario, the
application of project management is no longer limited to the projects in
construction and engineering sectors; these techniques are also applied to
projects in fields as diverse as education, healthcare, and software
development.
Timely and proper implementation of project and operations management
techniques enables effective management of resources which are used by the
organizations to produce goods and services. Growing inter-firm rivalry and
competition has increased the importance of operations management in
organizations. Of late, operations management has gained a lot of importance,
and has become a key discipline in management science. Organizations use
various operations management techniques to make decisions on various
aspects like facility location and capacity determination, identification of
appropriate manpower, determination of optimum inventory levels, and
production scheduling and job assignment.
Project & Operations Management examines key issues involved in the fields
of project management and operations management. The course is divided
into two major parts.
The first part of the course introduces students to the project management
The course discusses the complexities involved in handling projects and
managing the various phases of the project life cycle.
The second part of the course presents a step-by-step analysis of the activities
of operations managers and provides an understanding of the planning,
organizing, controlling, directing, motivating and coordinating activities of an
operations system in manufacturing and service organizations.
Block I
Project Management An Overview
The first block of the course on Project & Operations Management provides
an introduction to project management. The block contains five units. The first
unit provides an idea about project management. The second unit focuses on
the first stage of the project life cycle, that is, idea generation and screening of
projects. The third unit discusses the market, technical and environmental
analysis of projects, while the fourth unit examines the financial analysis of
projects. The fifth unit discusses project selection.
The first unit, Introduction to Project Management, discusses the definitions
of a project, program and project management. The unit focuses on the
characteristics, parameters and classification of projects. It examines the
relationship between the various project parameters, between project
management and other management disciplines, and between project
management and line management. The unit also deals with the project
management environment. It discusses project stakeholders, organizational
influences and project life cycle.
The second unit, Project Idea Generation and Screening, deals with the
generation of project ideas and discusses the various creative techniques
involved in the generation of ideas. The unit explains the various aspects in
scanning of the business environment. It then discusses the activities that can
be carried out to generate new project ideas. The unit explains the process of
initial screening of project ideas, and about the project rating index, an
evaluation method used to streamlining the initial screening process. Finally,
the unit discusses the factors that can be used by the firms to enhance the net
present value of a project.
The third unit, Market and Technical Analysis of Projects, deals with market
analysis, demand analysis, and technical analysis of projects. Under market
and demand analysis, the unit provides an idea about situational analysis and
objectives specification, collection of data, market survey, market description,
demand forecasting, uncertainties in demand forecasting and market planning.
Under technical analysis, the unit explains technology selection, input
requirements and utilities, product mix, plant capacity and functional layout,
location of the project, machinery and equipment and consideration of
alternatives.
The fourth unit, Financial Analysis of Projects, discusses the means of
financing the project. It provides an idea about the working capital
requirements and financing. It discusses the concepts of time value of money,
cost of capital, project appraisal criteria and risk analysis in capital investment
decisions. Finally, it discusses social cost benefit analysis.
The fifth unit, Project Selection, provides the criteria for project selection
models. The unit explains the various project selection models. It discusses the
ways and techniques used to analyze the uncertainties in a project. Finally, the
unit explains project proposal.
Unit 1
Introduction to Project Management
Structure
1. Introduction
2. Objectives
3. Definition of Project
4. Project Characteristics
5. Project Parameters
6. Relationship between Project Parameters
7. Classification of Projects
8. Definition of a Program
9. Project Management
10. Project Management Relationship with other Management Disciplines
11. Relationship between Project Management and Line Management
12. Project Stakeholders
13. Organizational Influences
14. Socio-economic Influences
15. Environmental and Legal Influences
16. Project Phases and the Project Life Cycle
17. Summary
18. Glossary
19. Self-Assessment Exercises
20. Suggested Reading/Reference Material
21. Answers to Check Your Progress Questions
1. Introduction
In this unit, we introduce you to the concepts in project management. Men have been
planning and managing projects since the beginning of civilization. Of late, people
recognized that techniques like cost control, scheduling of activities, resource
procurement, and risk management that are relevant for the success of a variety of
projects, whether building dams, laying roads, or organizing events. This led to the
evolution of a set of unique management tools, techniques, and methodologies, which
recognition as a specialized area of management about 50 years ago. Today, project
management has spread from its traditional focus on the fields of construction and
engineering into sectors as diverse as education, healthcare and software development.
This unit will introduce you to project management by discussing the definitions of
project, program, and project management. We will discuss the characteristics,
parameters and classification of projects. We shall then move on to discuss the
relationship between the various project parameters, between project management and
other management disciplines and between project management and line management.
Finally, we would be discussing the project management environment including
project stakeholders, organizational influences and project life cycle.
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2. Objectives
By the end of this unit, students should be able to:
define a project.
discuss the characteristics of a project.
identify the various project parameters, and demonstrate the relationship between
them.
classify projects.
define a program.
explain project management, and recognize the relationship of project management
with other management disciplines.
demonstrate the relationship between project management and line management.
define project stakeholders.
identify organizational, socio-economic, environmental and legal influences.
state the project phases, and explain the project life cycle.
3. Definition of Project
A project is a group of unique, inter-related activities that are planned and executed in
a certain sequence to create a unique product and/or service, within a specific time
a
temporary endeavor undertaken to create a unique product or service.
coordinated activities, with definite starting and finishing points, undertaken by an
individual or organization to meet specific objectives within defined schedule, cost,
Projects and operations are generally considered similar as both are carried out by
people, and are planned, implemented, and controlled to produce results within the
given resource constraints. However, projects are different from operations as they
policies and initiatives of the government.
Check Your Progress
1. In which of the following sectors is project management applicable?
i. Construction and engineering
ii. Education
iii. Healthcare
iv. Software development
a. Only i, ii, and iii
b. Only i, iii, and iv
c. Only ii, iii, and iv
d. i, ii, iii, and iv
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2. Which of the following options has defi
a. British Standard 6079 of 1996
b. Project Management Institute
c. Tandon Committee
d. American National Standards Institute (ANSI)
3. _______________ can be defined as a group of unique, inter-related activities
that are planned and executed in a certain sequence to create a unique product or
a. Operations
b. Process
c. Project
d. Program
4. Which of the following statements is true regarding projects and operations?
i. Projects and operations are generally considered similar.
ii. Projects and operations are both carried out by people.
iii. Projects and operations are planned, implemented, and controlled to produce
results within the given resource constraints.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
4. Project Characteristics
Organizational structures and processes are custom-made to produce a specific
product and/or service. Sometimes, organizations have to take up new tasks that they
are not equipped to handle. These tasks are new to the organization as they are not
performed earlier or they may not be repeated in the future again. To perform such
unique tasks, organizations adopt the project approach. The project approach is
adopted when the existing systems in the parent organization are not equipped to
handle new task. Some of the characteristics of the tasks that qualify to be projects are
unique activities, attainment of a specific goal, sequence of activities, specified time
and interrelated activities.
Unique Activities
Every project has a set of activities that are unique, which means it is the first time that
an organization handles that type of activity. These activities do not repeat in the project
under similar circumstances, i.e., there will be something different in every activity or
even if the activity is repeated, the variables influencing it change every time.
Attainment of a Specific Goal
Organizations take up projects to perform a particular task or attain a specific goal.
These tasks differ from project to project. The projects in an organization could be
constructing a new facility, computerizing the accounts department or studying the
demand for a new product that the organization plans to launch in the market. All
these projects have a specific goal or result to attain and hence we can say that every
project is goal-oriented.
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Sequence of Activities
A project consists of various activities that are to be performed in a particular
sequence to deliver the end-product. This sequence depends on the technical
requirements and interdependency of each of the activities.
Specified Time
Every project has a specified start date and completion date. This time limit is either
self-imposed or it is specified by the client. The life span of a project can run from a
few hours to a few years. A project comes to a close when it delivers the product
longer possible for the project to deliver the final product and/or service as required
by the client.
Interrelated Activities
Projects consist of various technically interrelated activities. These activities are
considered interrelated as the deliverable (output) of one activity becomes the input
for another activity of the project. Consider the project of building a multistoried
luxury hotel. This project consists of various activities such as making a building plan,
landscaping, constructing the building, designing the interiors, furnishing the rooms,
etc. All these activities are interrelated and are equally important for the completion of
the project.
5. Project Parameters
The primary aim of a project is to deliver a product and/or service to a client within
the specified time, budget (resources and cost), and according to the quality and
performance specifications. Usually, the clients ask for too much to be delivered
within limited resources. Therefore, it is important for the project manager to make
the clients aware of the limitations pertaining to time, budget, technicalities, etc., that
he/she is working under.
ability to strike a balance between these interrelated variables or constraints. Some
common constraints that influence a project are scope, quality, time, cost and resources.
Scope
Scope is a brief and accurate description of the end-products or deliverables to be
expected from the project that meet the requirements. Scope describes all the activities
that are to be performed, resources that will be consumed, and the end-products from
the successful completion of the project, including the quality standards. The scope
also includes the target outcomes, prospective customers, outputs, work, financial and
human resources required to complete the project.
Quality
Every project has to satisfy the quality requirements at two levels product quality
and process quality. The first quality requirement relates to products resulting from
the project and the second relates to the management processes that have to be in
place to implement the project. A comprehensive quality management system ensures
effective utilization of scarce resources to achieve the project objective of delivering
products and/or services to the client
Time
Time is one of the important resources available to a project manager. At the same
time, it is one of the major constraints within which a project has to be completed.
Generally, the client or the sponsor of the project specifies the time limit for the
completion of the project. The time required to complete a project is inversely related
to the cost of the project. Therefore, the cost of a project increases as the time
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available for its completion decreases. Since time cannot be stored as an inventory, it
is the duty of the project manager to manage time by carefully scheduling the various
activities on time.
Cost
Cost plays a major role in the various stages of a project life cycle. Project costs
include the monetary resources required to complete the activities mentioned in the
scope of the project. Project costs are costs associated with all the activities in the
planning and implementation phases. The client or the sponsor of the project prepares
a budget based on the estimated costs of various project activities, within which the
project manager has to deliver the product.
Resources
Resources include the people, finances, and the physical and information resources
required to perform the project activities.
Check Your Progress
5. Organizations adopt the project approach when ________________________.
i. the tasks are new to the organization
ii. the tasks may not be repeated in the future
iii. the existing systems in the parent organization are not equipped to handle the new
task.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
6. Which of the following is not a characteristic of a project?
a. Every project has a set of unique activities.
b. A project is taken up to perform a particular task or attain a specific goal.
c. A project consists of various technical activities that are independent and
unrelated.
d. A project consists of various activities that need to be performed in a particular
sequence to deliver the end-product.
7. ___________ can be defined as a brief and accurate description of the end-
products or deliverables to be expected from the project that meet the
requirements.
a. Quality
b. Scope
c. Program
d. Strategy
8. Identify the project resources.
i. People resources
ii. Financial resources
iii. Physical resources
iv. Information resources
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6. Relationship between Project Parameters
The scope and quality of a project are influenced by a variety of constraints like time,
cost, and availability of resources. The success of a project largely depends on the
the management prepares a project plan by estimating the approximate time, cost, and
the resources (people, equipment, land and buildings, etc.) required to accomplish the
goals mentioned in the scope and quality of the project as required by the
client/sponsor.
The project manager is given this plan describing the time, cost, and resource
allocations that are in equilibrium. But the success of the project depends on the
from within and outside (clients) the project system. The projects usually go off
balance when clients request for changes in time frame, scope and quality. The client
may want these changes because: there is a change in the market demand that requires
adding some more features to the end product; the product needs to be launched ahead
of its due date for competitive reasons; there is loss of key personnel or breakdown of
machinery that calls for rescheduling; and a new technology is expected in the market.
7. Classification of Projects
Projects can be classified based on their characteristics such as business value, risk
level, time span, complexity of tasks and the monetary value of the project. Projects
can be classified after studying them carefully. Once the project is classified, it
becomes easy for the management to select the project management style that best
suits that class of project.
Activity: Madurai Textiles is one of the leading manufacturers and exporters of
silk sarees in India. The company's revenues come from the export of sarees in
traditional designs to various countries in Europe, America and the Middle-East.
Of late, the demand for its products in the export market has come down
significantly owing to the changing tastes of the customers abroad. The company
sensed the need for modern designs and embarked on a project to introduce the
latest designs. It recruited three young graduates from the NIFT (National Institute
of Fashion Technology) to work on the new designs. Why do you think
organizations undertake projects? What are the different types of projects that an
organization can take up?
Answer:
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8. Definition of a Program
Since a program is a collection of different projects, it has wider scope than an
individual project. In business situations, it is very difficult for one project to deliver
all the benefits needed to achieve the objectives of an organization. Hence,
organizations take up business programs that are a combination of various projects
aimed at achieving corporate objectives.
9. Project Management
Project management is a system of procedures, practices, technologies, and know-how
that enables the planning, organizing, staffing, directing, and controlling necessary to
successfully manage a project. Accordin
application of knowledge, skills, tools and techniques to project activities in order to
Project management is a carefully planned and organized effort to accomplish a
specific (and usually) one-time effort, for example, constructing a residential complex
or implementing a new computerized banking system. Project management includes
developing a project plan that includes defining project goals, specifying how the
goals will be accomplished, what resources are needed, and relating budgets and time
for completion. It also includes implementing the project plan, along with careful
controls to ensure that the project is being managed according to the plan. Project
management usually follows five major phases feasibility study, project planning,
implementation, evaluation, and closing.
Check Your Progress
9. Projects usually go off-balance due to several reasons. Which of the following
options may not be a valid reason in such cases?
a. Change in the market demand that requires addition of new features
b. Breakdown of machinery
c. Recruitment of new employees in the organization
d. Loss of key personnel
10. Which of the following is not one of the five major phases in a project?
a. Controlling
b. Purchase management
c. Implementing
d. Closing
11. ______________ is a group of projects managed in a coordinated way to obtain
benefits not available from managing them individually.
a. Process
b. Program
c. Operation
d. None of the above
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10. Project Management Relationship with Other Management
Disciplines
Although project management has derived most of its knowledge from other
management disciplines, it has evolved as a specialized science over a period of time.
It has its own management techniques such as critical path analysis and work
breakdown structures (discussed later) that are unique to project management. Like
general management, project management also involves all aspects of planning,
organizing, implementing, and controlling. In many strategic projects, the function of
project management will involve disciplines like:
Finance: Preparing the financial statements while sending the project proposal and
managing the costs of the project.
Personnel: Identifying the skills required to carry out the project, selecting the project
team, and maintaining a good working environment.
Operations: Managing the activities/operations that are repetitive in nature.
Purchase and logistics: Identifying resources (raw materials, equipment, and
services) required for the project, preparing a list of eligible suppliers and negotiating
with them for procuring the right materials and managing the logistics for a smooth
implementation of the project.
R&D: New product development and quality assurance.
Marketing: Marketing the project idea to internal and external sponsors.
11. Relationship between Project Management and Line Management
According to the definition of project management, a project manager has to control
variables such as time, cost and other resources allocated for the project. But in
practice, he/she only has an indirect control over these resources as they are controlled
by the line managers or functional managers. Therefore, the project manager has to
maintain good relations with line managers to ensure a smooth flow of resources.
Thus, a project manager should exercise judicious control over the resources (money,
manpower, machinery, facilities, materials, technology, and information) allocated to
the project from various functional departments. The success of a project depends on
The characteristics of a
good relationship are:
amicable working relations between the project manager and the departmental heads
who allocate resources to the project.
functional project
department from where he/she comes from and the project manager for whom he/she
currently works for.
Employees of various functional departments who are selected to work on a
project usually face difficulties in reporting to multiple bosses. The issue of
who should have control over the functional employees becomes a source of
conflict between the line and the project managers. The relations can be
strained further if any one of them claims sole credit for the success of the
project or rewards for the profits generated by the project. These conflicts can
be resolved when the managers understand their distinct roles in achieving the
overall objectives of the organization.
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Check Your Progress
12. In case of strategic projects, the quality assurance function is taken care of by the
following discipline of project management:
a. Marketing
b. Purchase and Logistics
c. Operations
d. Research and Development
13. Which of the following statement is false regarding project management?
a. Project management involves developing a unique product or process and
managing change.
b. Project management involves managing many risk variables.
c. Project management involves managing the existing systems and services in an
organization.
d. Project management is performed as a one-time initiative that is conducted in a
relatively short time.
14. Which of the following situations will lead to conflicts between the project
managers and the line managers?
i. Issue of control over the functional employees who work for the project
ii. Difficulty in reporting to multiple bosses
iii. Claiming sole credit for the success of the project
iv. Claiming rewards for the profits generated by the project
12. Project Stakeholders
organizations who are actively involved in the project, or whose interest may be
positively or negatively affected as a result of project execution or successful project
The project management team should try to identify the stakeholders, determine
their needs and expectations, and then manage and influence those expectations t o
ensure a successful project. The manager can use methods like stakeholder analysis
to identify all the potential stakeholders who might have an impact on the project
and then determine their relative ability to influence the project. Project
stakeholders will include those -- who are directly related to the project like
suppliers, clients, employees, and managers; who can influence the physical,
organizational, technological, socio-economic, legal and political environments;
who have an authoritative relation to the project like government agencies at local,
regional, and national levels; and persons, groups, and associations that have a stake
in the project.
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Types of Stakeholders
The major stakeholders of any project include project manager, customers, project
team members, sponsor, and parent organization.
Project manager
The project manager is an important stakeholder of the project as he is responsible for
project activities are completed on time, within budget, and according to quality
standards. He also acts as an interface between customers and management. The
project manager is responsible for:
Ensuring the overall success of the project
Applying the experience gained from past and present projects, in future projects
Setting priorities for various project activities
Acting as a catalyst for resolving project problems and conflicts
Evaluating the strengths and weaknesses of the completed projects, and applying the
lessons learned to future projects
Providing timely information about the project to other stakeholders.
Customers
Customers are those who will use or pay for the deliverable (product or service)
produced by the project. These customers may be internal or external to the
organization. It is the responsibility of the customers to be actively involved in the
project to help ensure its successful completion. For some projects it may be difficult
to identify a specific group of customers. Generally, there are three categories of
customers: internal customers, intermediate customers and external customers.
Internal customers consist of individuals who are internal to the parent company. In
the above example, the production department is an internal customer. Intermediate
customers are usually external to the company, but they will not be the final users of
the product. Distributors and wholesalers constitute the intermediate customers of a
project. External customers are the individuals or organizations, who pay for the final
product and use it. The project team should consider all the requirements of different
categories of customers.
Project team members
All the groups and individuals who devote time, skills, and effort to the project
are regarded as project team members. Sometimes, the personnel of the vendor
and the client are also appointed members of the project team, along with the
employees of various functional departments who are assigned to the project.
Generally, project team members take care of the technical, managerial or the
administrative aspects of a project. They work directly with or under a project
manager, depending on the way the project is organized. The team members who
look after the technical aspects of a project perform activities concerned with
engineering, construction, procurement, quality and performance testing. The
members in charge of the administration of the project are involved in activities
concerned with planning, scheduling, budgeting, preparing status reports,
managing project communication etc. Team members play a crucial role in the
success of a project. Therefore, the project manager should use various team-
building skills to encourage the members to work as a team.
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Sponsor
A sponsor is an individual or a group within the parent organization who arranges the
resources for the project themselves. This assistance can be in cash or kind. The sponsor
may be a senior executive or a junior manager with formal authority who is responsible
for the project. He acts as a link between the project and the parent organization.
Parent Organization
The parent organization is a major stakeholder of the project since its employees are
directly involved in executing the project. Therefore, the project should contribute
towards achieving the corporate goals of the parent organization.
Activity: Sitcon Limited, a popular construction company in India, secured the first
major water retention barrage construction project in Bihar, India. The barrage was
expected to be the longest in India. Addressing the project team, the company CEO
success of this project depends more on how well you manage the stakeholders, as
this place is known for labor unrest, rivalry among local tribes, and many other
stakeholders in the success of this project? If yes, who are the stakeholders of this
project and what should the project team do to manage the stakeholders effectively?
Answer:
Check Your Progress
15. Which of the following statements are true regarding project stakeholders?
i. Project stakeholders are directly related to the project.
ii. They have a stake in the project.
iii. They have an authoritative relationship with the project.
iv. They influence the socioeconomic and political environments.
16. Which of the following activities is not a major responsibility of the project
manager?
a. Arranging the resources for the project
b.
c. Developing the project plan
d. Ensuring that the project activities meet the cost, time and quality standards
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17. Intermediate customers to a project are _____________.
a. customers who are internal to the company and the final users of the product.
b. customers who are external to the company but are not the final users of the
product.
c. customers who are external to the company and pay for the final product and use
it.
d. customers who provide financial and/or non-financial resources to the project.
18. Sahara International has a design team that has taken up a project to design a
multi-purpose machine. The production department has expressed a desire to use
the machine. The company also plans to sell the product to outside customers.
The production department will be the ____________ customer of the project
while the outside customers will be the ____________ customers of the project.
a. internal or external, intermediate
b. internal, intermediate or external
c. external or intermediate, external
d. internal or intermediate, external
19. Which of the following statements is/are not true regarding project team
members?
i. Project team members are all the groups and individuals who devote time, skills,
and effort to the project.
ii. Project team members take care of only the technical aspects of a project.
iii. Project team members work directly with or under a project manager, depending
on the way the project is organized.
a. Only i and ii
b. Only i and iii
c. Only ii
d. Only ii and iii
20. The project team members who look after the technical aspects of a project carry
out activities like:
i. Engineering
ii. Budgeting
iii. Quality and performance testing
iv. Managing project communication
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. Only iii and iv
21. Which of the following aspects is looked after by the project team members who
are in charge of the administrative aspects of a project?
a. Procurement
b. Quality testing
c. Preparing status reports
d. Construction
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22. Which of the following stakeholders is responsible for arranging the resources
required for the project?
a. Project manager
b. Customer
c. Sponsor
d. Parent organization
13. Organizational Influences
Projects are usually taken up by organizations larger than the projects themselves.
These organizations can be business corporations, government organizations,
professional associations, research and development centers etc. Organizations that
initiate a project will have an influence on the implementation of the project. These
organizational influences even act on projects that have been initiated by joint
ventures or partnerships. Some of the major aspects of large organizations that
influence projects are organizational systems, organizational culture and style, and
organizational structure.
Organizational Systems
Organizations, which primarily carry out projects, are known as project-based
organizations. They earn revenues mainly by undertaking projects. Some examples of
project-based firms are consultancy firms, architecture firms, software development
firms, infrastructure contractors etc. Some organizations adopt a management by
project approach to manage their ongoing operations. These organizations treat
various aspects of ongoing operations as projects and apply project management
principles to them.
Project-based organizations have well designed management systems (such as financial
systems, control systems, etc.) to help them manage projects effectively. These
organizations have a number of specifically designed systems in place to monitor the
progress of the activities of a project. For example, finance systems are designed to take
care of accounting, tracking and reporting activities of multiple projects.
Non-project-based organizations, such as manufacturing firms, hotels etc., may not have
any management systems for addressing project needs. Managing projects in these
organizations is a difficult activity. But some non-project-based organizations will have
separate divisions or sub-divisions that work as project-based organizations with project
oriented management systems. So, the project management team should be capable of
understanding the influence of various management systems on the project.
Organizational Culture and Style
Each organization has its own culture, i.e., its shared values, norms and beliefs. An
culture. Organizational culture and management styles have a direct impact on the
functioning of the project team. As a result, organizations that have an aggressive,
risk-taking culture will not employ conservative, cautious project managers.
Organizational Structure
Sometimes, the organization structure obstructs the free flow of resources from the
parent organization to the project. The organizational structure can be functional,
matrix, or project-based.
A functional organization has a hierarchical structure. In such a structure, superior-
subordinate relationships are clear, i.e., the line of control is clearly defined. The
employees are grouped into departments according to their areas of specialization, e.g.,
14
mechanical, engineering, electrical engineering, production, marketing, accounting etc.
Functional organizations also work on the projects but their project activities are limited
to a single function, e.g. engineering, manufacturing, marketing etc.
In a project-based organization, the project manager has the authority to assign
priorities and to direct the work of individuals assigned to the project. Most of the
us projects. These organizations also have
functional departments, but the groups working in these departments report directly to
the project manager and help in the execution of various projects.
A matrix organization structure combines some of the characteristics of functional
and project-based organizational structures. In matrix organizations, project managers
and functional managers are jointly responsible for assigning priorities and for
directing the work of individuals assigned to the projects. In this organizational setup,
project managers have equal authority to functional managers and the staff members
report to functional managers as well as project managers.
Every organization has one of the above discussed organizational structures and they
have an impact on the projects initiated by them. For example, when a project team is
formed by a functional organization, those teams have to form their own operating
procedures and reporting structures that are similar to that of project-based
organizations. This organizational structure also has an impact on the functioning of a
project manager.
Example: Impact of Organization Structure on the Project Manager
Selecting the right organizational structure will provide a competitive advantage
for an organization. Some of the effects of organizational structure on the
functioning of a project manager are given below.
Authority: The type of organizational structure existing in a firm may favor
projects or the ongoing operations of the firm. In the function-driven organization,
the project manager has almost no authority, and in the project-oriented firm, the
project manager has complete authority. A project manager having less authority
requires more effort to get decisions approved and implemented.
Communication: Communication plays a major role in the success of a project,
irrespective of the organizational structure of the parent organization. Most
organizational structures facilitate vertical (top-down and bottom-up)
communication patterns, but sometimes th
requirements may run counter to the existing communication patterns. Crossing
organizational boundaries always takes more effort. In this situation, the project
manager should do whatever is necessary to keep all the stakeholders informed and
coordinated for achieving the project objectives.
Priority: Multiple projects often compete for the limited resources of an
organization, such as people, equipment, and funding, especially in firms with a
traditional, function-driven management style. Project managers working in a
function-driven structure often have their teams and resources trimmed to meet the
needs of the ongoing operations of the organization or for starting a new project.
Focus: In project-oriented organizations, projects are in focus as they play a major
role in generating revenues for the organization. Every employee works towards
achieving a single objective, and this focus on a single objective helps to increase
productivity. The employees are focused on their projects as they work on them
throughout the year. This focus and sense of responsibility towards a single project
increases employee morale.
15
Chain of command: When the chain of command for a project goes against the
organizational structure, it takes more effort to bring a problem to the notice of the
manager concerned. As the project breaks through functional boundaries, more and
more functional managers are required to approve decisions. And, if certain
functional groups have competing interests, clashes over authority can bring the
progress of the project to a standstill.
Project-oriented organizations make it easy to run projects because their entire
structure is set up for that purpose. In most organizations, however, project
managers may have difficulties dealing with the authority structure. In these cases,
they will have to rely more on their own expertise and on other project
management techniques.
ley &
Sons, Inc. p 29-30.
Check Your Progress
23. Identify the major factors that influence projects in large organizations.
i. Organizational systems
ii. Organizational culture
iii. Organizational style
iv. Organizational structure
24. From the following options, identify the statements that are true regarding a
functional organization.
i. The line of control is clearly defined.
ii. Functional organizations work on projects and their project activities cover all
functions.
iii. The employees are grouped into departments according to their areas of
specialization.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
25. In the case of project-based organizations,
a. The project manager has the authority to assign priorities and to direct the work
of individuals assigned to the project.
b. Project managers and functional managers are jointly responsible for assigning
priorities and for directing the work of individuals assigned to projects.
c. All the departments concentrate on a single project and therefore, all the resources
are allotted only to this project.
d. Both (a) and (c)
16
14. Socio-economic Influences
A wide range of socio-economic issues influence projects. The project team should be
aware of these issues as even a minor change in the socio-economic environment can
sometimes affect the success of a project. Some of the socio-economic factors that
influence projects are standards and regulations, internationalization and culture.
Standards and Regulations
Standards are measures for judging the quality of products. Generally, standards are
documented and approved by a recognized agency/body. These standards specify the
rules and guidelines that organizations must observe when producing a product or a
service. Even when these standards are not mandatory, following them will enhance
the marketability of the products produced by the project organization.
Regulations are mandatory guidelines that lay down the necessary characteristics of
products or services. Building codes established by Roads and Buildings (R&B)
department are an example of regulations. Usually, these regulations are drafted by
various governmental regulatory agencies and are enforced by regulatory personnel.
The project team should be cautious enough to ensure that the project meets the
standards and regulations. The early detection of deviations from standards and
regulations can help reduce project costs and duration.
Internationalization
Many organizations have subsidiaries in different countries. The projects undertaken
by such organizations generally cross many national boundaries. Project managers
must therefore be familiar with the political and economic environment of the
countries in which the projects are being executed. They must also design a
communication plan that enables them to manage and coordinate the project activities
that are being carried out in different countries.
Culture
The culture of an organization and the external environment of a project have a
significant impact on the success of the project. The culture includes the
organizational culture, work environment, and the culture of various stakeholders of
the project. The project manager should have an in-depth understanding of the
organizational culture as it has a direct influence on the functioning of the project. The
organizational environment and culture depend on the philosophy and managerial
style of the top management; the organizational structure of the project (functional,
project-based, or matrix); the character and maturity level of project team members
i.e., achievement level, motivation level, etc.; and the size of the project.
The culture of the project team members (their values, beliefs and convictions)
influences their attitudes towards ethics, achievement, training and supervision and
their interpersonal, problem-solving and conflict resolution skills. It also determines
their level of motivation. A good understanding of different cultural values,
languages, and special business styles and techniques would be an asset for a project
manager, especially when handling international projects.
15. Environmental and Legal Influences
Environmental and legal concerns have a major impact on the successful completion
of a project. Therefore, the impact of the environment on the project should be
assessed before and after a project has been undertaken. In addition, analyzing the
impact of a future project on the environment will help the project manager define
rational goals for the project and the organization.
17
The project manager should acknowledge these regulatory processes as a part of good
planning, instead of regarding them as barriers to the achievement of project goals.
The project manager should obtain the necessary clearances from environmental
protection agencies before starting the project. If possible, he should integrate these
regulations (legal, environmental, etc.) into the overall plan of the projects.
All the projects should comply with all aspects of the law. Organizations usually take
the help of legal advisors to ensure that the activities of the project manager and his
team are in compliance with the law. Legal advisors must also ensure that the project
has applied for and received all the required permits and licenses.
16. Project Phases and the Project Life Cycle
Organizations generally divide a project into various project phases to help
management have better control over the project and to coordinate the project
activities with those of the organization. All the project phases put together comprise
the project life cycle.
Project Phases
A project phase is a collection of related project activities, which result in the
production of one or more major project deliverable. These phases are arranged in a
sequence to enable better understanding of the project. A review of the performance
of the deliverable is conducted at the end of every project phase to check if the project
can proceed to the next phase, and to identify and correct mistakes in a cost-effective
manner. All the activities of a project can be classified into five phases initiate, plan,
organize, control, and close.
Project Life Cycle
The project life cycle is a collection of generally sequential project phases. The
number of project phases is determined by the control needs of the project organization.
The project life cycle represents the linear progression of a project, from defining the
project, through developing a plan, implementing the plan and closing the project. A
project life cycle usually specifies the technical work that must be carried out in
various phases of the project and the list of individuals and their roles in each phase of
the project. The project life cycles of many projects share some common characteristics:
The manpower and finances required in the initial stages of the project are low. They
increase as the project progresses and gradually decrease as the project nears
completion.
The project starts with a very low probability of success. The probability of success
increases as the project passes through various phases and nears completion.
Project stakeholders are very influential at the beginning of the project. Their
influence decreases as the project progresses.
The cost of incorporating change requests and correcting mistakes increases as the
project comes to an end.
Check Your Progress
26. _____________ are measures for judging the quality of products. These are
documented and approved by a recognized agency.
a. Codes
b. Standards
c. Procedures
d. Regulations
18
27. From the following options, identify the factor that influences the environment
and culture of an organization, which, in turn, can have a significant impact on
the success of the project.
a. Level of socialization in the organization
b. Type of technology used in the organization
c. Philosophy and managerial style of the top management
d. Cost involved in the project
28. A project life cycle is
a. a collection of project processes
b. a collection of project phases
c. a collection of project programs
d. a collection of project operations
29. Review of the performance of the deliverable is conducted at the end of every
project phase in order to:
i. check if the project can proceed to the next phase
ii. identify and correct mistakes in a cost-effective manner
iii. close the project
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
17. Summary
A project is a group of unique, inter-related activities that are planned and executed in
a certain sequence to create a unique product and/or service, within a specific time
Some of the characteristics of the tasks that qualify to be projects are unique activities,
attainment of a specific goal, sequence of activities, specified time and interrelated
activities.
The primary aim of a project is to deliver a product and/or service to a client within
the specified time, budget (resources and cost) and according to the quality and
performance specifications. Some common constraints that influence a project are
scope, quality, time, cost, and resources.
The scope and quality of a project are influenced by a variety of constraints like time,
cost and availability of resources. The success of a project largely depends on the
according to the changes arising from within and outside the project system.
Projects can be classified based on their characteristics such as business value, risk
level, time span, complexity of tasks and the monetary value of the project.
A program is a group of projects managed in a coordinated way to obtain benefits not
available from managing them individually. Since a program is a collection of
different projects, it has wider scope than an individual project.
Project management is the application of knowledge, skills, tools and techniques to
project activities in order to meet or exceed stakeholder needs and expectations.
19
Project management has evolved as a specialized science over a period of time,
though it has derived most of its knowledge from other management disciplines.
Project management like general management involves all aspects of planning,
organizing, implementing, and controlling, apart from techniques like critical path
analysis and work breakdown structures that are unique to its own.
In many strategic projects, the function of project management will involve
disciplines like finance, personnel, operations, purchase and logistics, R&D, and
marketing.
The project manager has to maintain good relations with line managers to ensure a
smooth flow of resources. He/she should exercise judicious control over the resources
allocated to the project from various functional departments.
Project stakeholders are individuals and organizations who are actively involved in
the project, or whose interest may be positively or negatively affected as a result of
project execution or successful project completion.
The major stakeholders of any project include project manager, customers, project
team member, sponsor, and parent organization.
Organizations that initiate a project will have an influence on the implementation of
the project. Some of the major aspects of large organizations that influence projects
are organizational systems, organizational culture and style, and organizational
structure.
A wide range of socio-economic issues influence projects such as standards and
regulations, internationalization, and culture.
Impact of the environment on the project should be assessed before and after a project
has been undertaken. Also, analyzing the impact of a future project on the
environment will help the project manager define rational goals for the project and the
organization.
Organizations generally divide a project into various project phases to help
management have better control over the project and to coordinate the project
activities with those of the organization. All the project phases put together comprise
the project life cycle.
production of one or more major project deliverable. These phases are arranged in a
sequence to enable better understanding of the project.
The project life cycle is a collection of generally sequential project phases. It
represents the linear progression of a project, from defining the project, through
developing a plan, implementing the plan and closing the project.
18. Glossary
Functional organization structure: A hierarchical structure in which the employees
are grouped into departments according to their areas of specialization, e.g.,
mechanical, engineering, electrical engineering, production, marketing, accounting
etc.
Matrix organization structure: A hierarchical structure that combines the
characteristics of functional and project-based organizational structures. The project
managers and functional managers are jointly responsible for assigning priorities and
for directing the work of individuals assigned to projects.
Program: A group of projects managed in a coordinated way to obtain benefits not
available from managing them individually.
20
Project life cycle: A collection of generally sequential project phases. The number of
project phases is determined by the control needs of the project organization.
Project management: The application of knowledge, skills, tools and techniques to
project activities in order to meet or exceed stakeholder needs and expectations.
Project phase: A collection of related project activities, which result in the production
of one or more major project deliverable. These phases are arranged in a sequence to
enable better understanding of the project.
Project stakeholders: Individuals and organizations who are actively involved in the
project, or whose interest may be positively or negatively affected as a result of
project execution or successful project completion.
Project: PMI defined project as a temporary endeavor undertaken to create a unique
product or service. The British Standard 6079 of 1996 (BS6079) defined a project as a
unique set of coordinated activities, with definite starting and finishing points,
undertaken by an individual or organization to meet specific objectives within defined
schedule, cost, and performance parameters.
Project-based organization: A hierarchical structure in which the project manager
has the authority to assign priorities and to direct the work of individuals assigned to
the project. Most o
organizations also have functional departments, but the groups working in these
departments report directly to the project manager and help in the execution of various
projects.
Regulations: Mandatory guidelines that lay down the necessary characteristics of
products or services. These are usually drafted by various governmental regulatory
agencies and are enforced by the regulatory personnel.
Scope: A brief and accurate description of the end-products or deliverables to be
expected from the project that meet the requirements. It describes all the activities that
are to be performed, resources that will be consumed, and the end-products from the
successful completion of the project, including the quality standards.
Sponsor: An individual or a group within the parent organization who arranges the
resources for the project themselves. This assistance can be in cash or kind.
Standards: Measures for judging the quality of products. They specify the rules and
guidelines that organizations must observe when producing a product or a service.
1. Projects have been planned and managed since the beginning of civilization.
Define a project. Explain the characteristics of a project. How are the projects
different from operations?
2. The success of a project depends on the ability of the project manager to strike a
balance between the various project parameters. What are the parameters of a
project? In what way are these parameters related to each other. In what way can
the projects be classified?
3.
4. Project management has spread from its traditional focus on the fields of
construction and engineering into diverse sectors like education and healthcare.
What is project management? How is it related to the other management
disciplines? Explain its relationship with the line management.
21
5. The project management team should identify the stakeholders, determine their
needs, and manage these needs to ensure a successful project. Who are these
project stakeholders? In what way are they important to a project?
6. Organizations that start a project will have an influence on the implementation of
the project. What are the various organizational issues that influence a project?
7. The project team should be aware of the socio-economic, environmental and legal
issues that influence a project. Describe in detail these influences.
8. Dividing a project into various phases helps the management to gain control over
the project. What is a project phase? Explain a project life cycle and its
characteristics.
1. graw Hill, Seventh Edition, 2009.
2.
3.
4. A Systems Approach to Planning,
5.
Institute, Second Edition, December 2000.
6. Joseph Weiss and Ro -phase Project Management: A
Following are the answers to the Check Your Progress questions given in the unit.
1. (d) i, ii, iii, and iv
Project management is a system of procedures, practices, technologies, and
know-how that helps in the planning, organizing, staffing, directing, and
controlling necessary to successfully manage a project. Traditionally, project
management focused on the construction and engineering sectors. Of late, it is
being widely used in diverse sectors like education, healthcare, and software
development.
2. (b) Project Management Institute
A project is a group of unique, inter-related activities that are planned and
executed in a certain sequence to create a unique product or service, within a
Body of Knowledge
3. (c) Project
A project is a group of unique, inter-related activities that are planned and
executed in a certain sequence to create a unique product or service, within a
operating end of the business, where resources are transformed into goods and
services. A process is a series of activities that brings about a result. A program is
a group of projects managed in a coordinated way to obtain benefits not available
from managing them individually.
22
4. (d) i, ii, and iii
Projects and operations are generally considered similar. Both are carried out by
people. They are both planned, implemented, and controlled to produce results
within the given resource constraints.
Organizations adopt the project approach when they have to perform tasks that
are new to them. This approach is also adopted when the tasks are not likely to be
repeated in the future, and when the existing systems in the parent organization
are not equipped to handle the new task.
6. (c) A project consists of various technical activities that are independent and
unrelated
Projects consist of various technically interrelated activities. These activities are
considered interrelated as the deliverable (output) of one activity becomes the
input for another activity of the project.
7. (b) Scope
Scope is a brief and accurate description of the end-products or deliverables to be
expected from the project that meet the requirements. It describes all the activities
that need to be performed, resources that will be consumed, and the end-products
from the successful completion of the project, including quality standards.
The various project parameters are scope, quality, cost, time, and resources.
Resources in a project comprise the people resources, the financial resources, the
physical resources, and the information resources. These resources are required to
carry out the project activities.
9. (c) Recruitment of new employees in the organization
Projects usually go off balance when clients ask for changes in their time frame,
scope, and quality. Some of the reasons for projects going off-balance could be
change in market demand that requires the addition of new features, product
needing to be launched ahead of due date due to competition, loss of key
personnel, breakdown of machinery, new technology expected in the market, etc.
Recruitment of new employees in the organization will not make a project go off
balance.
10. (b) Purchase management
Project management usually follows five major phases, namely, the initiating
phase, planning phase, implementation phase, controlling phase and closing
phase. The initiating phase identifies the beginning of a project. The planning
phase involves designing and maintaining a realistic and achievable plan to attain
the business objective. The implementation phase involves managing all the
coordination and resource requirements to implement the plan. The controlling
processes include reviewing and measuring project progress and implementing
corrective measures when needed. The closing phase includes the formal
submission of the project to the client to give the project or phase a structured
ending. Purchase management is an operations activity and is not a phase in
project management. It is a process carried out by the operations manager of an
organization.
23
11. (b) Program
A program is a group of projects managed in a coordinated way to obtain benefits
not available from managing them individually. It is a collection of different
projects. It has wider scope than an individual project. A process is a series of
activities that brings about a result. Operations refer to the operating end of the
business, where resources are transformed into goods and services.
12. (d) Research and Development
The Research and Development discipline of project management takes care of
new product development and quality assurance functions, in case of strategic
projects.
13. (c) Project management involves managing the existing systems and services
in an organization.
Line management involves managing the existing systems and services in an
organization. The other options come under project management.
Functional employees selected from various departments usually face a difficulty
in reporting to multiple bosses. A major source of conflict that could arise
between the project managers and the line managers is the issue of who should
have control over the functional employees. The relations will be under further
strain when any one of them claims sole credit for the success of the project or for
the rewards generated by the project. These conflicts can be resolved when the
project and line managers understand their distinct roles in achieving the overall
organizational objectives.
Project stakeholders are those who are directly related to the project suppliers,
clients, employees, and managers; those who can influence the physical,
organizational, technological, socioeconomic, legal, and political environment;
those who have an authoritative relationship with the project government
agencies at the local, regional, and national levels; and persons, groups, and
associations that have a stake in the project.
16. (a) Arranging the resources for the project
The project manager is an important stakeholder of the project. He/she is
oject plan,
and ensuring that the project activities are completed on time, within the budget,
and according to quality standards. The resources for the project are arranged by
the sponsor, who could be an individual or a group within the parent organization.
17. (b) customers who are external to the company but are not the final users of
the product.
Customers are those who will use or pay for the product or service produced by
the project. These customers may be internal or external to the organization.
Internal customers are those individuals who are internal to the parent company.
Intermediate customers are usually external to the company but they are not the
final users of the product or service. External customers are the individuals or
organizations who pay for the final product or service and use.
24
18. (b) internal, intermediate or external
Customers are the project stakeholders who will use or pay for the deliverable
produced by the project. They can be internal or external to the organization.
Internal customers are individuals who are internal to the parent company. The
production department is an internal customer. In the given instance, the
production department will be the internal customer of the project as it will use
the machine. The company wants to sell the product to outside customers. These
can be intermediate customers (distributors or wholesalers who will not be the
final users of the machine) or external customers (individuals or organizations
who will pay for and use the machine) to the project.
19. (c) Only ii
All the groups and individuals who devote time, skills, and effort to the project
are regarded as project team members. Project team members take care of the
technical, managerial, or the administrative aspects of a project. They work
directly with or under a project manager, depending on the way the project is
organized.
20. (b) Only i and iii
Project team member are individuals and groups who devote their time, skills,
and effort to the project. They look after the technical and managerial or
administrative aspects of a project. The team members who look after the
technical aspects of a project carry out activities concerned with engineering,
construction, procurement, and quality and performance testing. Activities
concerned with planning, scheduling, budgeting, preparing status reports,
managing project communication, etc., are carried out by team members who are
in charge of the administrative aspects of the project.
21. (c) Preparing status reports
Project team member are individuals and groups who devote their time, skills,
and effort to the project. They look after the technical and managerial or
administrative aspects of a project. Activities concerned with planning,
scheduling, budgeting, preparing status reports, managing project
communication, etc., are carried out by team members who are in charge of the
administrative aspects of the project. The team members who look after the
technical aspects of the project carry out activities concerned with engineering,
construction, procurement, and quality and performance testing.
22. (c) Sponsor
The sponsor is an individual or a group within the parent organization who
arranges the resources for the project. This assistance could be in cash or in kind.
The project manager is responsible for channe
developing the project plan; and ensuring that the project activities are completed
on time, within the budget, and according to quality standards. Customers are
those who will use or pay for the deliverable produced by the project. The parent
organization is a major stakeholder of the project as its employees are directly
involved in executing the project.
Organizations that initiate a project will have an influence on the implementation
of the project. These organizational influences even act on projects that have been
initiated by joint ventures or partnerships. Some of the major aspects of large
organizations that influence projects are organizational systems, organizational
culture and style, and organizational structure.
25
A functional organization has a hierarchical structure. In such a structure,
superior-subordinate relationships are clear, i.e., the line of control is clearly
defined. The employees are grouped into departments according to their areas of
specialization. Functional organizations also work on projects, but their project
activities are limited to a single function.
25. (a) The project manager has the authority to assign priorities and to direct
the work of individuals assigned to the project.
In a project-based organization, the project manager has the authority to assign
priorities and to direct the work of individuals assigned to the project. Most of the
hese organizations also
have functional departments, but the groups working in these departments report
directly to the project manager and help in the execution of various projects.
26. (b) Standards
Standards are measures for judging the quality of products. These are generally
documented and approved by a recognized agency/body. Standards specify the
rules and guidelines that organizations must observe when producing a product or
a service.
27. (c) Philosophy and managerial style of the top management
The organizational environment and culture depend on the philosophy and
managerial style of the top management, the organizational structure of the
project, the character and maturity level of project team members, and the size of
the project.
28. (b) a collection of project phases.
The project life cycle is a collection of generally sequential project phases. A
project phase is a collection of related project activities, which result in the
production of one or more major project deliverables. These phases are arranged
in a sequence to enable better understanding of the project.
29. (a) Only i and ii
production of one or more major project deliverable. These phases are arranged in
a sequence to enable better understanding of the project. A review of the
performance of the deliverable is conducted at the end of every project phase to
check if the project can proceed to the next phase and to identify and correct
mistakes in a cost-effective manner.
Unit 2
Project Idea Generation and Screening
Structure
1. Introduction
2. Objectives
3. Generating Project Ideas
4. Creativity and Idea Generation
5. Scanning the Environment
6. Searching for New Project Ideas
7. Initial Screening
8. Project Rating Index
9. Sources of Positive Net Present Value
10. Summary
11. Glossary
15. Answers to Exercises
1. Introduction
In the previous unit, we have discussed about the fundamental concepts of project
management. We have also discussed about the project management environment. In
this unit, we will discuss how to generate project ideas and screen them.
When developing a new project, the project manager generates several ideas from
different sources like customers, employees and competitors, and finally selects those
project ideas that can be implemented. The generation of ideas requires creativity,
sensitivity to the changes in the
capabilities for any individual. So, the project manager has to be aware of several
techniques like attribute listing, checklist and brainstorming for generating new
project ideas.
After the ideas have been collected, the project manager has to screen them. The
objective of screening is to drop the poor ideas at the initial stages of new project
development. Project Rating Index, an initial evaluation method, helps management
streamline the process of initial screening. Net Present Value (NPV) is used to
conduct a financial analysis of projects. In the case of financial projects, the projects
with higher NPV are selected.
This unit deals with the generation of project ideas and discuss the various creativity
techniques involved in the generation of ideas. We will discuss the scanning of the
business environment, and the activities that can be carried out to generate new
project ideas. We shall then move on to discuss the initial screening of project ideas
and about the project rating index. Finally, we would be discussing the factors that can
be used by firms to enhance the net present value of a project.
27
2. Objectives
identify ways to generate project ideas.
define creativity, and state how it can be used for generating project ideas.
assess the strengths, weaknesses, opportunities, and threats of an organization by
scanning the business environment in which it is operating.
explain how to search for new project ideas.
perform the initial screening of new project ideas.
explain the project rating index.
identify the sources of positive net present value.
3. Generating Project Ideas
Changing customer needs and preferences, new technologies, shortened product life
cycles and increased competition force the project manager to be innovative. The
project manager always has to be on the look out for new ideas since an idea that seem
unattractive at one point can look appealing later. Most project ideas except those
arising from technological breakthroughs involve combining existing fields of
technology or adding more features to the present products or services.
New project ideas help firms achieve their objectives in an efficient manner. Ideas can
come from different sources like customers, competitors and employees and even
from accidents or luck. They can be derived from various sources, but it is the duty of
the project manager to ensure that the chosen idea for a new or modified product or a
service can really cater to a present unmet need. The project manager should also
ensure that the product based on that idea can effectively compete with similar
products or services through features like better quality or lower price.
Before deciding whether an idea is worth pursuing, the project manager must gather as many
ideas as possible. Since only a few ideas succeed commercially, most of the firms develop
purposeful, systematic approaches for generating new project ideas. Several firms foster an
organizational climate that encourages employees to come up with new, creative ideas.
Customer needs and interests are the logical place to start the search for new project
The project manager can conduct customer surveys and interview the customers to find
out their problems with current products. Through customer interviews, the project
manager can learn about customer needs. Several companies maintain an open culture
that encourages a free flow of ideas from all its employees. Companies also discover
good
Example: Encouraging Creativity through Culture at Xerox
The organizational culture posed a potentia
Alto Research Center (PARC). The chief scientist John Seely Brown (Brown)
found that the existing culture did not support radical innovation. When Brown
took over PARC in 1988, he worked towards building a culture that promoted
creativity. A plan called Xerox 2000 was prepared, which provided a strategic view
of where the organization would be in the year 2000. Anthropologists were hired to
study the organization and to reveal the hidden interests of the employees. John
aimed at adjusting the organizational structure, awarding incentives and so on by
was an organization that comprises a mix of new and old employees with a
common culture that was more supportive of rapid innovation.
-Hall of India, Sixth Edition,
1995, p.428-429.
28
Check Your Progress
1. Of the following stakeholders, who help the project manager in generating new
project ideas?
i. Customers
ii. Competitors
iii. Employees
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
2. Which of the following techniques does a project manager use to conduct a
financial analysis of projects?
a. Break-even analysis
b. Attribute Listing
c. Net Present Value
d. Program Evaluation and Review Technique
3. Screening is done to
a. generate new project ideas.
b. drop the unviable ideas at the initial stages of new project development.
c. select a project with a higher net present value.
d. All of the above
4. From the following options, identify the factors that help in generating ideas.
i. Creativity
ii. Sensitivity to external environmental changes
iii.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
5. Identify the statement that does not hold true where the Net Present Value
(NPV) of a project is concerned.
i. NPV is the difference between the present value of the future revenues minus
future costs.
ii. In the case of financial projects, the projects with negative NPV are selected.
iii. Superior technology, product differentiation, etc., help in enhancing the NPV of a
project.
a. Only i
b. Only i and ii
c. Only ii
d. Only ii and iii
29
4. Creativity and Idea Generation
Creativity refers to the ability of an individual or a group to develop something new. It
involves the ability to combine or synthesize the available information and experience
to see new patterns and possibilities. Creativity is best nurtured in a liberal climate
where everybody is encouraged to develop new ideas and new ways of doing things.
But few managers are able to create such a climate.
Stages of Creativity
The process of creativity involves four stages preparation, incubation, illumination
and verification.
Preparation
In this stage, an individual gathers necessary information, defines the problem
precisely, analyzes the data and generates a number of alternatives.
Incubation
An individual comes out with unusual alternatives because of subconscious mental activity
coupled with divergent thinking. In this stage, an individual does not consciously focus on
the problem, but allows the subconscious mind to look for a solution.
Illumination
In this stage, an individual gets an insight into a problem all of a sudden while he is
thinking several alternatives. The practicability of this idea is then examined.
Verification
In this stage, the feasibility of the alternative ideas is examined. The ideas for which
the solutions are not feasible are rejected.
Creativity can be nurtured at two different levels the individual level and the group
level. Organizations prefer to nurture creativity at the group level as it ensures
participation and acceptance of all the employees concerned.
Individual Creativity
It is not possible to establish a technique to enable someone to think creatively, but the
following methods have been found helpful in improving the creativity of an
individual.
Attribute listing: In this method, the attributes that can be attached to the end product
or service are listed. Based on the listed attributes, the final product is designed.
Checklist: A checklist consists of a set of questions that are relevant to a given
situation. Answering to these questions can help the individual find a solution to the
problem.
Black box: In this technique, all the required and available inputs as well as the
desired outputs are listed. It is also checked whether these outputs can be produced
through the use of available inputs.
Group Creativity
Organizations encourage group creativity to elicit more and better ideas. Some of the
popular group creativity techniques used by several organizations are discussed below:
Brainstorming: This technique encourages group members to generate as many ideas
as possible. Improving the ideas of other members and synthesizing two or more ideas
is allowed, but criticism of any idea is not entertained.
30
Delphi technique: This is a structured approach for finding out the ideas and opinions
of a number of experts. A panel of experts is asked to generate ideas, at the individual
level, for a given issue. The information is collected, analyzed and then summarized
by the group facilitator. Then the summarized information is given to each individual
member, and then opinion is requested again. Again, the information is collected and
summarized. The process continues till the entire panel of experts accepts a particular
idea. The project manager is expected to note down all the ideas that have been
generated throughout the process for further consideration.
Nominal group technique: This is a structured technique administered by a
coordinator. All the individual members prepare their ideas independently. Then they
are requested to present the ideas before the other members, who rate the ideas. The
coordinator notes down all the ideas generated, including the positive and negative
arguments of each idea, for future use.
Activity: Kamlesh Bharadwaj, an aircraft maintenance engineer with Kuwait Airways
came back to India after the Gulf War and started searching for a job. By a strange
coincidence, the manager of the garage where he was getting his car serviced wanted
him to sort out some technical problem with an imported car. Bharadwaj saw that the
facilities available at most of the garages were primitive and imported cars required
better servicing facilities. Bharadwaj realized that he could start a garage for imported
cars in India. He started an exclusive garage for imported cars. Discuss some of the
ways in which individuals/organizations can get new project ideas.
Answer:
Example: The Delphi Method at BHEL
Bharat Heavy Electricals Limited (BHEL), the largest heavy-electrical equipment
company in India, uses the Delphi process to explore new ideas and to decide the future
direction of its systems. The process is carried out in three steps. In the first step, an
open-ended questionnaire is given to all the prospective respondents. All the possible
ideas regarding major technological breakthroughs for the next 30 to 40 years are
gathered. The participants also mention when the technological breakthrough is likely
to occur. Then the coordinator collects the questionnaires from all the respondents and
prepares the list of technological breakthroughs and its estimated timings.
In the second step, the summarized list of technologies with its expected arrival is
fed back to the participants. The participants are then asked to reconsider their
earlier time estimates and give new ones with proper reasons. The information
obtained at this stage provides a priority ranking for each technological
development in terms of the urgency of each requirement.
In the third stage, the participants are given the new information about estimated
timings that was collected in the second stage. In this stage, the participants are
asked for their final estimates with their rationale for their forecasts. The company
feels that the obtained ideas will be useful for corporate planning.
- Hall of India
Private Limited, Second Edition.
31
Check Your Progress
6. Which of the following is not a technique used for developing creativity in an
individual?
a. Attribute listing
b. Brainstorming
c. Checklist
d. Black box
7. Identify the correct sequence of steps in the process of creativity from the given
sequences.
a. Illumination Incubation Verification Preparation.
b. Preparation Incubation Illumination Verification.
c. Incubation Preparation Illumination Verification.
d. Verification Preparation Illumination Incubation.
8. ___________ refers to the ability of an individual or a group to develop
something new, and involves the ability to combine or synthesize available
information and experience to see new patterns and possibilities.
a. Culture
b. Innovation
c. Creativity
d. Screening
9. In which technique do all individual members prepare their ideas independently
and present them before other members, who rate the ideas?
a. Brainstorming
b. Delphi technique
c. Nominal group technique
d. Black box
10. In which of the following stages in the creativity process does the individual
define the problem precisely, analyze the data, and generate a number of
alternatives?
a. Incubation
b. Preparation
c. Illumination
d. Verification
11. Identify the statement/s that explains/explain the characteristics of brainstorming
correctly.
a. Brainstorming is a structured technique administered by a coordinator.
b. Brainstorming is used for eliciting the ideas and opinions of a number of experts
for a given issue.
c. Brainstorming encourages group members to generate as many ideas as possible,
helps in improving ideas of other members, and allows synthesizing of two or
more ideas.
d. All of the above
32
12. Of the following options, which are true with regard to the activity carried out in
the verification stage in the creativity process?
i. The individual allows his/her subconscious mind to look for a solution.
ii. The feasibility of alternative ideas is examined.
iii. The ideas for which the solutions are not feasible are rejected.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
13. ___________ is a structured technique administered by a coordinator in which all
the individual members prepare their ideas independently.
a. Black box
b. Brainstorming
d. Delphi technique
14. Identify the stage in the creativity process in which the practicability of the idea
generated is examined.
a. Preparation
b. Incubation
c. Illumination
d. Verification
15. In the incubation stage of the creativity process,
a. the individual gets an insight into a problem all of a sudden while he/she is
thinking about several alternatives.
b. the individual comes out with unusual alternatives because of subconscious
mental activity coupled with divergent thinking.
c. the individual gathers the necessary information, defines the problem precisely,
analyzes the data, and generates a number of alternatives.
d. the practicability of the idea generated is examined.
16. Of the following techniques, which is not used by organizations for developing
group creativity?
a. Brainstorming
b. Delphi technique
c. Black box
d. Nominal group technique
17. Of the following statements, identify those that hold true with regard to
creativity.
i. Creativity is the ability of an individual or a group to develop something new.
ii. Creativity involves the ability to combine or synthesize available information and
experience to see new patterns and possibilities.
iii. Creativity is best nurtured in a liberal climate where everybody is encouraged to
develop new ideas and new ways of doing things.
iv. Creativity can be nurtured only at the individual level.
33
18. Which of the following statements is false regarding the attribute listing
technique that organizations use to improve creativity in individuals?
a. All the required and available inputs as well as the desired outputs are listed.
b. The attributes that can be attached to the end product and/or service are listed and
based on them the final product is designed.
c. Questions are developed and individuals have to answer these questions to find a
solution to the problem.
d. Both (a) and (c)
19. ______________ consists of a set of questions that are relevant to a given
situation, answering which helps the individual find a solution to the problem.
b. Black box
c. Delphi technique
d. Checklist
20. Which of the following techniques involves finding out the ideas and opinions of
experts?
a. Black box
b. Brainstorming
d. Delphi technique
21. Identify the technique in which all the required and available inputs as well as the
desired outputs are listed. It is also checked whether these outputs can be
produced using the available inputs.
a. Checklist
b. Black box
c. Attribute listing
d. Delphi technique
5. Scanning the Environment
Before accepting a project, a firm must conduct a corporate appraisal. A realistic
appraisal of corporate strengths and weaknesses provides for exploiting the
opportunities in the environment. Firms use their competitive strengths to exploit the
opportunities available. Most firms conduct a SWOT analysis to identify their
strengths and weaknesses, and the opportunities and threats in the business
environment. Firms take advantage of the market opportunities through use of their
strengths. For the purpose of scanning the environment, the whole business
environment may be divided into six broad sectors: economic sector, governmental
sector, technological sector, socio-demographic sector, competition sector, and
supplier sector. Each of these sectors is discussed below.
34
Economic Sector
The economic sector comprises the macro level factors like the state of the economy,
the overall rate of economic growth, the growth rate of primary, secondary and
tertiary sectors, position of BoP (Balance of Payment) and trade deficit/surplus of the
country. The project manager should also analyze the economic environment to assess
the viability of new project ideas.
The project manager should also closely observe the major trends in the income and
consumption patterns of the target customers. A study of consumer expenditures can
reveal several important facts. Such information can be useful when the project
manager has to take the financial decisions.
Governmental Sector
The economic and industrial policies of the government have a great impact on the
business. These policies can have a favorable impact on some categories of business
and an adverse impact on some other categories of business.
For example, the liberalization, privatization and globalization policy adopted by the
Indian government in 1991, has had a significant impact on several markets. Exports
and imports increased and the Balance of Payments (BoP) situation improved.
The policy has benefited many companies. Because of less regulation, many firms
have changed their product mix and increased production capacity. Some companies,
however, have been adversely affected by the increase in competition.
Technological Sector
The study of technological sector is important, as technology can effectively be used
to develop new materials and machines for increasing the production of goods and
services. Since new foreign and indigenous technologies are emerging rapidly, the
project manager should ensure that he has access to the latest information.
Technological changes often take place to meet changing customer needs. Because of
a rise in petrol prices, many customers preferred to purchase cars that give more
mileage. As a result, the automobile manufacturers had to design fuel-efficient
vehicles. Similarly managers should develop new technologies to meet the needs and
interests of the customers.
Socio-demographic Sector
A study of socio-demographic sector involves the study of population growth, age
shifts in population, educational profile of the people, gender composition, and
religious interests. During the industrial revolution, western countries faced the
problem of labor supply due to low population growth. This situation encouraged the
growth of labor saving technologies and automation.
Today, many multinational corporations are investing in developing countries to take
advantage of the cheap labor and large consumer markets. Project manager should
understand all the above aspects while setting the objectives of the project and in
preparing the relevant procedures.
Competition
The project manager should carefully analyze the competition in the market to design
a successful project. He should be aware of the number of firms in the industry and
the degree of homogeneity and differentiation among their products. The effect of
complementary and substitute products on the end product or service should also be
analyzed. Information on and understanding of all the above issues enables the project
manager to prepare necessary plans to sustain themselves in the face of cut-throat
competition.
35
Supplier Sector
The project manager should carefully analyze the input requirements for carrying out
the project. He should be aware of the availability and cost of raw materials and other
requirements like power and water. The project manager should ensure that the firm
has good contractual agreements with all its suppliers so that all the necessary goods
are delivered on time.
6. Searching for New Project Ideas
A wide variety of sources should be tapped to get good project ideas. Project
managers perform numerous activities to generate more and more project ideas. These
activities are discussed below.
Study the Existing Industries
A study of existing industries enables the project manager to assess the performance
of various industries in terms of their profitability and capacity utilization. A project
manager should identify and implement more profitable and risk-free activities so that
the probability for success of a project increases. He should also try to identify those
markets where the demand is going to be high relative to supply in near future.
Observe the Inputs and Outputs of Various Industries
An analysis of inputs and outputs of various industries can provide new project ideas.
A project opportunity exists when materials that are expensive or difficult to procure
can be obtained at a low cost from a manufacture who enjoys economies of scale. An
opportunity also exists when the waste products of certain firms can be used to
develop a new product. For example, flyash, a by-product of coal- fired electric
generating plant, is now used to improve the performance and quality of concrete.
Analysis of Imports and Exports
The project manager should study the imports and exports that have taken place over
the last five to seven years to understand the import trends of various goods. This will
enable him to identify the potential areas for import substitution. The project manager
can also plan for getting governmental benefit as part of its program to encourage
indigenous manufacturing.
Analysis of exports also helps the project manager to explore the profitable foreign
markets. Indian software products have lot of demand in the western markets. This
makes project manager think of different plans in the software industry, considering
its potential in the foreign markets.
Study of Economic and Social Trends
A study of the current economic and social trends can help the project manager
understand changes in customer preferences. For instance, because of the increase in
nuclear, double-income families, demand for time saving products like pressure
cookers, microwave ovens and canned food items has grown. As the desire for leisure
and recreational activities is increasing, there is a growing demand for products like
Audio Compact Disks, Video Compact Disks and Digital Versatile/Video Disks.
Observe New Technologies
India has a large network of research laboratories. The project manager should closely
examine the new research work carried out in those laboratories. Since technology
only can really bring new products, project manager can generate lot of ideas to
develop breakthrough products. A project manager can organize tie-ups with research
institutions to develop new products.
36
Identifying Psychological Needs
Questionnaires and interviews cannot reveal every need and interest of the customers.
Therefore the project manager should carefully identify the hidden demands and
psychological needs of customers. He can use a special technique called Spectrum
analysis.
Spectrum analysis enables the project manager to identify the gaps between the
Spectrum analysis, the important factors influencing cust
identified and then the existing brands in the market are placed on a continuum in
respect of the factors identified by the customers. Then the project managers attempt
at identify the gaps relative to the listed psychological needs.
Study the Government Guidelines and Recommendations for Financial Institutions
The government continuously encourages new project outlays in different sectors.
These outlays provide profitable areas where new initiatives can be taken up. A study
of these outlays of the government generates new project ideas. Recommendations
made by financial corporations or state industrial development corporations should be
carefully analyzed to identify the areas to be considered. The feasibility studies and
suggestions of research agencies help the project manager to identify promising
project ideas.
Above all, the project manager should attend trade fairs to know about new products
and current developments. Chance also plays an important role in identifying the new
project initiatives. When KVK Raju, founder of the Nagarjuna Group, visited the
Bokaro Steel Plant, he came to know that the factory was going to lose a Rs. 60,000
tonne order for hot rolled coil, because of its sub-standard packaging. This incident
prompted him to set up an exclusive industry to cater to the packaging needs of the
steel industry.
Check Your Progress
22. Which of the following activities can aid in searching for new project ideas?
i. Studying existing industries
ii. Observing new technologies
iii. Analyzing the imports and exports
iv. Identifying psychological needs
23. Of which of the following sectors does the scanning environment comprise macro
level factors like the growth rate of the primary, secondary, and tertiary sectors;
Balance of Payments position; and trade deficit/surplus of the country?
a. Competition sector
b. Economic sector
c. Governmental sector
d. Socio-demographic sector
37
24. A corporate appraisal should be conducted
a. before the environment is scanned.
b. before a project is accepted.
c. before idea generation.
d. All of the above
25. Arrange the following sentences based on the sequence in which the project
manager conducts a spectrum analysis.
i. d preferences are identified
ii. The project managers attempt to identify the gaps relative to the listed
psychological needs
iii. The existing brands in the market are placed on a continuum in respect of the
factors identified by the customers
a. iii-ii-i
b. i-iii-ii
c. ii-i-iii
d. i-ii-iii
26. A study of which of the following sectors involves the study of population
growth, age shifts in population, educational profile of the people, gender
composition and religious interests?
a. Competition sector
b. Economic sector
c. Socio-demographic sector
d. Governmental sector
27. Which of the following techniques enables the project manager to identify the
existing products?
a. Black box
b. Brainstorming
c. Spectrum analysis
d. Project rating index
7. Initial Screening
After a pool of ideas has been generated, the project manager must screen them. In
objective are rejected. Initial screening is a process of rejection rather than a process
of selection. The objective is to reject those ideas that cannot be considered for
implementation. Ideas can be screened in a variety of ways. Some managers use an
informal screening process to eliminate unsuitable ideas. A formal screening process
involves a checklist, rating system, and an economic analysis.
When screening ideas, the project manager must avoid two types of errors; drop error
and go error. A drop error occurs when a company rejects a good idea. The project
manager should review ideas that have been rejected to avoid a drop error. If a project
manager makes too many drop errors, it reveals that the manager is too conservative.
A go error occurs when the project manager permits a poor idea to move into the
development and commercialization phase. Since costs rise substantially with each
successive development stage, poor ideas have to be dropped as early as possible.
38
Example: Stage-Gate System at 3M
Minnesota Mining and Manufacturing (3M) fosters a culture of innovation throughout
the firm. The company manages the innovation process through a sophisticated tool
-
several stages. There will be a gate or check point at the end of each stage. The project
leader, who works with a cross-functional team, brings a set of known requirements to
each gate before the project passes from one stage to the next stage. The project leader
also performs a technical appraisal, competitive analysis and a market study of
customer interests and preferences. Senior managers review the criteria at each stage to
judge whether the project deserves to move to the next stage. Finally, the gatekeepers
make one of four decisions: go, kill, hold or recycle.
the process is repeated. Since all the steps are visible to all the people involved,
these systems put a strong discipline into the innovation process. Lego, the Danish
toy maker follows the same procedure to replace about one-third of its product line
with new products every year.
Prentice Hall of India Private Limited,
Millennium Edition p. 333-334.
The project manager must consider the following aspects to eliminate ideas that are
not promising:
Acceptable Risk Level
Assessment of the level of risk associated with a selected idea is a factor considered
during the initial screening. Particularly in large infrastructural projects, the
management considers the levels of risk involved in the project. The project manager
ial and environmental
conditions, sustainability over long periods, government policies and controls and
expected cash inflows.
Reasonability of Costs
The project manager should ensure that the costs involved for implementing the
project are reasonable and that the project provides an acceptable level of profits. An
analysis of raw materials costs, labor costs, factory overheads and administration costs
provides a clear picture of total cost involved. Management must ensure that these
costs are within allowable limits.
Compatibility with Promoter
The project idea should be compatible with the interests and abilities of the person
who is promoting the project. Since the promoter provides the necessary basic
resources, the project manager must ensure that the project is acceptable to him. He
should discuss the underlying facts, risks involved and expected returns of the project
with the promoter to avoid any clashes later on. For any intermediary problems, the
project manager should consult the promoter to take necessary steps.
Consistency with Government Priorities
The project manager should carefully screen the project ideas keeping in view the
priorities of the government. On several occasions, projects have been terminated
before completion because of their harmful effects on the society. The project
manager should therefore be familiar with all the rules and regulations framed by the
government concerning the issuance of licenses for commencing a project and the
import of raw materials from foreign countries.
39
Availability of Inputs
The project manager should consider the input requirements, their availability and
cost while screening project ideas. In India, many projects have to cope with shortages
of power and irregular supplies of required agricultural raw materials like cotton, jute
and oil seeds. Sometimes, many of the raw materials have to be imported. So, the
project manager should ensure in advance that all the necessary input requirements for
the project are available.
Adequate Market Demand
The project manager should estimate the potential for growth and the return on
investment for the proposed project ideas. Obviously all firms wish to invest in the
areas where demand exceeds supply. When screening the project ideas, the project
manager should consider factors like present domestic market demand, expected
future demand, number of competitors and their market shares and entry barriers for
the new entrants.
Check Your Progress
28. Which of the following aspects should the project manager consider to eliminate
ideas that are not promising?
i. Reasonability of costs
ii. Compatibility with promoter
iii. Availability of inputs
iv. Adequate market demand
29. Identify the activity or technique that is not a part of the formal screening
process.
a. Checklist
b. Black box
c. Rating system
d. Economic analysis
30. Initial screening is a process of rejection rather than a process of selection. What
are the types of project ideas rejected in the initial screening process?
a. Ideas that have limited commercial potential
b.
c. Ideas which are less risky
d. Both (a) and (b)
31. Acceptable risk level is a factor considered during the
a. initial screening stage.
b. market and technical analysis stage.
c. financial analysis stage.
d. project idea generation stage.
40
32. __________ occurs when the project manager permits a poor idea to move into
the development and commercialization phase.
a. Stand alone risk
b. Drop error
c. Systematic risk
d. Go error
33. Identify the factors that should be considered by the project manager to check the
acceptable risk level of a project.
i.
ii. Sustainability over long periods
iii. Government policies and controls
iv. Expected cash inflows
34. Which of the following statements is true regarding a drop error?
a. A drop error occurs when a company rejects a good idea.
b. A drop error occurs when the project manager permits a poor idea to move into
the development phase.
c. The project manager can avoid a drop error by reviewing ideas that have been
rejected.
d. Both (a) and (c)
8. Project Rating Index
The Project Rating Index is an evaluation method that helps management to
streamline the process of initial screening. In this method, the management identifies
factors for rating projects and assigns a weight to each factor. The projects are then
measured against these factors and assigned a score. This method is useful for the
firms when a large number of project ideas have to be evaluated.
The steps involved in developing a project-rating index are described below.
1. Identify the relevant factors useful for rating a project.
2. Assign factor weights to each factor, based on the relative importance of each
factor.
3. Use an appropriate rating scale (5-point or 7-point) and rate the project on the
listed factors.
4. Multiply the factor rating with the factor weight to calculate the factor score for
each factor.
5. Add all the facto
6. Reject the project if the rating index of the project is less than the desired value.
41
Activity: The management of Zenix Turbo Machines Limited wanted to screen the
project ideas generated by its employees. The CEO of the company wanted to use
the project index method for screening the project ideas. The job of screening was
entrusted to one of the senior managers of the company, Kamal Nath. The
management of the company identified the following factors in rating a project
input availability, complementary relationship with other products of the firm,
adequacy of market demand, technical know-how, and consistency with
government priorities. The factor weights assigned to these factors were 0.2, 0.15,
0.3, 0.1, 0.15, and 0.1 respectively. The management decided to reject a project
idea, if its project rating index was less than 3, and consider an idea, if its project
factor ratings for a project idea were 3, 2, 1, 2, 4
and 3 respectively. Do you think, the management of the firm will consider this
project for final selection?
Answer:
9. Sources of Positive Net Present Value
Project managers, obviously prefer to select project ideas that give higher returns than
the investment made. Consequently, they consider the Net Present Value (NPV) while
screening the project ideas. The net present value is defined as the present value of the
future revenues minus future costs. Some of the factors that firms can use to enhance
the net present value of a project are government policy, economies of scale,
product differentiation and superiority of technology.
Government Policy
The government imposes entry barriers to firms that import goods as part of its social
obligation. It uses import restrictions, restrictive licensing, high tariffs, and
environmental control to safeguard the interests of some specific industries. If a
project idea seems to be financially profitable, the project manager must ensure that
the project is not against the interests of the government. The project manager should
choose those projects which can receive special tax benefits and exemptions. This
results in positive net present value of the project.
Economies of Scale
A company is said to have actual economies of scale when it has reduced the cost per
unit produced through an increase in the scale of production, marketing or
distribution. The project managers should identify those ideas that will enable him to
achieve the benefit of economies of scale. But a considerable amount of capital is
required to achieve economies of scale. So it is the responsibility of the project
manager to screen the project ideas by analyzing the capital requirements of the
project. The project managers can also consider the possibility of mass production.
This is particularly relevant in the industries like petroleum refining, mineral
extraction, and aluminum, steel and iron production.
42
Product Differentiation
A company can create entry barriers for other companies by differentiating its
products from those of its competitors. Project managers try to select those ideas,
which recommend the development of products or services that are quite different
from those offered by its competitors. The factors that create differentiation are
innovative product features, high quality products and customized service. Effective
advertising and superior marketing yield better results when the product is truly
differentiable.
Superiority of Technology
New technologies can create new markets. Firms that have developed new
technologies will have an edge over their competitors. Firms like Xerox and Microsoft
earned superior returns for longer periods because of their technological capabilities.
Several Indian companies like Kine
competitors because of their emphasis on technology.
Check Your Progress
35. The factor score of a particular factor in calculating the project rating index is:
a. a sum of factor weight and factor rating.
b. a product of factor weight and factor rating.
c. a division of project rating index by the factor rating.
d. a product of factor weight and rating index.
36. Arrange the following options based on the sequence in which the project
manager develops a project rating index.
i. Multiply the factor rating with the factor weight to calculate the factor score for
each factor.
ii. Assign factor weights to each factor, based on the relative importance of each
factor.
iii. Identify the relevant factors useful for rating a project.
iv. Add all the fac
v. Use an appropriate rating scale and rate the project on the listed factors.
vi. Reject the project if the rating index of the project is less than the desired value.
a. iii-ii-v-i-iv-vi
b. iii-v-ii-iv-vi-i
c. iii-iv-vi-v-i-ii
d. iii-i-ii-v-iv-vi
37. ___________ is an evaluation method that helps the management to streamline
the process of initial screening.
a. Spectrum analysis
b. Project rating index
c. Delphi technique
d. Attribute listing
43
38. Identify the factors that firms can use to enhance the Net Present Value (NPV) of
a project.
i. Favorable government policy
ii. Economies of scale
iii. Product differentiation
iv. Superiority of technology
Exercises
(Questions A D)
Surjeet Technologies is planning to set up a plant in one of three locations
Bangalore, Chennai, or Hyderabad. Following are the details of the factors considered
by the company for selecting the plant location, the weights attached to each of them,
and the rating for various factors on a scale of 1 to 5.
Factors Hyderabad Chennai Bangalore
Weights Rating
Scale
(1 to 5)
Weights Rating
Scale
(1 to 5)
Weights Rating
Scale
(1 to 5)
Closeness to
Market
0.30 5 0.35 4 0.20 4
Technology 0.15 3 0.15 5 0.25 5
Cost of inputs 0.15 4 0.15 2 0.15 2
Government
regulations
0.15 3 0.10 3 0.20 3
Availability of
inputs
0.25 4 0.25 4 0.20 4
Based on the given data, answer the following questions.
A. Calculate the rating index for Hyderabad.
B. Calculate the rating index for Chennai.
C. Calculate the rating index for Bangalore.
D. The company wants to go ahead with a location that gives a rating index of more
than 4. Which of the locations would it select?
10. Summary
When developing a new project, the project manager generates several ideas from
different sources like customers, employees and competitors, and finally selects those
project ideas that can be implemented.
44
The generation of ideas requires creativity, sensitivity to the changes in external
environm
Creativity refers to the ability of an individual or a group to develop something new. It
to see new patterns and possibilities.
The process of creativity involves four stages preparation, incubation, illumination
and verification.
Methods like attribute listing, checklist and black box help in improving the creativity
of an individual.
Organizations encourage group creativity to elicit more and better ideas. Some of the
popular group creativity techniques used by organizations are brainstorming, Delphi
technique, and nominal group technique.
Most firms conduct a SWOT analysis to identify their strengths and weaknesses, and
the opportunities and threats in the business environment.
For the purpose of scanning the environment, the whole business environment may be
divided into six broad sectors: economic sector, governmental sector, technological
sector, socio-demographic sector, competition sector and supplier sector.
appraisal of corporate strengths and weaknesses provides for exploiting the
opportunities in the environment.
Project managers carry out various activities to generate more and more project ideas.
These include study the existing industries, observe the inputs and outputs of
various industries, analysis of imports and exports, study of economic and social
trends, observe new technologies, identifying psychological needs and study the
government guidelines and recommendations for financial institutions.
After a pool of ideas has been generated, the project manager must screen them. In
this phase, the ideas that
objective are rejected. Initial screening is a process of rejection rather than a process
of selection.
The project rating index is an evaluation method that helps management to streamline
the process of initial screening. In this method, the management identifies factors for
rating projects and assigns a weight to each factor. The projects are then measured
against these factors and assigned a score.
Project managers select project ideas that give higher returns than the investment
made. They consider the net present value while screening the project ideas. The net
present value is defined as the present value of the future revenues minus future costs.
Some of the factors that firms can use to enhance the net present value of a project are
government policy, economies of scale, product differentiation and superiority of
technology.
11. Glossary
Creativity: The ability of an individual or a group to develop something new. It
to see new patterns and possibilities.
Net Present Value: The present value of the future revenues minus future costs.
Project Rating Index: An evaluation method that helps management to streamline
the process of initial screening.
45
1. A project manager should always be on the look out for new ideas. Explain the
need for generating project ideas.
2. es in external
agree with this statement? Why or why not?
3. For the purpose of scanning the environment, the entire business environment
may be divided broadly into six sectors, namely, economic sector, governmental
sector, technological sector, socio-demographic sector, competition sector, and
supplier sector. Explain the importance of scanning these sectors in detail.
4. Project managers perform numerous activities to generate more and more project
ideas. What are these activities? Describe them in detail.
5. After the idea generation process, the project manager must screen them. Explain
the initial screening process. What are the aspects that are considered by the
project manager to eliminate ideas that are not promising? How is the project
rating index method used by the project manager to screen the project ideas?
6. A project manager selects ideas that give greater returns than the investment
made. How can a project manager find out whether a project idea gives greater
returns or not?
1.
2.
.
3.
4. A Systems Approach to Planning,
5.
6. -phase Project Management: A
New project ideas can come from different sources like customers, competitors
and employees. The project manager has to ensure that the chosen idea for a new
or modified product or a service can really cater to a present unmet need.
2. (c) Net Present Value
Net Present Value (NPV) is used to conduct a financial analysis of projects. In the
case of financial projects, those with higher NPV are selected. Break-even
analysis is a technique used by the project manager to determine when the project
-
enhance creativity in individuals. The Program Evaluation and Review Technique
is a technique used to prepare a plan for implementation of the project.
46
3. (b) drop the unviable ideas at the initial stages of new project development.
After the ideas have been collected, the project manager has to screen them. The
objective of screening is to drop the unviable ideas at the initial stages of new
project development. It is a process of rejection rather than one of selection.
Screening helps in rejecting ideas that cannot be considered for implementation.
The project manager uses different sources like customers, employees, and
competitors to generate ideas and finally selects those project ideas that can be
implemented. The generation of ideas requires creativity, sensitivity to changes in the
5. (c) Only ii
Net Present Value is used to screen project ideas. In the case of financial projects,
the projects with higher positive NPV are selected.
6. (b) Brainstorming
Attribute listing, checklist, and black box are techniques that organizations use
for developing creativity in an individual. Brainstorming is a technique used to
improve creativity in groups.
7. (b) Preparation Incubation Illumination Verification.
The process of creativity involves four stages preparation, incubation,
illumination, and verification. In the preparation stage, an individual gathers the
necessary information, defines the problem precisely, analyzes the data, and
generates a number of alternatives. In the incubation stage, he/she comes out with
unusual alternatives because of subconscious mental activity coupled with
divergent thinking. In the illumination stage, the individual gets an insight into a
problem all of a sudden while he/she is thinking of several alternatives. In the
verification stage, the feasibility of the alternative ideas is examined.
8. (c) Creativity
Creativity refers to the ability of an individual or a group to develop something
new. It involves the ability to combine or synthesize available information and
experience to see new patterns and possibilities.
9. (c) Nominal group technique
The nominal group technique is a structured technique administered by a
coordinator. All the individual members prepare their ideas independently. They
are then requested to present the ideas before the other members, who rate the
ideas. The coordinator notes down all the ideas generated (positive and negative
arguments of each idea) for future use.
10. (b) Preparation
illumination, and verification. In the preparation stage, an individual gathers the
necessary information, defines the problem precisely, analyzes the data, and
generates a number of alternatives.
11. (c) Brainstorming encourages group members to generate as many ideas as
possible, helps in improving ideas of other members, and allows synthesizing
of two or more ideas.
The brainstorming technique encourages group members to generate as many
ideas as possible. Improving the ideas of other members and synthesizing two or
more ideas is allowed, but criticism of any idea is not entertained.
47
12. (c) Only ii and iii
Verification is the last and final stage of the creativity process. In this stage, the
feasibility of alternative ideas is examined. The ideas for which solutions are not
feasible are rejected.
13. (c) Nominal group technique
The nominal group technique is a structured technique administered by a
coordinator. All the individual members prepare their ideas independently. They
are then requested to present the ideas before other members, who rate the ideas.
The coordinator notes down all the ideas generated (positive and negative
arguments of each idea) for future use.
14. (c) Illumination
illumination, and verification. In the illumination stage, an individual gets an
insight into a problem all of a sudden while he/she is thinking about several
alternatives. The practicability of this idea is then examined.
15. (b) the individual comes out with unusual alternatives because of
subconscious mental activity coupled with divergent thinking.
In the incubation stage, an individual comes out with unusual alternatives because
of subconscious mental activity coupled with divergent thinking. In this stage, an
individual does not consciously focus on the problem, but allows the
subconscious mind to look for a solution.
16. (c) Black box
The popular group creativity techniques that organizations use are brainstorming,
the Delphi technique, and the nominal group technique. Black box is a technique
that organizations use for developing individual creativity.
17. (a) Only i, ii, and iii
Creativity refers to the ability of an individual or a group to develop something
new. It involves the ability to combine or synthesize the available information
and experience to see new patterns and possibilities. Creativity is best nurtured in
a liberal climate where everybody is encouraged to develop new ideas and new
ways of doing things. However, very few organizations are able to create such a
climate. Creativity can be nurtured both at the individual as well as group levels.
18. (d) Both (a) and (c)
Attribute listing is a technique used to improve creativity in individuals. In this
technique, attributes that can be attached to the end product and/or service are
listed. Based on the listed attributes, the final product is designed.
19. (d) Checklist
A checklist consists of a set of questions that are relevant to a given situation.
Answering these questions can help the individual find a solution to the problem.
In the attribute listing technique, attributes that can be attached to the end product
or service are listed. In the black box technique, all the required and available
inputs as well as the desired outputs are listed. The Delphi technique is a
structured approach to elicit the ideas and opinions of a number of experts.
20. (d) Delphi technique
Delphi technique is a structured approach for eliciting the ideas and opinions of a
number of experts. A panel of experts is asked to generate ideas at the individual
level, for a given issue.
48
21. (b) Black box
In the black box technique, all the required and available inputs as well as the
desired outputs are listed. It is also checked whether these outputs can be
produced using the available inputs.
The various activities to be carried out while searching for new project ideas are
studying the existing industries, observing the inputs and outputs of various
industries, analyzing imports and exports, studying economic and social trends,
observing new technologies, identifying psychological needs, and studying the
government guidelines and recommendations for financial institutions.
23. (b) Economic sector
The economic sector comprises macro level factors like the state of the economy,
the overall rate of economic growth; the growth rate of the primary, secondary,
and tertiary sectors; the BoP (Balance of Payments) position; and the trade
deficit/surplus of the country. The project manager should also analyze the
economic environment to assess the viability of new project ideas.
24. (b) before a project is accepted.
appraisal of corporate strengths and weaknesses helps in exploiting the
opportunities in the environment.
25. (b) i-iii-ii
spectru
are identified and the existing brands in the market are then placed on a
continuum in respect of the factors identified by the customers. The project
managers then attempt to identify the gaps relative to the listed psychological
needs.
26. (c) Socio-demographic sector
A study of the socio-demographic sector involves the study of population growth,
age shifts in population, educational profile of the people, gender composition,
and religious interests. The project manager should understand all the socio-
demographic aspects while setting the objectives of the project and in preparing
the relevant procedures.
27. (c) Spectrum analysis
are identified and then the existing brands in the market are placed on a
continuum in respect of the factors identified by the customers. The project
managers then attempt to identify the gaps relative to the listed psychological
needs.
The project manager must consider the following aspects to eliminate ideas that
are not promising acceptable risk level, reasonability of costs, compatibility
with promoter, consistency with government priorities, availability of inputs, and
adequate market demand. The project idea should be compatible with the interests
and abilities of the person who is promoting the project. The promoter provides
49
the basic resources to the project. Therefore, the project manager should ensure
that the project is acceptable to him/her. The project ideas should be carefully
screened keeping in view the government priorities. Sometimes, a project may be
scrapped before completion due to its harmful effects on society. The project
manager should therefore be familiar with all the rules and regulations framed by
the government.
29. (b) Black box
Ideas can be screened in a variety of ways. Some managers use an informal
screening process to eliminate unsuitable ideas. A formal screening process
involves a checklist, a rating system, and an economic analysis. Black box is a
technique used to enhance creativity in individuals. In this technique, all the
required and available inputs as well as the desired outputs are listed. It is also
checked whether these outputs can be produced using the available inputs.
30. (d) Both (a) and (b)
In the initial screening phase, ideas that have limited commercial potential or do
rejection rather than a process of selection. The objective is to reject those ideas
that cannot be considered for implementation. A project manager usually
implements more profitable and risk-free activities so that the probability for
success of a project increases.
31. (a) initial screening stage.
Assessment of the risk level associated with a selected idea is a factor considered
during the initial screening stage. In the project idea generation stage, the project
manager uses several techniques like attribute listing, checklist, brainstorming,
etc., to generate new project ideas. In the market and technical analysis stage, the
market and technical feasibility of the project idea is determined. Market analysis
estimates the size of the potential market, patterns of consumption, level of
competition, and market composition. Technical analysis includes the study of all
the relevant design and engineering aspects, reliability, and sustainability of the
product. The financial feasibility of the project idea is determined in the financial
analysis stage of the project idea. In this stage, the project manager examines the
capital costs and operating costs and revenues of the proposed project.
32. (d) Go error
When screening ideas, the project manager must avoid two types of errors drop
error and go error. A go error occurs when the project manager permits a poor
idea to move into the development and commercialization phase. Since costs rise
substantially with each successive development stage, poor ideas have to be
dropped as early as possible.
33. (d) i, ii, iii and iv
Assessment of the risk level associated with a selected idea is a factor considered
during the initial screening stage. The project manager has to consider factors like
over long periods, government policies and controls, and expected cash inflows.
When screening ideas, the project manager must avoid two types of errors drop
error and go error. A drop error occurs when a company rejects a good idea. The
project manager should review ideas that have been rejected to avoid a drop error.
If a project manager makes too many drop errors, it shows that he/she is too
conservative.
50
35. (b) a product of factor weight and factor rating.
The project rating index is an evaluation method that helps the management to
streamline the process of initial screening. In this method, the management identifies
factors for rating projects and assigns a weight to each factor. The projects are then
measured against these factors and assigned a score. The factor score for each factor is
calculated by multiplying the factor rating with the factor weight.
36. (a) iii-ii-v-i-iv-vi
streamline the process of initial screening. The steps involved in developing a
project-rating index are identify the relevant factors useful for rating a project;
assign factor weights to each factor based on the relative importance of each
factor; use an appropriate rating scale (5-point or 7-point) and rate the project on
the listed factors; multiply the factor rating with the factor weight to calculate the
than the desired value.
37. (b) Project rating index
streamline the process of initial screening. In this method, the management
identifies factors for rating projects and assigns a weight to each factor. The projects
are then measured against these factors and assigned a score. This method is useful
for firms when a large number of project ideas have to be evaluated.
NPV is defined as the present value of the future revenues minus future costs. Some
of the factors that firms can use to enhance the net present value of a project are:
favorable government policy, economies of scale, product differentiation, and
superiority of technology. Favorable government policies will have a positive affect
on the business of the organization. Economies of scale will reduce the costs of the
organization, thus adding to its revenues. Product differentiation and use of superior
technology will help the company in bringing out products that are much superior
to those of its competitors. This will in turn add to the revenues of the organization.
All these factors will enhance the NPV of a project.
Following are the answers to the Exercises given in the unit.
A. 4
Hyderabad:
Factors Weights Rating Scale (1 to 5) Factor score
Closeness to Market 0.30 5 1.5
Technology 0.15 3 0.45
Cost of inputs 0.15 4 0.60
Government
regulations
0.15 3 0.45
Availability of inputs 0.25 4 1.00
Rating Index 4.00
51
B. 3.75
Chennai:
Government
regulations
0.10 3 0.30
Rating Index 3.75
C. 3.75
Bangalore:
Government
regulations
0.20 3 0.60
Rating Index 3.75
D. None of the three
In the project rating index method, a project is rejected if the rating index is less
than the desired value. Here, the company wants to select a location that has a
rating index of more than 4. Hyderabad has a rating index of 4, and Chennai and
Bangalore have a rating index of 3.75. Therefore, the company will not select any
of the three locations.
Unit 3
Market and Technical Analysis of Projects
Structure
1. Introduction
2. Objectives
3. Market and Demand Analysis
4. Technical Analysis
5. Summary
6. Glossary
7. Self-Assessment Test
8. Suggested Readings/Reference Material
1. Introduction
In the previous unit, we have discussed project idea generation and screening. In this
unit, we will discuss market and technical analysis of projects. Once the project ideas
are generated and screened, they are evaluated to test their marketability, technical
feasibility, and cost considerations. Market and demand analysis provides a detailed
analysis of all market conditions and technical analysis provides an assessment of all
technical aspects of the project idea. The market analysis estimates the size of the
potential market, patterns of consumption, level of competition, market composition
and demand analysis determines the aggregated demand for a product or service for a
particular period, variations in supply, hidden demands of the customers, etc.
Technical analysis of a project idea includes the study of all the relevant design and
engineering aspects, reliability and sustainability of the product. An in depth study of
market and demand analysis followed by technical analysis reveals the probability of
success of a project idea.
This unit will deal with market and technical analysis of projects. We shall first
discuss market analysis of projects that involves aspects like situational analysis and
objectives specification, collection of data, market survey, market description, demand
forecasting, uncertainties in demand forecasting and market planning. We shall then
move on to discuss technical analysis of projects that involves aspects like technology
selection, input requirements and utilities, product mix, plant capacity and functional
layout, location of the project, machinery and equipment, and consideration of
alternatives.
2. Objectives
explain how to conduct market and demand analysis of a project.
analyze the technical aspects of a project.
3. Market and demand analysis
A project manager should carefully study the market potential for a given project idea.
Conducting market surveys, collecting primary and secondary data, studying the
characteristics of the market are some of the activities to test the market environment
53
and see if the idea is feasible. Demand analysis of a product includes the study of
consumption patterns, income and price elasticity of demand, nature of competition,
availability and prices of substitutes and complementary products. The activities of a
project manager in conducting a market and demand analysis include situational
analysis and objectives specification, collection of secondary data, market survey,
market description, demand forecasting, and market planning.
Situational Analysis and Objectives Specification
Situational analysis is the process by which a project manager studies customer
preferences and their purchasing capacity and strategies of the competing firms and
intermediaries. In the process, the project manager interacts with the project
stakeholders such as clients, channel members, employees and competitors of the firm
to better understand market requirements.
A project manager need not go in for a formal study when he is satisfied with the
information generated through informal talks and feels that it is adequate to scale the
present and future demand for a product. But if there is a need for a formal study, the
project manager has to define the objectives of the study. Once the objectives are
clearly stated, the questions in the survey should be framed in such a way so as to
elicit the required response (answer relating to market demand, expected revenue etc).
Suppose a small firm has developed an inverter that is technically competitive to cater
to the customers whenever there is a power cut. The management of the firm should
answer the following questions to check whether the objectives of the firm are in tune
with market interests:
Who are the customers of inverters?
What is the existing demand for inverters? (specify country wise, state wise demand)
How is the pattern of demand over the year?
What are the areas with higher demand for power? (specify the hours of demand area
wise)
What are the prices and features of inverters being offered by the competitors?
How sensitive are customers to the price of an inverter?
How many types of distribution channels are available for inverters in the market?
What are the constraints faced by intermediaries to capture the market?
How can existing customers be convinced to use the newly developed product?
What price and warranty will ensure the products acceptance in the market?
Collection of Data
The project manager collects a lot of data from all the possible sources to answer the
questions listed above. Broadly, data is of two types: primary data and secondary data.
Primary data is the data that is collected for a specific purpose and for the first time.
Secondary data is the data that is already available but might have been collected for
some other purpose or by some other institutions. Secondary data is considered to be
more useful in market analysis as it is easy to obtain and is also economical.
Primary data can be obtained from sources both internal and external to the
organization. Internal primary data is obtained from past and current sales of the firm,
observations of employees of the firm etc. External primary data is obtained from the
opinion of the dealers, feedback of the sales personnel and sales trends. Survey
methods or experimental methods are ideal for gathering primary data.
54
The survey method of data collection includes personal interviews, telephonic
interviews and mail surveys with customers or middlemen. The experimental method
includes product testing, psychological techniques and consumer panel techniques.
Product testing is an objective appraisal of the product performance done on a limited
scale without using the firm's brand name. In psychological techniques, a researcher
who is trained in psychology, tests the subconscious emotions of customers.
Another technique called 'consumer panel technique', is done by selecting a group of
customers (on a permanent basis ) and interviewing the group at different intervals of
time to observe their behavioral changes. This enables the project manager to
understand market trends and changing preferences of customers. The primary data
provides problem specific and accurate information, but collection of primary data
requires more time and it also incurs more costs.
Project managers prefer to use secondary data as it is readily available and
economical. The secondary data are compiled by the government, non-profit
organizations, or some social welfare institutions. Professional market research
agencies like Market Analysis and Research Group (MARG), publications of Center
for Monitoring Indian Economy (CMIE), Journals of Federation of Indian Chambers
of Commerce and Industry (FICCI), annual reports of Central Statistical Organization
(CSO), Census of India, various research theses available in the universities and
research organizations are some sources of the secondary data.
A project manager should carefully select the sources of secondary data as the data
was collected by other organizations for their own needs. He should also ensure that
the sources are authentic and the information is accurate, reliable, relevant and
economical to obtain. Since the data is not collected for a specific problem, the project
manager has to correlate the available information with the existing problem.
Check Your Progress
1. The size of the potential market, the level of competition, etc., are estimated by
conducting a ____________.
a. market analysis
b. technical analysis
c. financial analysis
d. demand analysis
2. Variations in supply are determined by ____________.
a. technical analysis
b. financial analysis
c. market analysis
d. demand analysis
3. Which of the following activities are conducted to test the market environment
and see whether the project idea is feasible or not?
i. Market surveys
ii. Colleting primary and secondary data
iii. Studying the characteristics of the market
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
55
4. Identify the activities that the project manager uses to conduct a market and
demand analysis.
i. Situational analysis
ii. Market description
iii. Objectives specification
iv. Demand forecasting
5. Which of the following statements is false regarding primary data and secondary
data?
a. Primary data is the data that is collected for a specific purpose and for the first
time.
b. Secondary data is data that is already available but might have been collected for
some other purpose.
c. Primary data can be obtained only from sources internal to the organization.
d. Secondary data is readily available and economical to use.
6. Identify the statement(s) that does/do not hold true regarding secondary data.
a. Secondary data is considered to be more useful than primary data in market
analysis as it is easy to obtain and is also economical.
b. Secondary data provides problem specific information.
c. Secondary data is readily available and requires less time to collect than primary
data.
d. Both (b) and (c)
7. Which of the following is not an experimental method of data collection?
a. Product testing
b. Personal interviews
c. Consumer panel techniques
d. Psychological techniques
8. In psychological technique,
a. a researcher tests the subconscious emotions of customers.
b. a group of customers, selected on a permanent basis, are interviewed at different
intervals of time to observe their behavioral changes.
c. information about the changing preferences of customers is collected by sending
mails to them.
d. an objective appraisal of product performance is done on a limited scale without
using the firms brand name.
9. Identify the technique in which a group of customers are selected on a permanent
basis and interviewed at different intervals of time to observe their behavioral
changes.
a. Product testing
b. Consumer panel technique
c. Personal interviews
d. Psychological techniques
56
Market Survey
Sometimes information collected from secondary sources may not be enough to
understand the market conditions completely. Hence, information obtained from
secondary sources should be supplemented by primary data, which is problem-
specific. A market survey is a useful method of obtaining the primary data.
Market survey is a technique that is aimed at gathering all possible information by
conducting interviews. The project manager chooses a convenient sample, as it is not
possible to study the entire population in the market. He conducts personal interviews
with stakeholders of the project either directly or by phone to gather the information.
Opinion surveys, attitude surveys, information surveys, future invention surveys help
the project manager to understand what the customers wants.
The project manager considers the entire market population for the projects like
manufacturing intermediate goods and investment goods, where the project customers
(clients) are limited in number. These surveys are called census surveys. The results
obtained from this survey are more reliable than the sample survey, but conducting the
survey is more expensive.
A market survey is useful in determining the total market demand, demand growth
rate in different segments of the market, understanding the inner motives of the
customer and measuring the unsatisfied needs of the customers. Since it is not
possible to interview the entire population of the market, sample survey is a good
method to assess the market characteristics. The project manager conducts the sample
survey by choosing a sample that best represents the characteristics of the population.
A small sample is more convenient and economical as well. The following are the
steps in a sample survey:
Defining the Target Market
The project manager defines the target market of a project idea in terms of market
population. He then divides the population into the various segments based on the
buyer characteristics. For example, the various segments of customers for a power
project are household consumers, commercial consumers, industries, and all
state/central government offices.
Selecting the Sample
The project manager carefully selects a sample that represents all the characteristics of
the population from various segments. The sample should not be very small as it
cannot represent the characteristics of the population. In the same way, the sample
should not be large, as it is not economical for the firm conducting the survey.
Developing the Questionnaire
A questionnaire is a formalized set of questions for generating information. The
questions can be structured or unstructured or a combination of both, depending on
the requirement. Structured questions are questions followed by a fixed number of
choices from which the respondent should choose an answer. Unstructured questions
require the respondent to give descriptive answers. However, it is tedious to analyze
an unstructured questionnaire.
The questions in a questionnaire can be classified into three types based on the
content: administrative questions, classification questions and target questions.
Administrative questions include respondent identification, interviewer identification,
date and place of interview etc. Classification questions are about the respondents
characteristics, socio-demographic and behavioral information. These provide
57
information on sex, age, family size, household income, social class, education and
attitudes. The target questions are about the present project and its products. Questions
should carefully be sequenced so as to be understood by all segments of target
customers. An understanding of end product or service of the project, its usage and a
knowledge of human psychology are essential in developing the questionnaire.
Training the Surveyors
The management has to be diligent while recruiting the market surveyors who actually
conduct the survey. As survey methods are mostly personal, the project manager
should ensure that these surveyors are able to tap the hidden interests of the
customers. Proper training of the surveyors will ensure good results.
Recording the Information
The information obtained from the survey should be recorded for future use. This is
done by thoroughly scrutinizing the obtained information to avoid inconsistent and
unreliable data. Project manager does editing and tabulating of the information before
recording the information. The recorded information is used whenever required.
Interpreting the Information
The recorded data is interpreted by analyzing it by using some standard statistical
techniques such as Chi-Square test, correlation, regression, ANOVA analysis etc.
Market Description
Based on the information obtained from the secondary data sources and market
survey, the project manager describes the marketability of the project idea in terms of
its effective demand, breakdown of demand, price, consumers' interests, method of
distribution, types of sales promotion, supply and competition, impact of government
policies, etc.
Effective Demand
In a perfect market, effective demand for a particular product or service is nothing but
apparent consumption. Apparent consumption is calculated as the sum of production
and trade surplus/deficit minus changes in stock level. Because of limitations like
exchange restrictions and government controls over production and distribution, the
effective demand is less than apparent consumption. Apparent consumption takes into
account only the desirability and ability of the buyers. But effective demand also
considers willingness of the buyers. The project manager analyzes the present and past
effective demand for the product or service.
Breakdown of demand
The project manager can better determine the total demand of the product by dividing
it into various segments as per nature of the product, type of customers, or by
geographical location. For example, the total demand for steel is sum of the demand
of all products that are made of steel. In case of power projects, the total demand can
be divided into domestic consumers demand and industrial consumers demand. The
demand as per geographical location would be demand in rural and urban areas.
Price
The project manager collects the price statistics of the proposed project idea to
understand the market fluctuations and the changes of price of the product. This
allows him to arrive at the best price for his product. The project manager can also
explore the possibilities of keeping the price high by maintaining high quality or he
can look for ways to reduce project costs and keep the prices low.
58
Consumers Interest
The project idea is evaluated on the basis of the consumers' demographical,
sociological, cultural interests and values. A project idea that goes against these
interests and values should not be taken up. The project manager has to observe
different purchasing motives of the different consumer groups for a specific project
idea.
Methods of Distribution
The 'reach' of a product or service plays an important role in determining the success
of the product. As different products require different 'reach', project ideas should be
evaluated by its reach. Depending on the nature of the product (consumer/industrial
product), the project manager selects the method of distribution and plans the
promotional practices to generate more sales.
Sales Promotion
The project manager adopts different techniques of sales promotion after considering
the characteristics of the market, nature of product and the distribution channel.
Discounts, free gifts, coupons are some of the sales promotion techniques used to
increase sales of the product.
Supply and Competition
To survive competition, a project manager analyzes the 'supply and demand situation'
for all project ideas. Any product or service that has demand exceeding supply is
worth taking up. A project manager also considers the supply of complementary and
substitute products while studying the market competition.
Government Policy
The government provides incentives to certain industries for the benefit of the country
through its five-year plans, export incentives, preferential purchases and subsidies.
Therefore, the project manager has to understand government interests to evaluate the
project idea better. If the government provides certain incentives to a particular
industry, then the prices of the product are lowered. This change in the price in turn
will affect the demand for the product.
Activity: Vihar Manufacturing Limited, established in 1995, manufactures a
variety of grinding, milling and lathe machines. In 1999, the company planned to
manufacture numerical and computer-numerically controlled machines. Venkata
Raman, the CEO of Vihar Manufacturing Limited, wanted to estimate the market
demand for these machines. He went through market estimates prepared by the
marketing team, based on the secondary data. The CEO was skeptical about the use
of secondary data. He asked for estimates prepared on the basis of primary
research. Why does Raman prefer primary data? What type of sampling should the
company use when conducting a market survey for collecting the primary data?
Answer:
59
Check Your Progress
10. Arrange the following steps based on the sequence in which the sample surveys
are conducted.
i. Interpreting the information
ii. Developing the questionnaire
iii. Defining the target market
iv. Training the surveyors
v. Selecting the sample
vi. Recording the information
a. iii-ii-v-i-iv-vi
b. iii-v-ii-iv-vi-i
c. iii-iv-vi-v-i-ii
d. iii-i-ii-v-iv-vi
11. Target questions are
a. questions about age, family size, education, and attitudes of the respondent.
b. questions about the respondents characteristics, socio-demographic information,
and behavioral information.
c. questions about the present project and its products.
d. questions about the respondent identification, interviewer identification, and data
and place of interview.
12. Apparent consumption is calculated as
a. Production + Trade Surplus/Deficit + Changes in Stock Level
b. Production + Trade Surplus/Deficit Changes in Stock Level
c. Changes in Stock Level + Trade Surplus/Deficit Production
d. Production Trade Surplus/Deficit Changes in Stock Level
13. Identify the aspects that apparent consumption does not take into account.
a. Desire of the buyers
b. Ability of the buyers
c. Willingness of the buyers
14. The total demand for the product can be determined by dividing the entire market
into various segments based on all except
a. the nature of the product.
b. the type of organizational structure.
c. the type of customers.
d. the geographical location.
60
Demand Forecasting
The project manager forecasts the demand for a particular product or service using
information obtained from secondary sources, market survey and market description.
Statistical techniques like trend projections are useful in forecasting the demand for a
particular product. These methods extrapolate past trends into the future to forecast
future demand, revenues or sales.
Apart from statistical methods, the project manager forecasts future demand using
techniques like chain ratio technique, consumption level technique, end use technique,
leading indicator technique and econometric technique. These techniques study the
cause and effect relationship of several variables on demand of the product.
Chain Ratio Technique
This is a simple technique that applies a series of factors to forecast the demand for a
particular product or service. For example, a firm manufactures office bags for men.
The firm estimates the aggregate demand of the office bags for men in the following
manner by using the chain ratio technique.
Population of males in the country: 55 million
Proportion of educated males in the population: 0.68
So, population of educated males : 37.4 million
Proportion of employees in the educated males : 0.42
Population of male employees: 15.7 million
Proportion of male employees who will purchase an office bag : 0.61
So, potential sales of office bags : 9.58 million
The method seems simple to use, but the applicability of this method mainly depends
on the accuracy of the ratios used. Project manager should carefully estimate these
ratios to estimate demand for a particular product or service.
Consumption Level Technique
The consumption level technique estimates the demand for a particular product or
service on the basis of income and price elasticities of demand.
Income elasticity of demand
Income elasticity represents the effect of the change in the demand as a proportion to
change in the income. It is calculated as:
1
Q
2
Q
1
I
2
I
1
I
2
I
1
Q
2
Q
i
e
e
i
= Income elasticity of demand
Q
1
= Quantity demanded in the base year
Q
2
= Quantity demanded in the following year
I
1
= Income level in the base year
I
2
= Income level in the following year
The practical use of income elasticity of demand is explained below. Suppose per
capita annual demand for rice in the country is 70 kg. The elasticity of demand for rice
is 1.02. Assume the projected per capita annual income four years hence is 12% more
the present.
61
Then the projected demand for rice would be = (present per capita demand) (1+ per
capita income level income elasticity of demand)
= (70 kg) {1+ (0.12 1.02)} = 78.57kg per capita per annum.
Price elasticity of demand
The price elasticity of demand represents the effect of the change in the demand as a
proportion to change in the price. This is also calculated like income elasticity of
demand. Both these techniques are useful in estimating the sensitivity of demand to
changes in income and price levels.
End Use Technique
This technique is useful in estimating demand for intermediate products such as
investment goods and industrial tools. The project manager estimates the consumption
coefficient of the product for various uses for all users in the country.
Leading Indicator Technique
The change in the value of a particular variable leads to a change in the value of
another variable. For example, a change in the level of literacy of a country leads to a
change in the demand for paper. From the above example, the variable, literacy level
is called a leading variable and the change in the demand for paper is called a lagging
variable. There are two steps involved in using this technique -- identifying the
appropriate leading indicators; and establishing a relationship between the leading
variables and lagging variables to find the demand. In practice, identifying appropriate
leading indicators is difficult and it cannot be assumed that the relationship between
leading and lagging variables remains stable over a period of time.
Econometric Technique
This technique explains the behavior of the economic variables as per the equations
developed. The equation may be a single equation or multiple equations. In a single
equation model, the dependent variable is explained by several other independent
variables.
For example, the demand for rice is explained by the variation in population and
income as
D
t
= a
0
+ a
1
P
t
+a
2
I
t
where D
t
= demand for rice in year 't'
P
t
= population in year 't'
I
t
= income in year 't'
a
0,
a
1
and a
2
are the constants.
Another model, called 'simultaneous equation model' explains the economic
relationships between different variables in terms of two or more equations.
For example, the demand for paper is explained by the number of newspapers printed
and the number of computers. Again, the variable, number of newspapers is explained
by increase in population and the number of computers is explained by income levels.
P
t
= a
0
+ a
1
N
t
+ a
2
C
t
N
t
= a
3
+ a
4
P
t
C
t
= a
5
+ a
6
I
t
where, Pt = demand for paper in year t
N
t
= rise in number of newspapers
62
C
t
= rise in number of computers
I
t
= income level
This technique is useful while understanding complex cause and effect relationships
and in judging the sensitivity of certain variables.
Example: IBMs Structured Walk-Through Technique
The structured walk-through technique was developed by IBM in 1960 as a
relatively friendly approach in evaluating project ideas. Normally, all group
meetings do not come out with the best available ideas as most people criticize the
ideas. The structured walk-through approach deals with the problem by giving
control to people who are being evaluated over the process of evaluation itself.
Following are some rules that reflect the original IBM rules:
Rule 1: The Group being evaluated chooses its Judge and Jury
The people who give their opinion on a particular project idea elect an evaluation
team. This is to assume that the judgment is genuine and it creates a sense of trust,
and the people freely deliver their own ideas.
Rule 2: The Group being evaluated determines the rules of the evaluation
effort
The people being evaluated also frame the rules of evaluation. They prepare
evaluation instructions to the members who are conducting the evaluation.
Rule 3: The Group being evaluated determines the rules of the evaluation
meetings
The people being evaluated decide how the meeting should be conducted. They
decide who is supposed to talk, when and how long.
Rule 4: No upper level managers should be present at the evaluation sessions
As this process is aimed at creating an open environment for a free flow of ideas,
upper level managers normally do not attend the session.
Rule 5: Customers should not be present at the evaluation
This rule is not given by IBM. But experts recommend absence of customers, as
customers may criticize the idea or the people may hesitate to present their ideas
before the customers.
Rule 6: Documentation of the whole process
All proceedings of the session should be clearly documented for future
consideration.
Adapted from J. Davidson frame, 'The New Project Management, Jossey Bass Inc., p. 273-276.
Uncertainties in Demand Forecasting
The statistical techniques and causal methods explained above are prone to errors
because of the many uncertainties involved. The major sources of uncertainty are:
techniques of forecasting, past and present market data, and environmental change.
Techniques of Forecasting
Forecasts obtained by using statistical techniques are prone to errors as they take into
account only quantitative factors and ignore qualitative factors. Also, as some factors
are non-quantifiable, the outcome of these techniques is not accurate. Similarly,
certain unrealistic assumptions may lead to the change in the estimates of future
demand. For example, the consumption coefficients used in end-use method may be
unrealistic assumptions.
63
Past and Present Market Data
Past and present market data are very useful in forecasting the demand for a product.
But the data may not be completely reliable if some unusual events had occurred at
the time when the data was collected. Then, this data cannot be considered for
forecasting because of the influence of these unusual factors.
Environmental Changes
The changes in business environment like technological shifts, changes in the
government policy, discovery of new raw materials, international trade developments,
vagaries of monsoons influence projects in several ways. For example, the arrival of
VCD players in the market has affected the demand for VCRs. A rise in the prices of
petroleum products at the international level will have an effect on the demand for
automobiles.
Market Planning
The four Ps of marketing -- product, price, place, and promotion should be well
designed to achieve the expected level of market penetration. When dealing with
services, the market planning should also include the process, people, and physical
evidence. For example, planning a thermal power station project should include
determining its production capacity, likely cash inflows, place of construction and
transportation and sales programs. For service projects like medical camps, the
planning requires to find out the numbers of the people involved, the structure and
schedule of the project.
Activity: Prasad Engineering Services, using different forecasting techniques,
estimated that a new project would increase the company's revenues by 20% after
completion. But after the project was completed, it increased company revenues by
a mere 5%. The management of the company tried to understand why the project
did not generate the forecasted revenues. After much discussion, the management
concluded that the various uncertainties involved in the process of demand
forecasting had led to an over-estimation of market demand. What uncertainties are
normally involved in the process of demand forecasting? How can a project
manager cope with the uncertainties of demand forecasting techniques?
Answer:
Check Your Progress
15. The project manager forecasts the demand for a particular product or service
using information obtained from which of the following sources?
i. Secondary sources
ii. Market survey
iii. Market description
64
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
16. Which of the following techniques applies a series of factors to forecast the
demand for a particular product or service?
a. Leading indicator technique
b. Chain ratio technique
c. Econometric technique
d. End use technique
17. Identify the technique that makes use of income and price elasticities of demand
for estimating the demand for a particular product or a service.
a. End use technique
b. Econometric technique
c. Consumption level technique
d. Leading indicator technique
18. Income elasticity represents the effect of a change in the demand as a proportion
to a change in the income. Which of the following options give the correct
formula for calculating income elasticity?
a. e
i
=
1
Q
2
Q
1
I
2
I
1
I +
2
I
1
Q +
2
Q
b. e
i
=
1
Q +
2
Q
1
I +
2
I
1
I
2
I
1
Q
2
Q
c. e
i
=
2
I
1
I
1
I
2
I
2
Q
1
Q
1
Q
2
Q
d. e
i
=
1
I +
2
I
1
I
2
I
2
Q
1
Q
1
Q
2
Q
19. Identify the technique which assumes that a change in the value of a particular
variable will lead to a change in the value of another variable.
a. Chain ratio technique
c. Leading indicator technique
d. End use technique
20. Which demand forecasting technique explains the behavior of the economic
variables as per the equations developed?
a. End use technique
c. Leading indicator technique
d. Chain ratio technique
65
21. Which of the following formulae will help in finding out the demand for wheat in
a particular year with variations in population (P) and income (I)?
a. a
0
P
t
+ a
1
I
t
+ a
0
a
1
b. a
0
+ a
1
P
t
+ a
2
I
t
c. a
1
+ a
2
P
t
+ a
3
I
t
d. a
1
P
t
+ a
2
I
t +
P
t
I
t
22. Statistical techniques and causal methods are prone to errors because of the many
uncertainties involved in the process of forecasting demand. Which of the
following are the major sources of uncertainty?
i. Techniques of forecasting
ii. Past market data
iii. Present market data
iv. Environmental change
Exercises
A. The per capita annual demand for wheat in India is 100 kg. The elasticity of
demand for wheat is 1.05. Assume that the projected per capita annual income is
expected to increase by 15% in the next year. Calculate the projected demand for
wheat.
B. The current consumption of product P is 13 tons per year. If the income is
expected to increase by 7% next year and the demand for Product P is 15.5 tons,
calculate the income elasticity of the product.
4. Technical Analysis
Technical analysis of a project idea includes an in depth study of all technical aspects
related to basic manufacturing operations, detailed design, assembling, modeling and
prototype testing. A competent team of technical experts or reputed technical
consultants evaluate the technical aspects of the project. A project manager can also
appraise the current project idea with reference to similar technology already in use.
The project manager engages in detailed discussions with the technical crew to
ascertain the technical viability and feasibility of the proposed project idea.
Sometimes, technical analysis of a project idea includes technical testing of the model
in a simulated environment. For example, software modules are tested internally on a
limited scale to see if they meet the required standards. Similarly, O-shaped rings are
tested at very low temperatures to test the viability of its shape. This is because metal
contracts at low temperatures and the shape get distorted.
Technical evaluation of a project idea is a very crucial aspect and any wrong decision
at this stage will have far-reaching implications for the viability of a project. This is
because technical decisions are irreversible and they require high investments.
Determining technical parameters also decides the competitiveness of the firm. The
technical expert and the project manager have to establish a good rapport before they
determine the key parameters.
66
Technology Selection
It is possible that a project manager does not have the required technical expertise. In
such a case, the technical matters can be better handled by a specialist. But it can be
argued that the project managers can make good technical decisions without deep
technical knowledge.
According to W. Skinner, a management expert on technical aspects, a project
manager should ask himself the following questions to select an appropriate
technology -- What will the technology do? What will the technology not do? What is
required to adopt new technology? How much does the technology cost? and How
certain are the above apprehensions?
Apart from the above questions, the project manager also has to consider the scope for
future expansion, and experiences of the previous users. The project manager can
evaluate the project better if he has the details. Selecting an appropriate technology
also includes evaluating alternative technologies available. Selecting an appropriate
technology is also influenced by several other factors like the capacity of the firm,
inputs and their availability, investment capability, production costs, overheads and
technological upgradations.
Input Requirements and Utilities
To evaluate a project idea, one must also consider the availability and utility of the
inputs. The project manager should carefully assess the materials required and their
specifications. Material inputs for any project are normally classified into four
categories: raw materials, processed industrial materials and components, auxiliary
materials and factory supplies, and utilities. Raw materials include agricultural
products, forest products, mineral products, livestock and marine products. The
project manager has to determine the material inputs by assessing the quality of the
raw materials, their costs and their availability.
While purchasing industrial materials and components, the project manager makes use
of some testing equipments to measure parameters like quality, quantity, and
specifications. Pharmaceutical companies may use some chemicals to test their
chemical inputs. A project manager should develop a close relationship with the input
suppliers to ensure timely and economical inflow of required inputs. Most firms make
long term agreements with the suppliers till the completion of the project.
The manufacturing process is also determined by the availability and quality of raw
materials. For example, the quality of limestone decides whether wet or dry process is
to be used in a cement plant. Proper assessment of availability of infrastructure like
power, water, steam, fuel etc should be made by the project manager to effectively run
the project. All these utilities have to be evaluated in relation to the location, type of
technology, supplier's capacity and plant capacity. The project manager can also
obtain special permission from the local government to ensure better availability and
use of several utilities.
Product Mix
The project manager has the choice between a broad range of products or a shortened
product mix from a study of market requirements and the firm's ability to offer a
variety of products. For example, a carpenter offers a wide range of furniture units
with different features and specifications. But a supplier of electronic durables may
offer only a limited range of products. Similarly, Xerox offers its products only on a
limited scale. The project manager increases the product range when he adopts an
expansion strategy and reduces the product range with a retrenchment strategy.
67
Plant Capacity and Functional Layouts
Plant capacity is the ability of the firm to produce certain volumes or a certain number
of units in a given time period. It represents the production capacity of the firm under
normal working conditions. This is determined on the basis of installed capacity,
machinery, and availability of infrastructure and labor.
Input constraints, investments, market conditions, government policies, technological
upgradations, and financial resources play a critical role in determining the capacity of
a plant. Availability of skilled labor is also a crucial factor in evaluating the capacity
of a project. Layouts are essential for setting up an effective plant. The three types of
layouts are product layout, process layout, and fixed layout.
Product Layout
In this layout, machinery and equipment are arranged according to the products. This
layout is also referred to as an assembly line or production line, if the equipment is
dedicated to continuous production of a narrow product line. Suppose a firm produces
three products: A, B and C. According to this layout, each product is manufactured
separately and there will be no interferences in the production lines of these three
products.
Process Layout
In this layout, all similar equipment or functions are grouped together like all lathes in
one area, and all drilling machines in another area. Suppose a firm uses three varieties
of machines, say P,Q and R to produce a product X. All P type machines are grouped
at one place, all Q type machines are grouped at another place, and all R type
machines in another place.
Fixed Layout
A fixed layout is used when the product is bulky, large, heavy, and remains stationary.
For example, all manufacturing and construction firms select a fixed position for
construction and all materials, machines, sub contractors and workers are taken to the
the fixed place. Best examples of such layouts are ship building, aircraft assembling,
satellite assembling etc. The project manger can choose any of these layouts based on
the requirements of the project. Usually, no single type of layout can exactly fulfill the
purpose and the project manager may use a combination of different types of layouts.
Activity: Once data is available on the principal dimensions of the project like
market demand, plant capacity, technology used for production, plant site and
supply of inputs for the project, the important decision is designing a layout that
best suits the project. Why do firms need a layout? What are the different types of
layout that a project manager can design? Describe the layouts to be used for the
following projects:
i. Setting up a hospital
ii. Setting up a chemical plant
Answer:
68
Check Your Progress
23. Which of the following options include a study of the relevant design and
engineering aspects, and reliability and sustainability of the product?
a. Financial analysis
b. Market analysis
c. Technical analysis
d. Demand analysis
24. Samarth wanted to set up a sugar factory in Uttar Pradesh. He prepared a project
proposal and approached SBI for a loan. The bank required details pertaining to
the main products, plan outline, layout structure, soil test reports, socio-economic
conditions of the project site, licenses, HR policies, etc., in order to decide on the
proposal. What sort of an evaluation is the bank carrying out in order to grant a
loan to Samarth?
a. Market evaluation
b. Demand evaluation
c. Technical evaluation
d. Both (b) and (c)
25. Identify the statements that are true regarding plant capacity.
i. Plant capacity is the ability of the firm to produce certain volumes or a certain
number of units in a given time period.
ii. Plant capacity represents the production capacity of the firm under normal
working conditions.
iii. Plant capacity is determined on the basis of installed capacity, machinery, and
availability of infrastructure and labor.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
26. Which of the following aspects play a vital role in determining the capacity of a
plant?
i. Input constraints
ii. Investments
iii. Government policies
iv. Technological upgradations
27. When the equipment is dedicated to continuous production of a narrow product
line, ______________ is also called production line or assembly line.
a. product layout
b. process layout
c. fixed layout
69
28. In which of the following plant layouts are similar equipment or functions
grouped together?
a. Product layout
b. Process layout
c. Fixed layout
d. Both (a) and (c)
29. Identify the layout that is used when the product is bulky and remains stationary?
a. Product layout
b. Process layout
c. Fixed layout
d. All of the above
Location of the Project
Several of Indias space projects are conducted in Sriharikota as the place is close to
the Bay of Bengal. Most thermal power projects are located near rivers to meet the
high requirements of water. Airport projects are taken up in dry land areas so as to
minimize the land costs. From the above examples, it is clear that the place of
implementation of a project should be located strategically to take advantage of
benefits like availability of necessary inputs, necessary infrastructure, and nearness to
the markets.
The location of public sector undertakings is decided by the government, which
imposes certain rules and regulations on the private projects. The project manager
should carefully ensure that the location is as per the interests of the government. The
government also provides subsidies, and tax reliefs if the projects are located in
backward areas. Study of climatic conditions like temperature, rainfall, floods, and
seismic activity is very important while choosing the location of a project.
Factors like integrating all departments of the organization, availability of transport,
safety requirements, site cost, political, cultural and economic situation, geographical
proximity to competitors are also to be considered by the project manager in finalizing
the location of a project.
Steps in the Location and Selection Process
The size and scope of operations decide the approach to location and selection
process.
Following is a general procedure for making a location decision:
Defining multiple location objectives
The project manager formulates the broad location objectives based on the interests
and preferences of the project promoters, availability of technicians, proximity to
customers and suppliers, and other relevant factors.
Identifying relevant decision criteria
The project manager selects the project location on the basis of many economic
factors such as labor and material costs, and non-economic factors such as the impact
of the plant on the environment and community.
70
Relating the objectives to the criteria
The relevance of criteria should be evaluated using decision-making models/
techniques such as break-even analysis, linear programming and qualitative factor
analysis. Though firms prefer to use the aforesaid models for making the location
decision, in practice it is difficult to quantify certain aspects such as the firm's
relationship with local channel members, market sentiments etc.
Generating relevant data to evaluate the alternative locations
Alternative location choices are made that satisfy the location objectives of the firm.
They are evaluated based on the data obtained.
Selecting the best location
Finally, a location that meets the organizations objectives, best satisfies the criteria
and benefits the community is selected.
Machinery and Equipment
Technical evaluation of a project idea should include the study of required machinery
and equipment to run the project. The machinery and technology required depend on
the plant capacity and type of process selected to implement the project. The project
manager should study constraints like transportation of heavy equipment, import of
foreign machinery, and after sales service from the sellers of the equipment, before
selecting the necessary machinery and equipment. Machines should be installed in
appropriate places and they should be sequenced to ensure continuous flow of the
production process. Experiences of the existing users should also be taken into
account to find out the practical difficulties in running different machines.
Suggestions from external technical consultants and in-house technical experts are
also helpful.
Consideration of Alternatives
No single criterion is exactly useful in transforming a good project idea into a perfect
project. A great idea might not be technically feasible. Some good ideas may be poor
at gaining a market while others may require huge investments, which the firm may
not have. All these constraints force the project manager to think of alternatives and
come up with a workable project idea. Reconsideration of nature of the project also
generates new ideas and makes the idea feasible.
Market characteristics also force the project manager to produce a high quality
product at a premium price or a low quality item at a cheaper price. To meet the
required market demand, the project manager has two options either to construct a
single plant to cover the entire market or to construct multiple plants in different
locations. As none of the choices may be perfect, the ultimate decision regarding the
project will depend on the trade-off between the economies of scale in manufacturing
and the economies of distribution. The next chapter talks about how a project manager
selects a project from the several alternatives, on the basis of the financial
considerations.
Check Your Progress
30. Arrange the following steps based on the procedure followed to make location
decisions.
i. Selecting the best location
ii. Relating the objectives to the criteria
iii. Defining multiple location objectives
iv. Generating relevant data to evaluate the alternative locations
v. Identifying relevant decision criteria
71
a. iii-ii-v-i-iv
b. iii-v-ii-iv-i
c. iii-iv-v-i-ii
d. iii-i-ii-v-iv
31. Which of the following aspects is not covered by market and demand analysis?
a. Specification of objectives
b. Making the location decision
c. Conducting a market survey
d. Making a situational analysis
32. Technical evaluation of a project idea does not include:
a. collection of data.
b. availability and utility of the inputs.
c. the study of required machinery and equipment to run the project.
d. location of the project.
5. Summary
Market and demand analysis and technical analysis are carried out by the project
manager in the process of evaluating a project idea.
There are six steps in the market and demand analysis: situational analysis and
objectives specification, collection of data, market survey, market description,
demand forecasting and market planning.
The market and demand analysis helps the project manager to understand how the
firm's abilities can be synchronized with market requirements.
Market analysis studies market needs and consumer preferences for a given project
idea and demand analysis aims at calculating the aggregated demand for a particular
product or service.
Technical analysis of a project idea includes designing the various processes,
installing equipment, specifying material and prototype testing.
The project manager has to be careful in finalizing the technical aspects of the project
as the decision is irreversible and the investments involved may be high.
The project manager has to select the technology required in consultation with
technical experts and consultants.
6. Glossary
Chain ratio technique: A simple technique that applies a series of factors to forecast
the demand for a particular product or service.
Consumption level technique: This technique estimates the demand for a particular
product or service on the basis of income and price elasticities of demand.
Demand analysis: It determines the aggregated demand for a product or service for a
particular period, variations in supply, hidden demands of the customers, etc.
Econometric technique: This technique explains the behavior of the economic
variables as per the equations developed. The equation may be a single equation or
multiple equations.
72
End use technique: This technique is useful in estimating demand for intermediate
products such as investment goods and industrial tools.
Fixed layout: It is used when the product is bulky, large, heavy, and remains
stationary.
Income elasticity of demand: It represents the effect of the change in the demand as
a proportion to change in the income.
Leading indicator technique: This technique is used when the change in the value of
a particular variable leads to a change in the value of another variable.
Market analysis: It estimates the size of the potential market, patterns of
consumption, level of competition, and market composition.
Plant capacity: The ability of the firm to produce certain volumes or a certain
number of units in a given time period. It represents the production capacity of the
firm under normal working conditions.
Price elasticity of demand: It represents the effect of the change in the demand as a
proportion to change in the price.
Primary data: Data that is collected for a specific purpose and for the first time.
Process layout: In this layout, all similar equipment or functions are grouped
together.
Product layout: In this layout, machinery and equipment are arranged according to
the products. This layout is also referred to as an assembly line or production line, if
the equipment is dedicated to continuous production of a narrow product line.
Product testing: An objective appraisal of the product performance done on a limited
scale without using the firm's brand name.
Questionnaire: A formalized set of questions for generating information. The
questions can be structured or unstructured or a combination of both, depending on
the requirement.
Secondary data: Data that is already available but might have been collected for
some other purpose or by some other institutions.
Situational analysis: The process by which a project manager studies customer
preferences and their purchasing capacity and strategies of the competing firms and
intermediaries.
Structured questions: Questions followed by a fixed number of choices from which
the respondent should choose an answer.
Technical analysis: It includes the study of all the relevant design and engineering
aspects, reliability and sustainability of the product.
Unstructured questions: Questions that require the respondent to give descriptive
answers.
1. Once project ideas are generated and screened, they are evaluated to test their
marketability. How does the project manager test the marketability of a project
idea? Explain in detail all the activities that are carried out by a project manager
to test the marketability of a project idea.
2. An in depth study of market and demand analysis is followed by conducting the
technical feasibility of the project. Describe all the aspects that need to be
considered while conducting the technical analysis of projects.
73
1. Prasanna Chandra, Projects, Mcgraw Hill, Seventh Edition, 2009.
2. Robert K. Wysocki, Effective Project Management: Traditional, Agile,
Extreme, Wiley India, 2009.
3. Jack R. Meredith and Samuel J. Mantel Jr., Project Management: A Managerial
Approach, Sixth Edition, Wiley India, 2008.
4. Harold Kerzner, Project Management A Systems Approach to Planning,
Scheduling and Controlling, Second Edition, 2006.
5. A Guide to the Project Management Body of Knowledge, Project Management
6. Joseph Weiss and Robert K. Wysocki, Five-phase Project Management: A
Practical Planning and Implementation Guide, Basic Books, 1992.
Following are the model answers to the Check Your Progress questions given in the
Unit.
1. (a) market analysis
Once project ideas have been generated and screened, they have to be evaluated
for their marketability, technical feasibility, and costs involved. The market
analysis estimates the size of the potential market, patterns of consumption, level
of competition, and market composition. The technical analysis of a project idea
includes the study of all the relevant design and engineering aspects, and the
reliability and sustainability of the product. Demand analysis determines the
aggregated demand for a product or service for a particular period, variations in
supply, hidden demands of the customers, etc. Financial analysis involves
studying the financial aspects of the project idea. To assess the financial
feasibility of a project idea, the project manager has to examine the capital costs,
operating costs, and revenues of the proposed project.
2. (d) demand analysis
Demand analysis determines the aggregated demand for a product or service for a
particular period, variations in supply, hidden demands of the customers, etc. The
technical analysis of a project idea includes the study of all the relevant design
and engineering aspects, and the reliability and sustainability of the product.
Financial analysis involves studying the financial aspects of a project idea. To
assess the financial feasibility of a project idea, the project manager has to
examine the capital costs, operating costs, and revenues of the proposed project.
Once project ideas have been generated and screened, they have to be evaluated
for their marketability, technical feasibility, and costs involved. The market
analysis estimates the size of the potential market, patterns of consumption, level
of competition, and market composition.
Conducting market surveys, collecting primary and secondary data, and studying
the characteristics of the market are some of the activities to test the market
environment and see whether the project idea is feasible or not.
The activities of a project manager in conducting a market and demand analysis
include situational analysis and objectives specification, collection of secondary
data, market survey, market description, demand forecasting, and market planning.
74
5. (c) Primary data can be obtained only from sources internal to the
organization.
Primary data is data that is collected for a specific purpose and for the first time.
Secondary data is data that is already available but might have been collected for
some other purpose or by some other institutions. Primary data can be obtained
from sources both internal and external to the organization. Internal primary data
can be obtained from past and current sales of the firm, observations of
employees of the firm, etc. External primary data can be obtained from the
opinions of the dealers, feedback of the sales personnel, and sales trends.
6. (b) Secondary data provides problem specific information.
Secondary data is data that is already available but might have been collected for
some other purpose or by some other institution. It is considered to be more
useful than primary data in market analysis as it is easy to obtain and is also
economical. Primary data provides problem specific information, as data
pertaining to a particular problem/purpose is collected. Collection of primary data
requires more time and also involves higher costs.
7. (b) Personal interviews
The experimental method includes product testing, psychological techniques, and
consumer panel techniques. The survey method of data collection includes
personal interviews, telephonic interviews, and mail surveys of customers or
middlemen.
8. (a) a researcher tests the subconscious emotions of customers.
The experimental method includes product testing, psychological techniques, and
consumer panel techniques. In the psychological technique, a researcher who is
trained in psychology, tests the subconscious emotions of customers. Option b
refers to the consumer panel technique, option c refers to the survey method,
and option d to product testing.
9. (b) Consumer panel technique
The consumer panel technique is an experimental method of data collection. A
group of customers are selected on a permanent basis. They are interviewed at
different intervals of time in order to observe their behavioral changes. This
enables the project manager to understand market trends and the changing
preferences of customers.
10. (b) iii-v-ii-iv-vi-i
Following are the steps in a sample survey: defining the target market, selecting
the sample, developing the questionnaire, training the surveyors, recording the
information, and interpreting the information.
11. (c) questions about the present project and its products.
Target questions are about the present project and its products. The questions
have to be carefully sequenced so as to be understood by all segments of the
target customers. An understanding of the end product or service of the project,
its usage, and knowledge of human psychology are essential in developing the
questionnaire.
12. (b) Production + Trade Surplus/Deficit Changes in Stock Level
In a perfect market, effective demand for a particular product or service is nothing
but apparent consumption. Apparent consumption is calculated as the sum of
production and trade surplus/deficit minus changes in stock level. Due to
exchange restrictions and government controls, effective demand is usually less
75
than apparent consumption. Apparent consumption takes into account only the
desire and ability of the buyers while effective demand also considers the
willingness of the buyers. The project manager analyzes the present and past
effective demand for the product or service.
13. (c) Willingness of the buyers
In a perfect market, effective demand for a particular product or service is nothing
but apparent consumption. Apparent consumption takes into account only the
desire and ability of the buyers. But effective demand also considers the
willingness of the buyers.
14. (b) the type of organizational structure.
The project manager can determine the total demand for the product by dividing
it into various segments on the basis of nature of the product, type of customers,
or geographical location. The market cannot be divided based on the type of
organizational structure.
The project manager forecasts the demand for a particular product or service
using information obtained from secondary sources, market surveys, and market
description. Statistical techniques like trend projections are useful in forecasting
the demand for a particular product. These methods extrapolate past trends into
the future to forecast future demand, revenues, or sales.
16. (b) Chain ratio technique
The chain ratio technique is a simple technique that applies a series of factors to
forecast the demand for a particular product or service. The method seems simple
to use, but the applicability of this method mainly depends on the accuracy of the
ratios used. The project manager should carefully estimate these ratios to estimate
the demand for a particular product or service.
17. (c) Consumption level technique
The consumption level technique estimates the demand for a particular product or
service on the basis of income and price elasticities of demand. Both the income
and price elasticities of demand are useful in estimating the sensitivity of demand
to changes in income and price levels, respectively.
18. (b) e
i
=
1
Q +
2
Q
1
I +
2
I
1
I
2
I
1
Q
2
Q
Income elasticity represents the effect of the
change in the demand as a proportion to change in the income. It is calculated as
1
Q
2
Q
1
I
2
I
1
I
2
I
1
Q
2
Q
i
e
where,
e
i
= Income elasticity of demand
Q
1
= Quantity demanded in the base year
Q
2
= Quantity demanded in the following year
I
1
= Income level in the base year
I
2
= Income level in the following year
76
19. (c) Leading indicator technique
The leading indicator technique assumes that a change in the value of a particular
variable will lead to a change in the value of another variable. There are two steps
involved in using this technique: identifying the appropriate leading indicators
and establishing a relationship between the leading variables and lagging
variables to find the demand. For instance, an improvement in the level of literacy
of a country may lead to an increase in the demand for paper. Here, a change in
the level of literacy is the leading variable while the change in the demand for
paper is the lagging variable.
20. (b) Econometric technique
The econometric technique explains the behavior of the economic variables as per
the equations developed. This technique is useful in understanding complex cause
and effect relationships and in judging the sensitivity of certain variables. In the
end use technique, the project manager estimates the consumption coefficient of
the product for various uses for all users in the country. The leading indicator
technique assumes that a change in the value of a particular variable will lead to a
change in the value of another variable. The chain ratio technique applies a series
of factors to forecast the demand for a particular product or service.
21. (b) a0 + a1Pt + a2It
The econometric technique used to forecast demand explains the behavior of the
economic variables as per the equations developed. The equation may be a single
equation or multiple equations. In a single equation model, the dependent variable
is explained by several other independent variables. With variations in population
and income, the demand for a product can be explained through the use of the
following formula:
D
t
= a
0
+ a
1
P
t
+a
2
I
t
where,
D
t
= demand for wheat in year t
P
t
= population in year t'
I
t
= income in year t
a
0,
a
1,
and a
2
are the constants.
Statistical techniques and causal methods are prone to errors because of the many
uncertainties involved in the process of forecasting demand. The major sources of
uncertainty are techniques of forecasting, past and present market data, and
environmental change.
23. (c) Technical analysis
The technical analysis of a project idea includes the study of all the relevant
design and engineering aspects and the reliability and sustainability of the
product. An in depth market and demand analysis followed by a technical
analysis reveals the probability of success of a project idea. Financial analysis
involves studying the financial aspects of a project idea. To assess the financial
feasibility of a project idea, the project manager has to examine the capital costs,
operating costs, and revenues of the proposed project. This is taken up in the end
after the market analysis, demand analysis, and technical analysis have been
conducted.
77
24. (c) Technical evaluation
Technical evaluation of a project idea is a very crucial aspect of project evaluation
and any wrong decision at this stage will have far-reaching implications on the
viability of the project. This is because technical decisions are irreversible and they
require high investments. The bank should conduct a technical evaluation for the
project idea submitted by Samarth. Such an evaluation could include an evaluation
of the main products, the by-products, scrap, plan outline, building outline, layout
structure, vendors list for critical equipment, soil testing, socio-economic
conditions of the project site, off-site facilities, import licenses, installed capacity,
inspection and expediting, guarantee period, cost, availability, quality, organization
chart, HR policies, training facilities, etc.
Plant capacity is the ability of the firm to produce certain volumes or a certain
number of units in a given time period. It represents the production capacity of
the firm under normal working conditions. It is determined on the basis of
installed capacity, machinery, and availability of infrastructure and labor.
Plant capacity is the ability of the firm to produce certain volumes or a certain
number of units in a given time period. It represents the production capacity of
the firm under normal working conditions. Factors like input constraints,
investments, market conditions, government policies, technological upgradations,
and financial resources play an important role in determining plant capacity. For
instance, the company would decide on the plant capacity to be installed based on
the financial resources available and the investment to be made. Government
policies or restrictions would also affect the companys decision in this regard as
also market conditions such as the competitive scenario; demand scenario, etc.
27. (a) product layout
In product layout, the machinery and equipment are arranged according to the
products. If the equipment is dedicated to continuous production of a narrow
product line, this layout is also referred to as an assembly line or production line.
28. (b) Process layout
In process layout, all similar equipment or functions are grouped together. For
instance, all lathes are grouped in one area and all drilling machines in another.
29. (c) Fixed layout
A fixed layout is used when the product is bulky, large, heavy, and remains
stationary. For example, all manufacturing and construction firms select a fixed
position for construction and all materials, machines, sub-contractors, and
workers are taken to that place. The best examples of such layouts are ship
building, aircraft assembling, and satellite assembling.
30. (b) iii-v-ii-iv-i
The procedure followed to make a location decision: defining multiple location
objectives, identifying relevant decision criteria, relating the objectives to the
criteria, generating relevant data to evaluate the alternative locations, and
selecting the best location.
31. (b) Making the location decision
Making the location decision is a part of technical evaluation of the project idea.
Market and demand analysis covers aspects like specification of objectives, making
a situational analysis, conducting a market survey, forecasting demand, etc.
78
32. (a) collection of data.
Collection of data is a part of the market and demand analysis. Technical
evaluation of the project idea includes aspects such as selecting an appropriate
technology, location of the project, availability and utility of the inputs, study of
required machinery and equipment to run the project, etc.
A. 115.75 kg
Projected demand for wheat = (present per capita annual demand) (1+ projected
per capita annual income level income elasticity of demand)
= (100 kg) {1+ (0.15 1.05)} = 115.75 kg per capita per annum.
B. 2.75
Projected demand for Product P would be = (present per capita demand) (1+ per
capita income level income elasticity of demand)
15.5 tons = (13 tons) {1+ (0.07 income elasticity of demand)}
13
15.5
= 1+ (0.07 income elasticity of demand)
1.1923 = 1+ (0.07 income elasticity of demand)
Income elasticity of demand =
07 . 0
1 1923 . 1
= 2.75.
Unit 4
Financial Analysis of Projects
Structure
1. Introduction
2. Objectives
3. Project Cost
4. Means of Financing the Project
5. Working Capital Requirements and Financing
6. Time Value of Money
7. Costs of Different Sources of Finance
8. Evaluation of Project Investments
9. Risk Analysis of Project Investments
10. Social Cost Benefit Analysis
11. Summary
12. Glossary
1. Introduction
In the previous unit, we have discussed how to conduct the market analysis and
technical analysis of projects. In this unit, we will discuss how to conduct the financial
analysis of projects. Once the commercial and technical aspects of a project idea have
been evaluated and approved, the project manager must examine the financial
feasibility of the project. Since the primary objective of any firm is to maximize
profits, the financial aspects of a project idea must be studied carefully. Even if the
project is marketable and technically feasible, it cannot be implemented if it is not
financially viable. To assess the financial feasibility of a project idea, the project
manager must examine the capital costs, operating costs and revenues of the proposed
project.
To conduct a financial analysis, the project manager must collect information about all
the costs pertaining to the project, different ways of financing the project, working
capital requirements, profitability projections and projected cash flows of the project.
On the basis of this data, the project manager can appraise all the functions of the
project and decide whether a particular project idea is worth implementing or not.
This chapter discusses the various appraisal techniques used by the project managers
to evaluate the financial viability of a project.
This unit will introduce you to the means of financing a project. We will discuss the
working capital requirements and financing. We shall then discuss the concepts of
time value of money, cost of capital, project appraisal criteria, and risk analysis in
capital investment decisions. Finally, we would also be discussing social cost benefit
analysis.
80
2. Objectives
This unit will help you understand:
define project cost.
identify the means of financing a project.
analyze working capital requirements and financing.
discuss the time value of money.
determine the costs of different sources of finance.
evaluate project investments.
perform risk analysis for project investments.
explain social cost benefit analysis.
3. Project Cost
The project cost is the sum of all the costs of activities associated with the project. It
includes all costs under the following heads: building and civil works, land and site
development, plant and machinery, expenses on foreign technicians, miscellaneous
fixed assets, margin money for working capital, provision for contingencies, pre-
operative expenses and initial cash losses.
4. Means of Financing the Project
The project manager can finance the project in a number of ways: share capital, term
loans, debenture capital, deferred credit, and other miscellaneous sources. Any one or
a combination of two or more of these methods can be chosen to finance the project.
Share Capital
Share capital is of two types: equity capital and preference capital. Equity capital is
the capital contributed by the owners of the firm. Equity holders enjoy the profits and
bear the risks of the firm. Preference capital refers to the contribution made by
preference shareholders by investing in a firms preference shares.
Term Loans (H2)
Term loans are secured borrowings provided by financial institutions and commercial
banks. These loans help firms take up expansion, modernization, and renovation
projects. Term loans are available in both rupees and foreign currencies. Companies
take foreign currency term loans to meet their foreign currency expenditures e.g.
import of machinery, or consultation fees of foreign technicians.
Debenture Capital
Debentures are issued by firms to raise debt capital, normally for a period of 5 to 10
years. The debentures are secured against the assets of the issuing firm. There are
three types of debentures: non - convertible debentures, partially convertible
debentures, and fully convertible debentures. A fixed interest is paid for non -
convertible debentures. In the case of Partially Convertible Debentures (PCDs), only a
part of them are converted into equity shares; but in the case of fully convertible
debentures, all the debentures are fully converted into equity shares as per pre-
determined terms.
Deferred Credit
Machinery and equipment suppliers often provide credit facilities to firms. This is
referred to as deferred credit. This credit is repaid over a period of time, depending on
the value of the machinery and the credit standing of the buyer. Normally, suppliers
demand a bank guarantee equivalent to the value of the machinery.
81
Miscellaneous Sources
Miscellaneous sources include unsecured loans, public deposits (as per the rules of
Central Government and RBI), incentive sources form government agencies, and
leasing and hire purchase finance. But these sources contribute only a small part of the
total project capital.
5. Working Capital Requirements and Financing
The project manager considers the following points when estimating the working
capital requirements of a project:
Raw materials and components
Work-in-process
Stocks of finished goods
Operating expenses
The important sources of working capital are
Working capital advances from commercial banks
Long-term sources of financing
Trade credit
Accruals and provisions
The project manager should be aware of the limits for obtaining working capital
advances from commercial banks:
The aggregate permissible bank finance, as per the norms of lending, prescribed by
the Tandon Committee.
The amount of margin money a firm can provide against each current asset.
Initially, the Tandon Committee proposed a method for determining the maximum
amount of money a project can obtain to meet its working capital requirements.
According to that method, at least 25 percent of current assets must be supported by
long term sources of finance. To provide greater freedom to borrowers to assess
working capital requirements, this method (and similar methods) was withdrawn,
effective 15 April, 1997. Banks were instructed to evolve their own methods to assess
working capital requirements of projects.
The margin requirement varies with the type of current asset. The ranges within which
margin requirements lie for various types of current assets are raw materials 10-
25%, work-in-process 20-40%, finished goods 30-50%, and debtors 30-50%.
However, there is no standard formula for determining the margin amount.
Check Your Progress
1. Identify the correct sequence of steps in which a project manager evaluates
project ideas.
a. Technical analysis Market analysis Financial analysis.
b. Market analysis Technical analysis Financial analysis.
c. Financial analysis Technical analysis Market analysis.
d. Market analysis Financial analysis Technical analysis.
82
2. Which of the following options is not required to assess the financial feasibility
of a project idea?
a. Capital costs
b. Operating costs
c. Price elasticity of demand
d. Revenues
3. About which of the following aspects should information be collected in order to
conduct a financial analysis of a project?
i. Costs pertaining to the project and the various ways of financing it
ii. Working capital requirements of the project
iii. Profitability projections and projected cash flows of the project
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
4. A project can be financed in a number of ways through share capital, term
loans, issue of debentures, etc. Which of the following sources of financing do the
owners of the firm contribute?
a. Term loans
b. Equity capital
c. Deferred credit
d. Debentures
5. Which of the following statements is not true regarding debentures?
a. Debentures are issued by firms to raise debt capital, normally for a period of 5 to
10 years.
b. Debentures are secured against the liabilities of the issuing firm.
c. A fixed interest is paid for non-convertible debentures.
6. Machinery and equipment suppliers often provide credit facilities to firms. This
credit is repaid over a period of time, depending on the value of the machinery
and the credit standing of the buyer. What is this form of financing known as?
a. Equity capital
b. Preference capital
c. Deferred credit
d. Term loans
7. Identify the factors that the project manager needs to consider to estimate the
working capital requirements of a project.
i. Raw materials and components
ii. Work-in-process
iii. Stocks of finished goods
iv. Operating expenses
83
8. Match the following current assets with the range in which the margin
requirements fall for each of them.
i. Debtors
ii. Work-in-process
iii. Finished goods
p. 20-40%
q. 10-25%
r. 30-50%
a. i/q, ii/p, iii/r
b. i/p, ii/r, iii/r
c. i/q, ii/r, iii/p
d. i/r, ii/p, iii/r
6. Time Value of Money
The project manager considers the time value of money when evaluating the financial
aspects of a project idea. To understand time value of money, consider the investment
of one rupee. One rupee invested today would generate (1+r) a year hence, where r is
the rate of return per annum. The following calculations are used to determine time
value future value of single cash flow, future value of annuity, present value of
single cash flow, and present value of annuity.
Future Value of Single Cash Flow
The future value of a single cash flow is given by the following formula:
n
r) PV(1 FV
Where, FV = Future value n years hence
PV = Present value of cash flow
r = Interest rate per annum
n = Number of years
Example: Future Value of a Single Cash Flow Compounded Annually
Suppose the investment of Rs.100 crore is made. The rate of return is 6 percent
p.a., compounded annually for the next three years.
Then the future value of the investment at the end of three years is
crore 119.10
3
0.06 1 100 FV
The following formula is useful for calculating the future value of money when
compounding is done several times a year.
mn
r/m 1 PV FV
84
Where, m = Number of times interest is paid
n = Time period
Example: Future Value of a Single Cash Flow Compounded Semi-Annually
Suppose the interest rate is compounded semi-annually in the above problem. Then
the future value at the end of three years is
2 3
2) (0.06 1 Rs.100 FV
= 119.40 crore
Future Value of Annuity
An annuity is a series of periodic cash flows (payments or receipts) of equal amounts.
The future value of an annuity is calculated as:
r
1]
n
r) A[(1
n
FVA
Where, A = Constant periodic flow
r = Interest rate per period
n = Duration of the annuity
Example: Calculating the Future Value of an Annuity
Suppose a project incurs an amount of Rs. 200 crore every year. Assume the
compound interest is 6.5 percent per annum. Then the future investment value of
the project after five years is:
0.065
1
5
0.065 1 200
5
FVA = Rs. 1138.72 crore.
Check Your Progress
9. Assuming that compounding is done more frequently than annual compounding,
which of the following is a generalized formula for shorter compounding periods?
a. FV = PV (1 + r)
n
b. FV =
r
r
A
n
1 1
c. FV=
n m
m
r
PV 1
d. FV =
r
r
A
n
1 1
(1 + r)
85
10. The future value of a regular annuity for a period of n years at a rate of interest
r is given by the formula
a. FVA
n
=
r
r
A
n
1 1
b. FV =
n m
m
r
PV 1
c. FV= PV(1 + r)
n
d. FVA
n
=
n
n
r r
r
A
1
1 1
Exercises
A. Sridhar has invested Rs. 2,000 in a bank that pays 12% interest compounded
annually. How much will Sridhar get after 10 years?
B. In Consumers Bank, term deposits can be made for periods ranging from six
months to 10 years. The rate of interest paid is 14% per annum for a three-year
deposit and the interest is compounded every quarter. To what amount will Rs.
10,000 invested in term deposits for three years will grow to?
Present Value of Single Cash Flow
The formula for calculating present value is given by:
n
r) (1
FV
PV
Where, PV = Present value of the cash flows
r = Annual discount rate
n = Number of years
and 1/(1+r)
n
is called the discounting factor
When discounting is done several times, the following formula is used for calculating
the present value.
mn
) n r (1
n
FV
PV
Where, m = Number of times per year discounting is done
n = Number of years
The following formula is used to find out the present value when the cash inflows
occur in an uneven manner.
n
r) (1
n
A
.......
3
r) (1
3
A
2
r) (1
2
A
r) (1
1
A
n
PV
86
Where,
PV
n
= Present value of a cash flow stream
A
t
= Cash flow occurring at the end of year t
Example: Calculating the Present Value of a Single Cash Flow
Assume a project is expected to receive Rs. 100 crore, Rs. 200 crore and Rs. 300
crore at the end of the next one, two and three years respectively, at a discount rate
of 8 percent.
Then, the present value of the cash stream to be received for the next three years is:
3
0.08) (1
300
2
0.08) (1
200
0.08) (1
100
3
PV
PV
3
= Rs. 502.2 crore
Present Value of an Annuity
The following formula is used to find the present value of an annuity:
n
r 1 r
1 1 A
n
PVA
n
r
Where,
PVA
n
= Present value of an annuity that has a duration of n periods
A= Constant periodic flow
r = Discount rate
Example: Calculating the Present Value of an Annuity
Assume the project is expected to receive Rs.200 crore for 3 years, each payment
occurring at the end of the year. Then the present value of this cash stream, if the
annual discount rate is 8 percent is
3
0.08 1 0.08
1
3
0.08 1 200
3
PVA
PVA
3
= Rs. 515.42 crore
Exercises
C. Srinidhi Bank has introduced a deposit scheme for all individuals and
organizations. A deposit amount is remitted and the principal is received with an
interest of 14% per annum in 12 installments. Find out the amount of initial
deposit in order to receive a monthly installment of Rs. 100 for 12 months.
87
D. The annuity deposit scheme of Swaraj Bank provides for a fixed monthly income
for suitable periods based on the choice of the depositor. After the first month of
the deposit, the depositor receives monthly installments depending on the number
of months he/she has chosen as the annuity period. The rate of interest is 9% per
annum. If an initial deposit of Rs. 5,000 is made for an annuity period of 60
months, calculate the value of the monthly annuity.
7. Costs of Different Sources of Finance
A project can be carried out only after the necessary finance has been collected from
different sources. Identifying the right kind of source is crucial because each source of
finance will have its own cost. The project manager has to assess these costs.
The cost of capital is the minimum rate of return the firm must earn on its investments in
order to satisfy the various categories of investors who have made investments in the form
of shares, debentures, term loans, etc. A firm's cost of capital is the weighted arithmetic
average of the post-tax cost of various sources of long-term finance used by it.
Example: Calculating the Cost of Capital
Suppose a firms capital base is Rs. 100 crore, of which Rs. 75 crore is equity and
Rs. 25 crore is debt. Assume the cost of equity is 12 percent and the post-tax cost
of debt is 8 percent. Then, the cost of capital of the firm is = (proportion of equity
cost of equity) + (proportion of debt cost of debt).
8%
100
25
12%
100
75
= 11%.
Cost of Debt
It is the rate of discount that equates the present value of post-tax interest and
principal repayments with the net proceeds of the debt issue. The cost of debt is
represented by K
d
. If the interest on debt is payable annually, following formula is
used to calculate the cost of debt.
n
d
K 1
R
t
d
K 1
T 1 I
1
P
n
t
Where P = Net amount realized on debt issue
I = Annual interest payable
T = Tax rate
R = Redemption price
n = Maturity period of debt
t = a parameter whose value ranges from 1 to n.
To obtain a quick estimate, the following approximated formula is used to calculate
the cost of capital.
2 P R
n P) (R T 1 I
d
K
88
Example: Calculating the Cost of Debt
Indhra Limited has issued Rs. 20 crore worth of non-convertible debentures, each
at a face value of Rs. 100, at a rate of 12 percent. Each debenture is redeemable at a
premium of 5 percent, after 10 years. If the net amount realized is Rs. 95, what is
the cost per debenture? Assume the tax rate is 40%.
Given, I = 12, T = 0.4 P = Rs. 95,
n = 10 years, R = Rs. 105,
2 95) (105
10 95 - 105 0.4 1 12
d
K = 8.2 percent.
Cost of Preference Capital
It is the discount rate that equates the net proceeds from preference capital issue to the
payments associated with the same i.e., dividend payment and principal payments. It
is represented by K
p
. The cost of preference capital is calculated by using the
following formula
n
p
K 1
R
t
p
K 1
D
1
P
n
t
Where, P = Net amount realized per share
D = Preference dividend per share payable annually
R = Redemption price
n = Maturity period.
Following is the approximated formula to find the cost of preference capital;
2 P R
n P R D
p
K
Example: Calculating the Cost of Preference Capital
The terms of the preference share issue made by ELV Industries are as follows:
each preference share has a face value of Rs. 100 and carries a rate of dividend of
12% payable annually. The share is redeemable after 12 years at par. If the net
amount realized per share is Rs. 95, calculate the cost of preference capital.
2 ) 95 100 (
12 95 100 12
p
K
= .127 or 12.7%
89
Check Your Progress
11. Which of the following is the minimum rate of return that a company must earn
on its investments in order to satisfy the various categories of investors who have
made investments in the form of shares, debentures or term loans?
a. Return on investment
b. Cost of capital
c. Capital recovery factor
d. Effective rate of interest
12. A companys cost of capital is the __________ of the cost of various sources of
finance.
a. compounded value
b. weighted average
c. simple arithmetic average
d. All of the above
Exercises
E. Tushaar Manufacturing Limited issued preference shares of Rs. 100 face value
carrying a 15% dividend repayable at par after 12 years. The net amount realized
per share is Rs. 95. Find the cost of preference capital.
F. Sacred Enterprises has a total capital base of Rs. 50 million in the ratio of 1:1 of
debt-equity. The post-tax costs of debt and equity are 6% and 9%, respectively.
Calculate the cost of capital of the company.
Cost of Equity Capital
Equity capital can be raised by issuing of external equity (allotment of shares) and
through retention of earnings. The project manager estimates the rate of return
required by equity shareholders before determining the cost of equity capital.
Several approaches are available to estimate the rate of returns required by the equity
shareholder. They are:
Dividend capitalization approach
Capital asset pricing model approach
Realized yield approach
Bond yield plus risk premium approach
Earnings-price approach
Dividend Capitalization Approach
In this approach, the market price per share is equal to the present value of the
expected dividends, discounted at the return required by the equity shareholders. The
rate of return required by the equity shareholders is represented as K
S
. In symbols,
t
K 1
t
D
1
o
P
s
n
t
Where, P
O
= Current market price per share of the equity stock
90
D
t
= Expected dividend per share at the end of year, t
If equity shareholders expect a constant dividend every year, then
o
P
D
s
K
If equity shareholders expected the dividend to grow annually at a rate of g% forever, then,
g
o
P
D
s
K
1
Where, D
1
= Dividend Expected at the End of Year 1. That is, D
1
= D
0
(1 + G).
Capital Asset Pricing Model (CAPM)
According to this approach, the cost of equity is reflected by the following equation,
K
i
= r
f
+
i
(k
m
r
f
)
K
i
= Required rate of return on a security i
r
f
= Risk free rate of return
k
m
= Rate of return on market portfolio.
i
= Beta of security i (Beta is a measure of volatility of a security or portfolio of
securities in comparison with the market as a whole. A beta of 1 indicates that the
securitys price will move with the market. A beta greater than 1 indicates that the
securitys price will be more volatile than the market. A beta less than 1 means that it
will be less volatile than the market).
Example: Calculating the Cost of Equity
The beta factor of RK Industries shares is 1.4. The risk free rate of interest on
government securities is 10%. The expected rate of return on equity shares is 17%.
Calculate the cost of equity.
19.8% 10 17 1.4 10
i
K
Realized Yield Approach
In this approach, the rate of return realized by equity shareholders in the past is
regarded as a proxy for the rate of returns required by them. The rate of return (yield)
on an equity stock is given by the formula;
1
1 t
P
t
P
t
D
t
Y
Where, Y
t
= Yield for year t
D
t
= Dividend per share, for the year t payable at the end of the year t
P
t
= Price per share at the end of year t
P
t-1
= Price per share at the end of year t -1, i.e., at the beginning of year t
1
1 t
P
t
P
t
D
t
Y is also called as wealth ratio, denoted by W
t
o S PD K
1 1 t t t t P P D Y
91
The yield for an n-year period is 1
1/n
n
W ......
2
W
1
W
Here,
1 t
P
t
P
t
D
t
W
Bond Yield Plus Risk Premium Approach
According to the approach, the rate of return required by the equity shareholders is
based on the risk profile of a company. So, the rate of return required by the equity
shareholders is calculated as, yield on the long-term bonds of the firm + risk premium.
Earnings Price Ratio Approach
According to this approach, the rate of return required by equity shareholders is equal to.
0 1
P E
Where, E
1
= Expected earnings per share for next year
P
0
= Current market price per share
E
1
is calculated by multiplying the current earnings per share by (1 + growth rate).
Check Your Progress
13. According to the Dividend Capitalization approach, the cost of equity capital is
given by:
a. g
0
P
0
D
s
K
b. g
0
P
1
D
s
K
c. g
0
P
g 1
0
D
s
K
d. g
0
P
g 1
0
D
s
K
14. In the Capital Asset Pricing model, to know the cost of equity we require
i. the risk free rate of return
ii. the return on investment.
iii. the rate of return on market portfolio
iv. the beta of security
Exercises
G. The current dividend paid by LMG Limited is Rs. 15 per share and it is expected
to grow at 5% infinitely. If the current market price per share of LMG is Rs. 75,
calculate the cost of equity.
92
H. Following are the dividend per share and price per share details of an equity stock
over a period of 10 years.
Year Dividend per Share (Rs.) Price per Share (Rs.)
1 10 10
2 10 12
3 12 14
4 13 12
5 10 10
6 12 15
7 14 10
8 15 10
9 15 12
10 15 12
Calculate the average yield of the equity stock.
Cost of External Equity
It is the rate of return that the firm must earn on the net funds raised by it when it
issues equity capital externally so that equity investors earn the required rate of return
on their subscription to the equity capital of the firm. Cost of external equity is
represented by K
S.
The following approaches are useful to calculate cost of external
equity.
Dividend Capitalization Approach
According to this approach, the cost of external equity (K
s
) is calculated as
g
f 1
o
P
1
D
s
K
Where, D
1
= Dividend expected at the end of year 1
f = Floatation costs (legal, printing, underwriting, brokerage, issue expenses etc.)
expressed as a percentage of the current market price.
P
0
= Current market price per share
g = Dividend growth rate
Capital Asset Pricing Model and Other Approaches
The following formula is useful to calculate cost of external equity.
f 1
e
K
s
K
K
e
= Rate of return required by equity investors
93
Example: Calculating Cost of External Equity using CAPM
Happy Homes Private Limited decided to raise some equity from the market. The
issue costs are 10% of the issue amount, and the investors are expecting a return of
28% from their investment. Calculate the cost of external equity of the company.
f 1
e
K
s
K
K
s
= cost of external equity
K
e
= rate of return required by the equity investors = 28%
f = floatation costs as a percentage of the current market price = 10%
f 1
e
K
s
K =
10 . 0 1
28 . 0
= 0.3111 or 31.11%.
Cost of Retained Earnings
Two approaches are useful to determine the cost of retained earnings. They are
Tax adjusted rate of return approach
External yield approach
Tax-adjusted rate of returns approach
According to this approach, the cost of retained earnings is calculated as the post-tax
rate of return available to the investor. So, the K
s
has to be adjusted for ordinary and
long-term capital gains tax as expressed below:
g
t 1
p
t 1
s
K
r
K
K
r
= Cost of retained earnings
K
s
= Rate of return required by equity investors
t
p
= Ordinary personal income tax
t
g
= Personal long term capital gains tax rate
This approach has two limitations: The income tax rate varies from stakeholder to
stakeholder and alternative investment opportunities of the firm are not being
considered as the firm reinvests its cash flows instead of paying dividends.
External yield approach
Here, the firm evaluates the possibility of purchasing shares of other companies with
similar characteristics of risk. So, the opportunity cost of retained earnings is
considered equal to the rate of return that can be earned on such investment.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is the sum of the weighted values obtained by
multiplying the cost of each source of financing by its proportion in the capital
structure.
The Weighted Average Cost of Capital is calculated as:
e
k
e
w
p
k
p
w
d
k
d
w
a
k
94
where k
a
= Weighted average cost of capital
k
d
= Cost of long-term debt capital
k
p
= Cost of preference capital
k
e
= Cost of equity
w
d
= Proportion of long-term debt in the capital structure
w
p
= Proportion of preference capital in the capital structure
w
e
= Proportion of equity in the capital structure
Here, the value of (w
d
+ w
p
+ w
e
) is equal to 1.
Check Your Progress
15. If K
e
is the cost of equity and f is the floatation cost as percent of the amount
raised, cost of external equity, K
s
is given by
a.
f 1
e
K
s
K
b. f
e s
K K
c.
f 1
e
K
s
K
d. f
e s
K K
Exercises
I. The cost of retained earnings of a company is 21%. If the issue expenses as a
percentage of the issue amount are 7%, calculate the cost of external equity of the
company.
(Questions J-O)
Happy Home Needs Private Limited has the following capital structure.
(Rs. in millions)
Equity Capital (10 million shares at par value) 100
12% Preference Capital (1 million shares at par value) 100
Retained Earnings 100
15% Non-convertible Debentures (1 million debentures at par value) 100
16% term loan from SBI 100
Total 500
Following are the other details provided by the company.
The market price per equity share is Rs. 50. The next expected dividend is Rs. 10 per
share and it is expected to grow at a constant rate of 8%.
95
The preference shares are redeemable after seven years at par and are currently quoted
at Rs. 80 per share in the stock exchange.
The debentures are redeemable after five years at par and their current market price is
Rs. 95 per debenture. The tax rate is 40%.
Based on the given data, answer the following questions.
J. Calculate the cost of equity capital.
K. Calculate the cost of retained earnings.
L. Calculate the cost of debentures.
M. Calculate the cost of preference capital.
N. Calculate the weighted average cost of capital of the company.
8. Evaluation of Project Investments
The project manager uses the following criteria to evaluate returns from project
investments. They are:
Non-discounting criteria
Discounting criteria
Non-Discounting Criteria
The non-discounting criterion does not consider the time value of money. Following
are the two methods in non-discounting criteria:
Average Rate of Return (ARR)
Payback period
Average Rate of Return (ARR)
This method estimates the relationship between the average annual profits earned by a
project and the investments made in the project. This is expressed in percentage form.
100
s Investment Initial
Profit Annual Average
Return of Rate Average
Accept - reject criterion
A project is accepted when the actual ARR is higher than the minimum desired ARR.
The project manager can also rank all the alternative options in descending order and
choose the project with the highest ARR.
Advantages of ARR
The method is simple to calculate, as it uses readily available accounting information.
A quick decision can be taken comparing the ARR values of various projects.
Disadvantages of ARR
It Ignores The Time Value Of Money.
Example: Evaluation of Projects Using the ARR Method
Assume there are two investment options. For Investment 1, the initial investment
is Rs.10,000 and the average profit is Rs. 1250; for Investment 2, the initial
investment is Rs.10,000 and the average profit is Rs. 1800. Using the ARR method,
the two proposals can be evaluated in the following manner.
Contd
96
Contd
Investment 1:
Average profit = Rs.1,250
Initial investment = Rs.10,000
12.5% 100
Rs.10,000
Rs.1,250
ARR
Investment 2:
Average profit = Rs.1,800
Initial investment = Rs. 10,000
18% 100
Rs.10,000
Rs.1800
ARR
According to the ARR method, Investment 2 is better as it generates a higher
average rate of return than Investment 1.
Payback Period Method
Payback period is the time period in which a firm can recover its investments made in
a project.
Accept-Reject criterion
The actual payback period of a project is compared with a pre-determined payback set
by the firms management. If the actual payback period is less than the predetermined
payback period, the project can be accepted; otherwise, the project is rejected. The
project manager can also rank alternative project proposals according to their payback
period and the project with shortest payback period is chosen.
Advantages of payback method
The method favors the projects with substantial cash inflows in earlier years.
The method is easy to understand and does not require complex calculations.
Disadvantages of payback period
It measures only the capital recovery of the projects, not their profitability.
The method ignores cash flows beyond the payback period.
Example: Evaluation of Projects Using the Payback Period Method
Suppose a firm has two options, Option A and Option B. The initial outlay for both
the options is Rs.10,000. The expected cash flows for both options are as follows:
Option A:
Year Cash Flow
1 4000
2 6000
3 4000
4 1000
Contd
97
Contd
The payback period for Option A is two years: Rs. 4000 (year 1) + Rs.6,000 (year 2)
In two years, the total investment is recovered. Hence, the payback period is two
years.
Option B:
Year Cash Flow
1 1000
2 2000
3 5000
4 5000
5 6000
The payback period for option B is 3.4 years:
1000 (year 1) + 2000 (year 2) + 5000 (year 3) + 2000/5000 (40% of year 4)
For option B, the total investment is recovered in 3.4 years.
Hence, option A is accepted.
Discounted Cash Flow Criteria
In this criteria, the time value of money is considered when evaluating the costs and
cash flows of a project. There are three methods:
Net present value method (NPV)
Internal rate of return (IRR)
Profitability Index
Net Present Value Method (NPV)
The net present value of a project is equal to the sum of all the cash flows associated
with the project. In this method, all the future cash flows are converted into their
present values, using the required rate of return. The difference between the present
value of cash outflows and the present value of all cash inflows gives the net present
value.
The net present value of a project is calculated by the following formula:
t
k) (1
t
A
NPV
Where t= Time period
k= Required rate of return
A= Cash flows
Accept-reject criterion
In the NPV method, the project is accepted if the NPV is positive and rejected if it is
negative.
98
Advantages of NPV
This method considers the time value of money.
It considers the total benefits accruing out of the option over its life -time.
Disadvantages of NPV
It is difficult to calculate and understand, compared to the earlier methods.
The NPV may not give satisfactory results when the project manager has to choose
between projects of different duration. In general, the one with a shorter economic life
is preferred, other things remaining same.
Example: Evaluation of Projects Using the NPV Method
Suppose a firm has two options; each of them costing Rs.10,000 and having a life
period of 5 years. Assume a required rate of return of 8%, after taxes. The net cash
flows for both the projects are shown below. Which option should be accepted?
Option-1:
Year Net cash flows
1 5000
2 5000
3 4000
4 3000
5 500
Option-2:
Year Net cash flows
1 4000
2 5000
3 4500
4 3500
5 3000
For Option-1, the NPV is:
5
08 . 1
500
4
08 . 1
3000
3
08 . 1
4000
2
08 . 1
5000
08 . 1
5000
10000 = Rs. 4,636.
5
08 . 1
3000
4
08 . 1
3500
3
08 . 1
4500
2
08 . 1
5000
08 . 1
4000
10000 = Rs. 6,177.
Since the NPV of Option-2 is higher, it is accepted.
99
Internal Rate of Return (IRR)
The internal rate of return is the discount rate at which the present values of cash
outflows and cash inflows are equal. In other words, it is the discount rate that makes
the NPV of the project equal to zero.
Mathematically, it is expressed as:
0
0
t
r) (1
t
A n
t
Where r = Internal rate of return
A= Cash flows
t = Time period
The actual IRR value is compared with the cut-off rate (set by the project firm). The
project is accepted if the IRR exceeds the cut-off rate.
Advantages of IRR
The IRR indicates the profitability of a proposal.
It is consistent with the overall objective of maximizing shareholders wealth.
Disadvantages of IRR
It involves complex calculations.
The method assumes that all intermediate cash flows are reinvested at the IRR rate.
Example: Evaluating of Projects Using the IRR Method
Consider the earlier example given in the NPV method, for Option 1,
0
5
r 1
500
4
r 1
3000
3
r 1
4000
2
r 1
5000
r 1
4000
10000
To solve this, we consider interest rates on a trial and error basis and find the rate
that makes sum of cash flows equal to zero.
Here r = 28.7%.
For Option 2:
0
5
r 1
3000
4
r 1
3500
3
r 1
4500
2
r 1
5000
r 1
4000
10000
r = 30.63%
So, we select Option-2 as it has the higher IRR.
Profitability Index or Benefit-Cost Ratio (B/C ratio)
The ratio of future cash benefits to the initial outflows is called as profitability index.
It is calculated as:
flows cash future of PV
(PI) Index ity Profitabil
100
o
C
n
t
t
r
t
A
1 ) 1 (
PI
Where, r = Required rate of return on the proposal
The PI gives the ratio of benefits to costs. If PI<1, the project should be rejected. If PI
>1, it means the benefits of the project exceed its costs and so it can be accepted.
Advantages of PI
Considers the time value of money.
Enables comparison of various alternatives.
Disadvantages of PI
The concept is similar to NPV.
Example: Evaluation of Projects Using the PI Method
Consider the earlier example given in the NPV method,
For Option 1, 1.46
10,000
14,636
PI
For Option 2, 1.6177
10,000
16,177
PI
Since the PI of Option 2 is higher, it is accepted.
Exercises
O. A company is considering an investment option. The initial investment is Rs.
200,000 and the average annual profit is Rs. 25,000. Calculate the average rate of
return of the proposal.
P. Project Z requires an investment of Rs. 20 million. The cash flows generated by
the project are given below. What is the payback period for the project?
End of Year 1 2 3 4 5 6
Cash flow (in Rs. million) 1 2 4 5 8 5
(Questions Q-T)
A firm has two options; each of them costing Rs. 50,000 and having a life period of 5
years. Assume a required rate of return of 7%, after taxes. The net cash flows for both
the projects are shown below.
101
Option 1:
Year Net cash flows
1 20000
2 20000
3 15000
4 10000
5 9000
Option 2:
Year Net cash flows
1 15000
2 20000
3 15000
4 10500
5 8000
Based on the data given above, calculate the following.
Q. The NPV of Option 1.
R. The NPV of Option 2.
S. PI of Option 1.
T. PI of Option 2.
9. Risk Analysis of Project Investments
Every project is exposed to a certain amount of risk and the extent of risk varies from
project to project. So, the project manager should attempt to estimate the possible
level of risk his project is likely to be exposed to.
Suppose the project manager has a choice two between two alternatives, X and Y,
each involving the same investment, but offering different outcomes as given below:
The expected outcome of Proposal X is (10,000 x 0.5 + 0 x 0.5) = 5,000; Therefore,
the expected outcome of both proposals are equal. If the project manager does not
want to take any risk, he prefers Proposal Y. The project manager can also take up
Proposal X, if he wants to take up some risk.
Proposal Possible Outcome Probability
X 10000 0.5
0 0.5
Y 5000 1
Normally, three types of project risks are studied for each project idea. They are stand
alone risk, corporate risk, and systematic risk.
Stand Alone Risk
Stand alone risk refers to the risk a project faces when it is considered in isolation.
102
Corporate Risk
This refers to the risk a firm faces because of a project.
Systematic Risk
This risk is caused by the existing market situation. This risk is also called market
risk.
Techniques of Risk Analysis
Firms follow different techniques to protect their projects from risks. Some of the
techniques used by firms are Sensitivity Analysis, Scenario Analysis, etc.
Sensitivity Analysis
This technique is used to find out how sensitive the results of a particular financial
model are to changes in input variables. For example, the net present value of a project
depends on several factors like selling price of the product, annual sales, project life
period, income tax etc. Sensitivity analysis aims at examining how net present value
changes with changes in the above factors. To carry out this analysis, the project
manager establishes a relationship between the net present value and factors that affect
the net present value. Then he studies the range of net present values with variations in
each of the factors affecting it. By understanding the affect of several factors, the project
manager estimates the possibility of achieving the project objectives.
Scenario Analysis
In sensitivity analysis, we can study the changes in the NPV with changes in one of
the variables. But most of the time in real life projects, two or more variables change
at the same time and the changes may be interrelated. In such situations, scenario
analysis is used. If the variables are interrelated, then it is helpful to look at some
plausible market scenarios or market conditions where each scenario represents a
consistent combination of variables. This type of analysis is called scenario analysis.
In scenario analysis, different scenarios are generated and the desirability of the
project is studied in each scenario. The objective of such scenario analysis is to get a
feel of what happens under the most favorable or the most adverse combination of key
variables, without bothering much about the internal consistency of such
combinations. Therefore, it is considered to be the most suitable technique for
analyzing the fate of a project in different scenarios or market conditions.
Check Your Progress
16. The risk that a project faces when it is considered in isolation is termed
a. Systematic risk
b. Stand alone risk
c. Market risk
d. Corporate risk
17. If you want to analyze the fate of a project under different market conditions, then
the most appropriate analysis would be a
a. sensitivity analysis.
b. scenario analysis.
c. Monte Carlo simulation.
d. All of the above
103
18. Sensitivity analysis
a. is one of the tools of technical appraisal.
b. examines the impact of change in the net present value with changes in one of the
project variables.
c. studies the impact of changes in multiple variables at a time on the internal rate of
return.
d. involves imitating the behavior of some situation or process by using a similar
situation in order to study the characteristics of the variables in the situation.
10. Social Cost Benefit Analysis (SCBA)
Since projects affect society, they should also be studied from the point of view of
society. So the project manager has to analyze the social and economic benefits
generated by the project and also the social costs of the project.
Social costs refer to the harmful effects of a project to society like air pollution, water
pollution, soil erosion, deforestation, production of harmful products, etc. Social
benefit refers to the positive impact of a project on society like increase in
employment opportunities, rise in per capita income etc. The objective of a Social
Cost Benefit Analysis is to assess the positive and negative effects of a project on
society. The project manager finally chooses the project that is socially beneficial.
Indicators of Social Desirability of a Project
There are several evaluation methods for testing the social desirability of a project.
Some of the important indicators of the social desirability of a project are discussed
below.
Employment Opportunities
Unemployment is a major problem in developing countries like India. So, a project
with high employment potential is desirable. Since there is surplus labor in these
countries, labor intensive projects would generate more employment opportunities.
Foreign Exchange Benefits
Countries that are experiencing a foreign exchange crunch give preference to projects
that earn foreign exchange. An import substitution project that saves the country's
foreign exchange is thus a desirable project.
Output per Unit of Capital
In countries where there is a dearth of capital, a project that gives a higher output per
unit of capital employed is preferred.
Value Addition Criterion
The 'Value addition' of a project refers to the difference between the market price of a
project's output and the costs/price of the goods and services bought from other firms
for carrying out the project. According to this approach, the value added per unit of
capital is ascertained so that the project that gives higher value can be chosen.
Cost Benefit Ratio
The social costs and social benefits associated with a project are calculated and the
project that provides more benefits than costs is selected and implemented. Here, costs
and benefits are ascertained based on the shadow prices. The shadow price is the real
price that would have prevailed had there been no imperfections in the market. Then
these costs and benefits are discounted to the present value of social costs and benefits
and the ratio of benefits to the costs gives the cost benefit ratio.
104
UNIDO Approach
Social Cost Benefit Analysis is a useful tool for selecting a project. However, it is not
easy to quantify the social costs and social benefits. The United Nations Industrial
Development Organization (UNIDO) has therefore developed a method for measuring
social costs and social benefits.
The method consists of five steps:
Calculating financial profitability at market prices
Calculating net benefits at economic prices
Adjustment for project's impact on savings and investment
Adjustment for project's impact on income distribution
Adjustment for impact of project on merit and demerits goods
Calculation of Financial Profitability at Market Prices
In this step, the project manager assesses the net profitability of the project on the basis of
the market prices of all inputs and outputs. The profit is obtained by subtracting the
expenditure incurred from the firms revenues. The project manager calculates the
profitability of the project as the percentage of profit to the capital employed.
Calculation of Net Benefits at Economic Prices
In this step, the project manager measures the net benefits of the project in terms of
economic prices (also called shadow prices). These are calculated on the basis of
impact of the project on the national economy.
If the projects product has an impact on consumption, then the price that the
consumer is willing to pay for the product becomes the shadow price of the product. If
the impact is on production, shadow price is the cost of production. If the impact of
the product is on international trade, then the shadow price is the foreign exchange
value of the product. In the case of pure tradable goods, the shadow price of a good is
the international price of the good since there exists no opportunity cost in the
country. Taxation makes it difficult to calculate shadow prices.
Adjustment for Projects Impact on Savings and Investment
In this step, the project manager estimates the impact of the project on the savings of
different social groups like the customers, government and other private businesses.
The impact on savings is measured as:
i
MPS
i
Where,
i
is the net income change because of the project and MPS
i
is the marginal
propensity to save. The marginal propensity to save is the fraction of each extra rupee
of income that goes to saving.
Example: Marginal Propensity to Save
Assume three groups were affected by the project and their net income gains were;
Group 1: Rs. 10,000;
Group 2: (Rs. 8,000); and
Group 3: Rs. 7,500
MPS
1
= 0.03, MPS
2
= 0.15 and MPS
3
= 0.42.
The impact of the project on the savings of these groups is:
(10,000 0.03) + (-8,000 0.15) + (7,500 0.42) = Rs. 2,250.
105
Adjustment for Projects Impact on Income Distribution
Projects that increase the income of weaker sections of society must be preferred. The
project manager considers the elasticity of marginal utility of income to understand
the redistribution of income. The elasticity of marginal utility of income is defined as
the rate at which the marginal utility of income falls with an increase in income level.
Suppose the marginal utility of income decreases by 5% with a 5% increase in
income, then the elasticity of marginal utility of income is 1. In other words, a gain of
Rs. 10 to a person earning Rs. 1,000 a year is the same as a gain of Rs. 1,000 to a
person earning Rs. 1,00,000 a year. So the project manager assigns weights to each
income group on the basis of income levels. More weight is given to low income
groups and less weight is assigned to high income groups.
Adjustment for Projects Social Value
In this step, the project manager considers the social and economic value of the
projects goods. Goods are divided into merit goods and demerit goods on the basis of
their social and economic value. Merit goods are those goods whose social value is
more than their economic value. For example, petroleum products are merit goods as
the production of petroleum products reduces the countrys dependence on foreign
supplies. Goods such as alcohol are, however, demerit goods as they produce negative
effects on society.
The procedure for adjustment of social values is given below. Suppose the economic value
of the project output is Rs. 20 million. And suppose that the social value of the project
output exceeds its economic value by 20%. So, the adjustment factor is 0.2 (120 percent/
100 percent -1). By multiplying the adjustment factor with the economic value of the
project output, we obtain an adjustment of Rs. 4 million. The social value of the project
will therefore be Rs. 20 million (economic value) plus Rs. 4 million, i.e. Rs. 24 million.
Check Your Progress
19. Which of the following techniques assesses the positive and negative effects of a
project on society?
a. Scenario analysis
b. Sensitivity analysis
c. Social cost benefit analysis
20. Which of the following institutions has developed a method for measuring social
costs and social benefits?
a. Project Management Institute
b. American National Standards Institute
c. United Nations Industrial Development Organization
d. Federation of Indian Chambers of Commerce and Industry
21. The United Nations Industrial Development Organization (UNIDO) has
developed a method for measuring social costs and social benefits. Arrange the
following steps into the sequence in which they should be carried out in that
method.
i. Adjust for impact of the project on merit and demerit goods
ii. Adjust for the projects impact on savings and investment
iii. Calculate financial profitability at market prices
iv. Adjust for the projects impact on income distribution
v. Calculate net benefits at economic prices
106
a. iii-ii-v-i-iv
b. iii-v-ii-iv-i
c. iii-iv-v-i-ii
d. iii-i-ii-v-iv
22. Profitability of the project is the
a. sum of profit and capital employed.
b. percentage of profit to the capital employed.
c. percentage of capital employed to the profit.
d. difference between profit and capital employed.
23. Which of the following options would be the best to use in order to understand
the redistribution of income?
a. Price elasticity of demand
b. Income elasticity of demand
c. Elasticity of marginal utility of income
d. All of the above
24. Identify the statements that are not correct with regard to the elasticity of
marginal utility of income.
i. Elasticity of marginal utility of income is used to understand the redistribution of
income.
ii. Elasticity of marginal utility of income is the rate at which the marginal utility of
income increases with an increase in income level.
iii. The projects impact on income distribution is adjusted by assigning weights to
each income group on the basis of income levels.
iv. Weights are given based on the income levels, i.e., less weight is given to low
income groups and more weight is assigned to high income groups.
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
25. Goods whose social value is more than their economic value are called
a. merit goods.
b. veblen goods.
c. demerit goods.
d. giffen goods.
Exercises
U. The net income gains of Group P, Group Q, and Group R because of execution of
a project are Rs. 10,000, Rs. 9,000, and Rs. 12,000. The marginal propensity to
save (MPS) of P, Q, and R is 0.02, 0.12, and 0.03, respectively. Calculate the net
impact of the project on the savings of the three groups.
V. The net income gains of Group X, Group Y, and Group Z because of execution of
a project are Rs. 15,000, Rs. 12,000, and Rs. 17,000. The marginal propensity to
save (MPS) of X and Y is 0.05 and 0.10, respectively. The net impact of the
project on the savings of these three groups is Rs. 2,630. Calculate the MPS of Z.
107
11. Summary
The primary objective of any project is to earn reasonable returns for the investment
made.
The project manager must examine the financial feasibility of projects when selecting
a project for implementation.
In this process, the project manager first estimates the total cost of the project and then
identifies various means for financing the project.
Share capital, term loans, debenture capital, deferred credit are some of the means for
financing a project. Then the project manager identifies the working capital needs of
the project and the means for financing the needs.
The project manager uses two criteria to evaluate rate of returns of project
investments: non-discounted criteria and discounted criteria.
The time value of money is ignored in non-discounted criteria but is considered in the
discounted criteria.
The important methods in the non-discounted criteria are Average Rate of Return and
Payback Period method.
The time value of money is considered in the discounted criteria, and Net Present
Value, Internal Rate of Return, and Profitability Index are important methods in this
criteria.
Sensitivity analysis and scenario analysis are used by the project manager to analyze
the risks involved in each project investment.
Also, the project manager studies each project proposal from the point of view of the
society.
Project managers use Social Cost Benefit Analysis to study a projects impact on the
society. The United Nations Industrial Development Organization (UNIDO) has
developed an approach, called UNIDO approach in this regard.
12. Glossary
Corporate risk: This refers to the risk a firm faces because of a project.
Cost of capital: The minimum rate of return the firm must earn on its investments in
order to satisfy the various categories of investors who have made investments in the
form of shares, debentures, term loans, etc. A firms cost of capital is the weighted
arithmetic average of the post-tax cost of the various sources of finance used by it.
Cost of debenture: The discount rate at which the present value of post-tax interest
and principal repayments is equal to the net proceeds from the issue of debentures.
Cost of external equity capital: The rate of return that the company must earn on the
net funds raised by it when it issues equity capital externally.
Cost of preference capital: The discount rate that equates the net proceeds from the
preference capital issue to the payments associated with it like dividend payment and
principal payments.
Deferred credit: The credit provided by the machinery and equipment suppliers is
referred to as deferred credit.
Internal rate of return: The discount rate at which the present values of cash
outflows and cash inflows are equal.
Net present value: The sum of the present values of all the cash inflows and cash
outflows associated with the project.
108
Payback period: The time period during which a firm can recover the investments it
has made in a project.
Profitability index: The ratio of future cash benefits to the initial outflows is called as
profitability index. It is also called as benefit-cost ratio.
Project cost: The project cost is the sum of all the costs of the activities associated
with the project.
Scenario analysis: In this case, different scenarios are generated and the desirability
of the project is studied in each scenario. The objective of such scenario analysis is to
get a feel of what happens under the most favorable or the most adverse combination
of key variables, without bothering much about the internal consistency of such
combinations.
Sensitivity analysis: This technique is used to find out how sensitive the results of a
particular financial model are to changes in input variables.
Social benefit: It refers to the positive impact of a project on society, like increase in
employment opportunities, rise in per capita income etc.
Social cost benefit analysis: It assesses the positive and negative effects of a project
on society. According to this analysis, the project manager chooses the project that is
socially beneficial.
Social cost: It refers to the harmful effects of a project to society like air pollution,
water pollution, soil erosion, deforestation, production of harmful products, etc.
Stand alone risk: It refers to the risk a project faces when it is considered in isolation.
Systematic risk: This risk arises from the existing market situation. This risk is also
called market risk.
Weighted average cost of capital: The sum of weighted values obtained by
multiplying the cost of each source of financing by its proportion in the capital
structure.
1. To conduct a financial analysis, the project manager must collect information
about all the costs pertaining to the project and the different ways of financing a
project. Explain project cost. What are various means of financing a project?
Explain in detail about the importance of working capital in projects.
2. The project manager considers the time value of money when evaluating the
financial aspects of a project idea. Discuss in detail the concept of the time value
of money, and its related concepts.
3. The project manager uses the discounting and non-discounting criteria to
evaluate returns from project investments. Explain these criteria giving details of
the acceptance-rejection criterion, their advantages and disadvantages.
4. Every project is exposed to a certain amount of risk and the extent of risk varies
from project to project. Explain the various techniques used by a project manager
to estimate the possible level of risk a project is likely to be exposed to.
5. As projects affect society, they should be studied from the point of view of
society. The project manager has to analyze the social and economic benefits
generated by the project and also the social costs of the project. In this context,
discuss the concept of social cost benefit analysis.
109
Following are the model answers to the Check Your Progress questions given in the
Unit.
1. (b) Market analysis Technical analysis Financial analysis.
Once project ideas have been generated and screened, they are evaluated for
marketability, technical feasibility, and cost factors. The project manager first
conducts a market analysis; a technical analysis of the project idea then follows.
Once the commercial and technical aspects of a project idea have been evaluated
and approved, the project manager examines the financial feasibility of the project.
2. (c) Price elasticity of demand
To assess the financial feasibility of a project idea, the project manager must
examine the capital costs, operating costs, and the revenues of the proposed
project. Price elasticity of demand is part of conducting the demand analysis of a
product and is used to forecast demand.
To assess the financial feasibility of a project idea, the project manager must
examine the capital costs, operating costs, and revenues of the proposed project.
To conduct a financial analysis, the project manager must collect information
about all the costs pertaining to the project, different ways of financing the
project, working capital requirements, profitability projections, and projected
cash flows of the project.
4. (b) Equity capital
Share capital is of two types equity capital and preference capital. Equity capital
is the capital contributed by the owners of the firm. Equity holders enjoy the
profits and bear the risks of the firm. Term loans are secured borrowings provided
by financial institutions and commercial banks. These loans help firms take up
expansion, modernization, and renovation projects. Deferred credit refers to the
amount that a firm receives but has still not reported as income. The amount is
actually a liability that is realized at a future date, when the goods or services are
provided. In a project, the machinery and equipment suppliers may provide credit
facilities to firms. This credit amount is repaid over a period of time depending on
the value of the machinery and the credit standing of the buyer. Generally,
suppliers demand a bank guarantee which is equivalent to the value of the
machinery. It is repaid over a period of time, depending on the value of the
machinery and the credit standing of the buyer. Debentures are issued by firms to
raise debt capital, normally for a period of 5 to 10 years. The debentures are
secured against the assets of the issuing firm.
110
5. (b) Debentures are secured against the liabilities of the issuing firm.
Debentures are issued by firms to raise debt capital, normally for a period of 5 to
10 years. The debentures are secured against the assets of the issuing firm. There
are three types of debentures: non-convertible debentures, partially convertible
debentures, and fully convertible debentures. A fixed interest is paid on non-
convertible debentures. In the case of partially convertible debentures, only a part
of them are converted into equity shares. Where fully convertible debentures are
concerned, all the debentures are fully converted into equity shares as per pre-
determined terms.
6. (c) Deferred credit
Deferred credit refers to the amount that a firm receives but has still not reported
as income. The amount is actually a liability that is realized at a future date, when
the goods or services are provided. In a project, the machinery and equipment
suppliers may provide credit facilities to firms. This credit amount is repaid over
a period of time depending on the value of the machinery and the credit standing
of the buyer. Generally, suppliers demand a bank guarantee which is equivalent to
the value of the machinery. Share capital is of two types equity capital and
preference capital. Equity capital is the capital contributed by the owners of the
firm. Equity holders enjoy the profits and bear the risks of the firm. Preference
capital refers to the contribution that preference shareholders make by investing
in a firms preference shares. Term loans are secured borrowings provided by
financial institutions and commercial banks. These loans help firms take up
expansion, modernization, and renovation projects.
The project manager should consider the following factors while estimating the
working capital requirements of a project -- raw materials and components, work-
in-process, stocks of finished goods, and operating expenses. Working capital is
the capital required to carry out the day-to-day operations of the firm. Raw
materials, components, operating expenses, etc., are the items that would need
capital at various points of time. Therefore, the requirements of raw materials,
components, etc., are found out in order to estimate the working capital
requirements of the firm.
8. (d) i/r, ii/p, iii/r
The margin requirement varies with the type of current asset. The ranges within
which margin requirements lie for various types of current assets are are: raw
materials 10-25%, work-in-process 20-40%, finished goods 30-50%, and
debtors 30-50%.
9. (c) FV=
n m
m
r
PV 1
The generalized formula for shorter compounding periods is
FV=
n m
m
r
PV 1
where,
FV = Future value n years hence
PV = Present value of cash flow
111
r = Interest rate per annum
m = Number of times interest is paid
n = Number of years
10. (a) FVA
n
=
r
r
A
n
1 1
An annuity is a series of periodic cash flows (payments or receipts) of equal
amounts. The future value of an annuity is calculated as:
r
1]
n
r) A[(1
n
FVA
Where, A = Constant periodic flow
r = Interest rate per period
n = Duration of the annuity
11. (b) Cost of capital
Cost of capital is the minimum rate of return that a company must earn on its
investments in order to satisfy the various categories of investors who have made
investments in the form of shares, debentures, or term loans. The cost of capital
of a company is the weighted arithmetic average of the cost of various sources of
finance that have been used by it.
12. (b) weighted average
The cost of capital of a company is the weighted arithmetic average of the cost of
various sources of finance that have been used by it. Costs of equity, retained earnings,
preference capital, debentures, and term loans are first calculated and weights are
attached to them in order to calculate the weighted average cost of capital.
13. (d) g
0
P
g 1
0
D
s
K
According to the Dividend Capitalization approach, the intrinsic value of an
equity stock is equal to the sum of the present values of the dividends associated
with it. It can be written as follows:
K
s
= g
0
P
1
D
, where, D
1
= D
0
(1 + g).
14. (b) Only i, iii, and iv
According to this approach, the cost of equity is reflected by the following
equation,
K
i
= r
f
+
i
(k
m
r
f
)
Where, K
i
= Required rate of return on a security i
r
f
= Risk free rate of return
k
m
= Rate of return on market portfolio.
i
= Beta of security i
112
Therefore, in order to calculate the rate of return on security i according to the
capital asset pricing model, we would need risk-free rate of return, beta of
security i, and rate of return on market portfolio. The return on investment is not
required in the capital asset pricing model.
15. (c)
f 1
e
K
s
K
According to the dividend capitalization approach, the cost of external equity can
be calculated as:
f 1
e
K
s
K
where,
K
s
K
e
= rate of return required by the equity investors.
f = floatation cost
Floatation costs are included in order to adjust for the issue expenses and in case
the pricing of the share in an IPO is done at less than the market value.
16. (b) Stand alone risk
Stand alone risk refers to the risk a project faces when it is considered in
isolation. Corporate risk refers to the risk a firm faces because of a project.
Systematic risk is caused by the existing market situation. It is also called as
market risk.
17. (b) scenario analysis.
In scenario analysis, different scenarios are generated and the desirability of the
project is studied in each scenario. Therefore, it is considered to be the most
suitable technique for analyzing the fate of a project in different scenarios or
market conditions.
18. (b) examines the impact of change in the net present value with changes in
one of the project variables.
Sensitivity analysis is used to find out how sensitive the results of a particular
financial model are to changes in input variables. In sensitivity analysis, we can
study the changes in the net present value with changes in one of the variables.
By understanding the affect of several factors, the project manager estimates the
possibility of achieving the project objectives.
19. (c) Social cost benefit analysis
Projects affect society. Therefore, they should be studied from the point of view
of their impact on society. The project manager has to analyze the social and
economic benefits generated by the project and also the social costs of the project.
Social cost benefit analysis is a technique that assesses the positive and negative
effects of the project on society. Scenario analysis is used if the variables that
affect the project output are inter-related. This analysis identifies combinations of
inputs that lead to a change in output values. Sensitivity analysis is used to find
out how sensitive the results of a particular financial model are to changes in
input variables.
113
20. (c) United Nations Industrial Development Organization
The United Nations Industrial Development Organization (UNIDO) has
developed a method for measuring social costs and social benefits. As projects
affect society, they should be studied from the point of view of their impact on
society. The project manager has to analyze the social and economic benefits
generated by the project and also the social costs of the project. Social cost
benefit analysis is a technique that assesses the positive and negative effects of a
project on society and is a useful tool in selecting a project.
21. (b) iii-v-ii-iv-i
UNIDO has developed a method for measuring social costs and social benefits.
Following are the steps involved in the method: Calculate financial profitability at
market prices, calculate net benefits at economic prices, adjust for the projects
impact on savings and investment, adjust for the projects impact on income
distribution, and adjust for impact of the project on merit and demerit goods.
22. (b) percentage of profit to the capital employed.
The project manager assesses the net profitability of the project on the basis of the
market prices of all inputs and outputs. The profit is obtained by subtracting the
expenditure incurred from the firms revenues. The project manager calculates the
profitability of the project as the percentage of profit to the capital employed.
23. (c) Elasticity of marginal utility of income
The elasticity of marginal utility of income is defined as the rate at which the
marginal utility of income falls with an increase in income level. The elasticity of
marginal utility of income is used by the project manager to understand the
redistribution of income. It is also used to adjust the impact of the project on the
distribution of income.
24. (c) Only ii and iv
The project manager uses the elasticity of marginal utility of income to
understand the redistribution of income. The elasticity of marginal utility of
income is defined as the rate at which the marginal utility of income falls with an
increase in the income level. More weight is given to low income groups and less
weight is assigned to high income groups.
25. (a) merit goods.
Merit goods are those goods whose social value is more than their economic
value. For example, petroleum products are merit goods as producing them
reduces the countrys dependence on foreign supplies. Veblen goods are those
goods whose demand is directly related to a change in the price. Giffen goods are
inferior goods, and an increase in their price would make people buy more
quantities of them.
Following are the answers to the Exercises given in the Unit.
A. Rs. 6,211.70
Investment = Rs. 2,000
Period of investment = 10 years
Rate of interest = 12% per annum
Future value of the investment after 10 years = Rs. 2,000 (1 + 0.12)
10
= Rs.
6,211.70.
114
B. Rs. 15,110.69
FV =
n m
m
r
PV 1
where,
PV = Rs. 10,000
r = nominal interest rate per annum = 14% per annum.
m = frequency of compounding during a year = 4 times a year
n = number of years for which compounding is done = 3 years
FV
3
= 10,000
3 4
4
0.14
1 = 10,000 (1.035)
12
= Rs. 15,110.69.
C. Rs. 1,113.80
Nominal rate of interest per month =
12
0.14
= 0.01167
The initial deposit can be calculated as follows:
PVA
n
=
n
1 r
1
n
1
A
r
r
=
12
01167 . 0 1 01167 . 0
1
12
01167 . 0 1
100
=
1494 . 1 01167 . 0
1 1494 . 1
100 = Rs. 1,113.80
D. Rs. 103.79
Nominal rate of interest per month =
12
0.09
= 0.0075
The initial deposit can be calculated as follows:
n
r 1 r
1 1 A
n
PVA
n
r
5000 =
60
0075 . 0 1 0075 . 0
1
60
0075 . 0 1
A
5000 =
5657 . 1 0075 . 0
1 5657 . 1
A
5000 = A (48.1744)
A =
1744 . 48
5000
= Rs. 103.79.
115
E. 15.81%
K
p
=
2
P R
n
P R
D
where,
K
p
= cost of preference capital
D = preference dividend per share payable annually = 15%
R = redemption price = Rs. 100
P = net amount realized per share = Rs. 95
n = maturity period = 12 years
K
p
=
2
P R
n
P R
D
=
2
95 100
12
95 100
15
= 0.1581 = 15.81%.
F. 7.5%
Cost of capital of the company = (proportion of equity cost of equity) +
(proportion of debt cost of debt).
= 9%
100
50
6%
100
50
= 7.5%.
G. 26%
g
0
P
1
D
s
K
where,
D
1
= Expected dividend = D
0
(1 + g)
D
0
= 15, g = Growth rate = 5%
D
1
= D
0
(1 + g) = 15 (1 + 0.05) = 15.75
P
0
= Market price
K
s
= (15.75/75) + 0.05 = 0.26 or 26%.
H. 112.17%
Year Dividend per Share (Rs.) Price per Share (Rs.) Wealth Ratio
1 10 10 -
2 10 12 2.2
3 12 14 2.167
4 13 12 1.7857
116
Year Dividend per Share (Rs.) Price per Share (Rs.) Wealth Ratio
5 10 10 1.67
6 12 15 2.7
7 14 10 1.6
8 15 10 2.5
9 15 12 2.7
10 15 12 2.25
Wealth ratio =
1 - t
P
t
P
t
D
where,
t = 1, 2,.... n.
D
t
= dividend per share for year t payable at the end of year
P
t
= price per share at the end of year t
P
t-1
= price per share at the end of year t-1 (i.e., price per share at the beginning
of year t)
Wealth ratios:
W
1
= 0
W
2
=
1 - 2
P
2
P
2
D
=
10
2 1 0 1
= 2.2
W
3
=
1 - 3
P
3
P
3
D
=
12
4 1 2 1
= 2.167
Similarly, wealth ratios for the other years can be calculated.
Average yield = (W
1
x W
2
x .. x W
n
)
1/n
1 = (2.2 x 2.167 x 1.7857 x 1.67 x 2.7
x 1.6 x 2.5 x 2.7 x 2.25)
1/9
1= (932.7744)
0.11
1 = 2.1217 1 = 1.1217 =
112.17%.
I. 22.58%
K
s
=
f 1
e
K
where,
K
s
K
e
= rate of return required by the equity investors = 21%
f = floatation costs as a percentage of the current market price = 7%
K
s
=
07 . 0 1
21 . 0
= 0.2258 or 22.58%.
117
J. 28%
K
e
= g
0
P
1
D
where,
D
1
= Expected dividend = Rs. 10
g = Growth rate = 8%
P
0
= Market price = Rs. 50
K
e
= 08 . 0
50
10
= 0.28 or 28%.
K. (c) 28%
Cost of retained earnings is equal to the rate of return expected by the equity
investors. Therefore, cost of retained earnings, k
r
= cost of equity, k
e
= 28%.
L. 10.26%
K
d
=
2
P R
n
P R
) (1 I T
where,
K
d
= post-tax cost of debenture capital
I = annual interest payment per debenture capital = 15%
T = corporate tax rate = 40%
R = redemption price per debenture = Rs. 100
P = net amount realized per debenture = Rs. 95
K
d
=
2
95 100
5
95 100
) 40 . 0 1 ( 15
= 10.26%.
M. 16.51%
K
p
=
2
P R
n
P R
D
where,
K
p
= cost of preference capital
D = preference dividend per share payable annually = 12%
R = redemption price = Rs. 100
118
P = net amount realized per share = Rs. 80
K
p
=
2
80 00 1
7
80 00 1
2 1
=
90
86 . 14
= 0.1651 = 16.51%.
N. 16.55%
In order to calculate the weighted average cost of capital of the company, we
need the costs of various sources of finance and the weights. The costs of various
sources of finance used by the company are:
Cost of equity capital, k
e
= 28%
Cost of preference capital, k
p
= 16.51%
Cost of debentures, k
d
= 10.26%
Cost of retained earnings, k
r
= 28%
Weights for these can be calculated using the book value approach. In this, the
weight of a particular source of finance is equal to the book value of that source
divided by the total of the book values of all the sources of finance used by the
company.
That is,
w
e
=
500
100
= 0.2
w
p
=
500
100
= 0.2
w
d
=
500
100
= 0.2
w
r
=
500
100
= 0.2
Therefore,
Weighted Average Cost of Capital = k
e
w
e
+ k
p
w
p
+ k
d
w
d
+ k
r
w
r
= 0.28
0.2 + 0.1651 0.2 + 0.1026 0.2 + 0.28 0.2 = 0.056 + 0.03302 + 0.02052 +
0.056 = 0.1655 = 16.55%.
O. 12.5%
100
Profit Annual Average
Return of Rate Average
Average annual profit = Rs. 25,000
12.5% 100
200,000
25,000
ARR .
119
P. 5 years
The payback period for the project will be 5 years. After 5 years, the total of all
cash flows will be equal to the initial investment:
Rs. 1 million + Rs. 2 million + Rs. 4 million + Rs. 5 million + Rs. 8 million =
Rs. 20 million.
Therefore, payback period = 5 years.
Q. Rs. 12,451
For Option 1, the NPV is:
5
07 . 1
9000
4
07 . 1
10000
3
07 . 1
15000
2
07 . 1
20000
07 . 1
20000
50000
= 50,000 + 18,692 + 17,469 + 12,244 + 7,629 + 6,417 = Rs. 12,451.
R. Rs. 7,446
5
07 . 1
8000
4
07 . 1
10500
3
07 . 1
15000
2
07 . 1
20000
07 . 1
15000
50000
= 50,000 + 14,019 + 17,469 + 12,244 + 8,010 + 5,704 = Rs. 7,446.
S. 1.2490
For Option 1,
50,000
62,451
PI = 1.2490
T. 1.149
For Option 2,
50,000
57,446
PI = 1.149
U. Rs. 1,640
Net income gains of the three groups are:
Group X = Rs. 10,000
Group Y = Rs. 9,000
Group Z = Rs. 12,000
Marginal propensity to save of the three groups is:
MPS
X
= 0.02
MPS
Y
= 0.12
MPS
z
= 0.03
The impact of the project on the savings of these groups is = (10,000 0.02) +
(9,000 0.12) + (12,000 0.03) = Rs. 1,640.
V. 0.04
Net income gains of the three groups are:
Group X = Rs. 15,000
120
Group Y = Rs. 12,000
Group Z = Rs. 17,000
Marginal propensity to save of the three groups is:
MPS
X
= 0.05
MPS
Y
= 0.10
The impact of the project on the savings of these groups is = (15,000 0.05) +
(12,000 0.10) + (17,000 MPS
z
)
i.e., Rs. 2,630 = (15,000 0.05) + (12,000 0.10) + (17,000 MPS
z
)
MPS
z
=
17000
680
= 0.04.
Unit 5
Project Selection
Structure
1. Introduction
2. Objectives
3. Criteria for Project Selection Models
4. Project Selection Models
5. Analyzing the Uncertainty of a Project
6. Project Proposal
7. Summary
8. Glossary
1. Introduction
In the previous unit, we have discussed the financial analysis of projects. In this unit,
we shall discuss project selection. Project selection is a systematic process of choosing
a project idea for implementation from the available alternative project ideas. The
project manager attempts to decide which idea to choose, which technology to
develop, and which methodology to follow in selecting a project. The project manager
has to carefully prioritize all the available options and choose the best. A wrong
choice of a project may result in ineffective use of resources and project failure.
As project clients and management teams become more sophisticated, the focus of a
project organization is mainly on aspects such as how to choose the right projects and
how to prioritize them. Ineffective project selection is the most common reason for the
failure of many projects. It may result from ambiguity in the framing of objectives,
absence of planning, and lack of team coordination. The project manager has to be
very careful in selecting a project. He/she should consider the objectives and policies
of the organization, the availability of resources, and the selection of the right team to
take up the project.
This unit will discuss the criteria for project selection models. We will discuss the
various project selection models and then move on to discuss the ways and techniques
used to analyze the uncertainty of a project. Finally, we shall discuss project proposal.
2. Objectives
identify the criteria for project selection models.
explain project selection models.
analyze the uncertainity of a project.
define project proposal.
122
3. Criteria for Project Selection Models
Management of change is essential for every firm to survive in the competitive
environment. Earlier, firms took up a project as part of their strategy along with their
actual operations. Today, organizations are specializing in getting and executing the
projects. Every project is important for the firm and each project demands separate
development and implementation strategies.
It is the duty of a project manager to choose those projects that guarantee returns in
the near future. Proper project selection also determines the allocation of resources
which is aimed at ensuring better returns. A rational decision making process is
essential to choose the right project.
Souder, a well-known author in the area of project management describes the criteria
to be used while choosing a project selection model. He suggests that the project
selection model should fulfill the following characteristic realism, capability, cost,
flexibility, ease of use, and easy computerization.
Realism
The model considered for selection of a project should consider all the relevant factors
that influence the decision of a project manager. The model should explicitly state the
objectives of the project manager and the firm in selecting a particular project. It
should also consider the risks (technical, cost, time and performance risks) that a
project may encounter.
For example, consider a firm that has three projects in hand; Project A, Project B,
and Project C. Project A is an innovative project that improves the image of the
firm, but requires lot of capital investment. Project B can gain competitive edge for
the firm by strengthening the capabilities of its scientists and skilled labor. Project C
can increase the sales of the firm by adding new features to the existing product. The
project selection model should be a common measurement system that is capable of
comparing different projects. Then the best project can be selected based on firms
ability to execute the project successfully.
Capability
The selection model that the project manager considers should be capable of
providing the optimum decision taking into consideration all the risks and constraints
involved in the project. The selection model should have the capability to evaluate
future project proposals based on the expected returns of each project without
subjectivity.
Costs
The various costs incurred in obtaining the right selection model should be kept at
minimum. The costs associated with designing a selection model include data
generation costs, data processing and storage costs. The objective here is to identify
the best selection model and optimize the costs incurred to select the decision model
based on the size of the project. Firms should also ensure that the project costs do not
exceed the benefits of the project.
Flexibility
The selection model should provide the desired results within the given conditions and
taking into account the firms interests. The model should be easy to modify or should
be capable of adjusting on its own to the changes in the firms environment.
Ease of Use
The selection model should be convenient to implement and easy to communicate.
The model should be tested as to how best it can be used by existing employees
without further interpretation to take a decision.
Project Selection
123
Easy Computerization
The data should be computerized for easy storage and retrieval. Software packages
like MS Excel, Lotus 1-2-3, Quatro Pro. work like Decision Support Systems, and
assist the project manager in data analysis and decision making.
Activity: Galaxy Constructions Ltd. is involved in various projects like the
construction of domestic dwellings, commercial complexes, larger apartments,
entertainment parks, etc. As the company accepts all types of projects, its resources
are being over stretched. To its surprise, the management has found that the
company is incurring losses because of some of its projects. So the management of
Galaxy Constructions Ltd. decided to be more cautious when selecting projects.
What should be the characteristics of a good project selection model for Galaxy
Constructions?
Answer:
Check Your Progress
1. Match the following criteria for choosing a project selection model with their
respective characteristics.
i. Realism
ii. Capability
iii. Flexibility
p. This criterion states that the model should be easy to modify or should be capable
of adjusting on its own to changes in the firms environment.
q. This criterion states that the project selection model should consider the technical,
cost, time, and performance risks that a project may encounter.
r. This criterion states that the selection model that the project manager considers
should be able to provide the optimum decision, taking into consideration all the
risks and constraints involved in the project.
a. i/p, ii/q, iii/r
b. i/p, ii/r, iii/q
c. i/q, ii/r, iii/p
d. i/r, ii/p, iii/q
2. _____________ is a systematic process of choosing a project idea for
implementation from among the available alternatives.
a. Project control
b. Project selection
c. Project screening
d. Project risk analysis
124
3. From the following, identify the criterion that was not proposed by Souder to
choose a project selection model.
a. Cost
b. Capability
c. Rigidity
d. Ease of use
4. Identify the costs that a firm might incur while designing a project selection
model.
i. Data generation costs
ii. Data processing costs
iii. Storage costs
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
5. Ineffective project selection is the most common reason for the failure of many
projects. This may be the outcome of
i. ambiguity in the framing of objectives.
ii. absence of planning.
iii. lack of team coordination.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
6. Which of the following statements are true regarding a project selection model?
i. The selection model should explicitly state the intentions of the project manager
and the firm in selecting a particular project.
ii. It should have the capability to evaluate future project proposals without
subjectivity, based on the expected returns of each project.
iii. The selection model should provide the desired results within the given
conditions, taking into account the firms interests.
iv. It should be convenient to implement and easy to communicate.
7. Which of the following options should the project manager consider in order to
select an effective project?
i. Objectives and policies of the organization
ii. Availability of resources
iii. Number of new employees
iv. Selection of the right team to take up the project
Project Selection
125
b. Only i, ii, and iv
c. Only i, iii, and iv
d. Only ii, iii, and iv
4. Project Selection Models
Broadly, project selection models are of two types: numeric and non-numeric.
Numeric models use numbers as inputs and non-numeric models use discussions,
suggestions to select a project. The project manager uses either one model or a
combination of the two models, to help him select the best model, although they do
not provide a complete decision. Even though the task of selecting a project is
delegated to a specific person or team, the ultimate responsibility to choose a right
project lies with project manager.
In order to construct a project selection model, the project manager generates a list of
objectives. The list includes the goals and interests of the firm such as improving the
brand image, generating employment for certain categories of workers, expanding the
business etc. The list of objectives can also be refined by assigning specific weights to
each objective. This prioritizes the firms objectives and is useful in understanding the
relationship between the projects expected results and organizational goals. With the
availability of new technologies, the project manager can create a Decision Support
System (DSS) for evaluating and selecting a project.
Non-numeric Models
These models use inputs other than numerical data to select a project. These models
are constructed based on the subjective evaluation, ideas and opinions of the project
manager and the project team. Although these models seem simple to use, they require
the team to understand the practical use of these models.
Sacred Cow
In this model, the firms select projects that enjoy support of the higher officials. For
example, when a CEO of an electronics company foresees a high market demand for
Internet-ready TVs, then the firm takes up the project of developing a television that
facilitates Internet access. Here, the project is selected because the suggestion came
from a key executive in the firm and resources are provided in accordance with the
interests of the top management.
The project is considered sacred as everyone in the firm tries to make the project a
success. These projects do not face any resource constraints generally and they are
persisted with, until a satisfactory product is delivered. Most of these projects are
successful because of the ability and experience of the key executive who gave the
project idea, and also because of the top managements interest in making the project
a success. These projects are terminated only when the top management is convinced
that the project is a failure.
Extension of Product Line
New projects are taken up as extensions to the existing product line, in order to fill the
gaps between the market offer and customer needs. This type of project is treated as a
part of the organizations strategy. Therefore, it is free from establishing a selection
criterion. Firms take up projects to cater to the unfulfilled needs of the customer and
to strengthen their product line.
126
Operating Necessity
Some projects are initiated in order to cater to the operating necessity of some other
existing projects. For example, a special project like building a dike is necessary for
operating a project that is facing a threat of inundation. Similarly, Election
Commission of India initiates the project of issuing Identity Cards to new voters
before taking up the project of conducting elections throughout the country.
Competitive Necessity
The competition in the market forces the management to take up new projects. For
example, the need for computerizing in an organization arose out of competitive
necessity to provide better services to the customers and to survive in the market.
Similarly, many business schools are restructuring their courses to stay afloat and gain
competitive advantage.
Comparitive Benefit
When an organization has many projects in hand, the top management chooses the
most beneficial project. This is because of the comparative benefit that a project has
relative to other projects. Firms initiate certain projects as an attempt to construct a
portfolio that best fits the firms objectives and its capacity.
Q-Sort Technique
Q- Sort technique is a useful evaluation and selection technique used to prepare a list
of priority projects. According to this technique, a project manager first collects the
various project ideas and then classifies them as good, fair and poor projects based on
economic and technical feasibility, market potential, organizational urgency, level of
complexity and risks involved, organizational needs and expected returns of the
project. In the second step, the project manager further subdivides the projects
arranges them in descending order (excellent to worst). The sorting process is
continued till the project manager succeeds in identifying the best project.
The sorting of project ideas is carried out by the project manager or by a team of
experts. When it is carried out by different individuals, there is a possibility of
deviations in assigning the ranks to the projects. But the deviations will not be drastic
as experts evaluate the projects considering the broad organizational objectives and
requirements. After sorting the project ideas, the best project is sent for financial
analysis before implementation.
Example: Q-Sort Technique
The following are the steps in Q-Sort technique:
Collecting Ideas and Rating
In this step, the project manager prepares the list of all projects that are
chosen for selection. Each participant is given a deck of cards, with the name
and description of the project written on them. Each participant is expected to
rate the project ideas on the basis of the broad organizational objectives.
Dividing Ideas
Based on relative merit, the project ideas are divided into high level and low
level piles, which may not be equal in size.
Creating a Medium Level Pile
Contd
Project Selection
127
Contd
The participants are again instructed to divide the above cards from each pile into
two groups, on the basis of relative merit. This creates a new medium level pile
that consists of less valued ideas from high level pile and high valued ideas from
the low level pile.
Creating a Very High and Low Level Pile
From the available high level pile, ideas are again classified into very high
level and high level ideas. Similarly, the low level pile is divided into low
level and very low level pile.
Selecting
The participants check the ideas once again to ensure the segregation of ideas
is satisfactory. With the above procedure, the project manager can select an
idea that is appreciated by most participants.
Adapted from Jack R.Meredith, Samuel J.Mantel Jr., Project Management: A Managerial
Approach, Fourth Edition, 2000 John Wiley & Sons, Inc, p 47.
Activity: The Deans Council of a university got a number of project proposals
from various departments requesting for grants. Madan Sarma, the vice-chancellor
of the university, wanted to use a Q-sort technique to determine the project (s) to be
taken up for the next academic year? Explain why Sarma preferred the Q-sort
technique?
Answer:
Check Your Progress
8. Which of the following is a useful evaluation and selection technique used for
preparing a list of priority projects?
a. Sacred cow
b. Q-Sort technique
c. Comparative benefit
d. Competitive necessity
9. Which of the project selection models are constructed based on subjective
evaluation, ideas, and opinions of the project manager and the project team?
a. Numeric models
b. Non-numeric models
c. Profitability models
d. Scoring models
128
10. Which of the following options is not a non-numeric project selection model?
a. Q-Sort technique
b. Profitability index
c. Sacred cow
d. Comparative benefit
11. In which of the project selection models do the firms select projects that enjoy the
support of higher officials?
a. Sacred cow
b. Competitive necessity
c. Q-Sort technique
d. Comparative benefit
Numeric Models
Firms depend on numeric models heavily while selecting a project. Most firms
consider the numeric models more useful than non-numeric models which are very
subjective and unscientific. Broadly, numeric models are of two types --
profit/profitability models and scoring models.
Profit/ Profitability Models
The profit/ profitability models that are followed by the project manager are --
Payback Period, Average Rate of Return (ARR), Net Present Value (NPV), Internal
rate of Return (IRR), and Profitability Index.
Payback Period: The payback period method is the simplest way of looking at one or
more major project ideas. Payback period indicates how long the project takes to earn
back the money spent on the project. The formula to find the payback period is: Cost
of Project divided by Annual Cash Inflow from Project. If a project costs Rs.50,000
and expects to earn Rs.12,000 annually, then the payback period of the project would
be 50,000 12,000 = 4.16 years. The project manager selects the project with a lower
payback period.
Average Rate of Return (ARR): The project manager selects the project that gives a
reasonable rate of return for the investment made. The project manager considers the
Average Rate of Return of the project before selecting it as it is a simple way of
gauging the return on an investment.
The Average Rate of Return (ARR) is calculated using the following formula:
Investment Initial
n Depreciato - Inflows Cash Annual
Here, depreciation is calculated as (using the straight-line method):
Life Useful
Value Salvage Cost
For example, an equipment costing Rs.7,500 is expected to return Rs.2,000 per year
for five years. After five years, the equipment can be sold at Rs.500.
Then the depreciation would be = (7,500 - 500) 5 = Rs.1,400 per annum.
Therefore, ARR = (2,000 1,400)/ 7,500 = 8%
Project Selection
129
Thus, ARR gives a quick estimate of the projects profitability and provides a basis
for comparing several different projects.
Net Present Value (NPV): NPV is the net present value of all future cash flows from
the project. It is a method that compares the value of a rupee today with the value of
the rupee in the future. If the NPV of a project is positive, then the project can be
accepted. If the NPV for a project is negative, then it should be rejected.
Internal rate of Return (IRR): Internal rate of return is defined as the rate that
discounts all of the cash flows of an investment to zero. It is the discount rate which
makes the NPV of a project zero. If the IRR of the project is greater than the
minimum acceptable rate of return, then the project is considered for selection.
Profitability Index: Profitability index or cost-benefit ratio is the net present value of
all cash flows to the initial investment outlay. If the profitability index is greater than
one, then the project is profitable. If it is less than one, the project should be rejected.
Advantages of Profit/Profitability Numeric Models
Non-discounted models like payback period, average rate of return methods are
simple to understand and use.
These models ensure standard and clear decision making.
In all the above models, cash flows are calculated from readily available accounting
information
Disadvantages of Profit/Profitability Numeric Models
Except risk, the models do not consider non-monetary factors.
Non-discounted models like Payback Period and Average Rate of Return ignore the
time value of money and the timing of cash flows.
Models that reduce cash flows to their present value are applicable in short-run.
All the models are sensitive to errors in the data input and it is also difficult to predict
the behavior of these cash inflows in the nascent years of the project.
Payback model does not consider the cash flows after the payback period. This model
cannot work on projects where the returns are high in the long- run.
Check Your Progress
12. The ________________ can be defined as the ratio of the net present value of all
cash flows to the initial investment outlay.
a. payback period
b. profitability index
c. average rate of return
d. internal rate of return
13. Which of the following statements is not true regarding payback period?
i. The payback period method is the simplest way of looking at one or more major
project ideas.
ii. Payback period indicates how long the project takes to earn back the money spent
on it.
iii. Project managers select the projects that have a higher payback period.
iv. The payback model considers the cash flows after the payback period, and
therefore, can work on projects where the returns are high only in the long run.
130
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. Only iii and iv
14. _____________ is a profitability method that indicates how long the project takes
to earn back the money spent on it.
a. Profitability index
b. Payback period
c. Internal rate of return
d. Average rate of return
15. Projects that have a ___________ payback period are selected.
a. Lower
b. Negative
c. Higher
d. Positive
16. Identify the correct formula to calculate the average rate of return.
a.
investment Initial
inflows cash Annual
b.
project from inflow cash Annual
project of Cost
c.
investment Initial
on Depreciati inflows cash Annual
d.
project of Cost
17. Net present value, payback period, etc., are
a. Numeric models
b. Scoring models
c. Profitability models
d. Both (a) and (c)
18. Which of the following options is not an advantage of profitability models of
project selection?
a. Profitability models are simple to understand and use.
b. Profitability models ensure clear decision making.
c. In profitability models, cash flows are calculated from readily available
accounting information.
d. Profitability models are applicable only in the short-run.
19. Which of the following is a profitability model of project selection?
a. Q-Sort technique
b. Unweighted 0-1 factor model
c. Average rate of return
d. Sacred cow
Project Selection
131
20. A project will be selected if the profitability index of the project is
a. less than 1.
b. equal to 1.
c. equal to zero.
d. more than 1.
21. Which of the following is also called the cost-benefit ratio?
a. Net present value
b. Profitability index
c. Average rate of return
d. Internal rate of return
22. ______________ is defined as the rate that discounts all the cash flows of an
investment to zero.
a. Profitability index
b. Average rate of return
c. Internal rate of return
23. A project will be accepted if the net present value of the project is
a. lower.
b. higher.
c. negative.
d. positive.
24. Identify the correct formula to calculate the payback period.
a.
investment Initial
inflows cash Annual
b.
project of Cost
c.
investment Initial
d.
project of Cost
Exercises
A. Project X requires an investment of Rs. 1,000,000. It expects to earn Rs. 200,000
per annum. Calculate the payback period of the project.
B. A machine costs Rs. 15,000 and is expected to return Rs. 5,000 per year for 5
years. Depreciation for the machine is Rs. 2,500 per year. Calculate the
approximate average rate of return on this investment.
C. A machine costs Rs. 10,000 and is expected to return Rs. 3,000 per year for 3
years. After 3 years, the machine can be sold at Rs. 4,000. Calculate the average
rate of return of the investment.
132
Scoring Models
As all the profitability models focus on a single decision criterion, the project manager
uses scoring techniques that involve multiple criterion to select a project. In these
models, decisions are arrived at by the discussions of the project team with the top
management. Some of the scoring models are discussed below.
Unweighted 0-1 Factor Model
The management first lists factors that can normally be considered in rating a project
for selection. Management constitutes a team of raters to select the project. The people
involved in the team must be familiar with goals of the organization and the firms
potential project portfolio. The list of factors is given to the team of raters and the
project is selected on the basis of the score given to each project idea. The evaluators
rate every project idea, and the management selects the project with the highest factor
score. The advantage of using this technique is that it gives equal weightage to the
opinions of all the raters and produces an explicit final result.
Unweighted Factor Scoring Model
The disadvantage of unweighted 0-1 Factor Model is that the raters are forced to
choose either qualified or not qualified for a particular factor. The unweighted
factor scoring model overcomes this limitation by constructing a simple linear
measure of scale, normally a scale from 1 to 5. The rater can choose any values from 1
to 5, where 5 is very good, 4 is good, 3 is fair, 2 is poor and 1 is very poor. The
management can also include a factor, the expected future profit from a particular
project in the next 3 years. This makes the management aware of the extent to which a
project can be selected or rejected.
Weighted Factor Scoring Model
The two models talked about earlier are based on the assumption that every factor that
is included in the list of factors is equally important. But this assumption is not true,
and often impracticable. Therefore, the management considers weighted factor scoring
models where the factors are weighted as per their importance. Then scoring for each
factor becomes the product of the factor weight and the factor. The sum of all the
factor scores gives the project score. The above calculation is done by using the
formula,
S =
n
0 t
i
i
W F
Where, S = Project score
F
i
= Factor score of factor
W
i
= Weight assigned to the factors
n = number of factors
The Delphi technique or the brainstorming technique is used to assign weights to each
factor. Normally, weights are associated in the range of 0 to 1. The management can
also examine the degree to which the score of a project changes for a change in the
level of resources allocated.
Advantages of Numeric Scoring Models
Consideration of weights to each factor is the most objective oriented way of selecting
a project.
These models consider the interests of all the people involved in project selection.
Project Selection
133
These models reveal the exact objectives and policies of the company.
These models are logical and follow a simple methodology.
Disadvantages of Numeric Scoring Models
These models assume that all the factors involved are linear and independent, which is
not practically possible.
Project scores provide only a relative measure, but they cannot exactly reflect the
utility of the project.
Other Approaches
The project manager can use the Iterative rating method as an alternative to scoring
models. Here, the project manager ranks all the projects based on a set of
predetermined attributes. The attributes that do not differentiate the project
alternatives are ignored. The project that satisfies the most number of attributes is
finally selected.
The model employed for selection of a project should be relevant, consistent and
sufficient. Very few project managers use mathematical programming techniques for
selection criterion and most projects are selected on the basis of convenience. Many
people prefer weighted scoring model that consider the multiple objectives of the
organization, are easy to modify in the changing environment and are not biased.
Check Your Progress
25. Identify the project selection model in which the raters are forced to choose
whether a particular project is either qualified or not qualified.
a. The Q-Sort technique
b. The unweighted 0-1 factor model
c. The unweighted factor scoring model
d. The weighted factor scoring model
26. Identify the project selection model that overcomes the limitation of the
unweighted 0-1 factor model by constructing a simple linear measure of scale.
c. The unweighted factor scoring model
d. The ueighted factor scoring model
27. Identify the statements that hold true with regard to the iterative rating method.
i. The project manager ranks all the projects based on a set of predetermined
attributes.
ii. The project that satisfies the most number of attributes is finally selected.
iii. The iterative rating method is used as an alternative to the scoring models.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
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28. Which of the following is not an advantage of numeric scoring models?
a. These models are logical and follow a simple methodology.
b. These models reveal the exact objectives and policies of the company.
c. The project scores provide a relative measure and therefore, reflect the projects
utility.
d. These models consider the interests of all the people involved in project selection.
29. Identify the project selection model that makes use of the Delphi or brainstorming
technique to assign weights to each factor.
a. The unweighted 0-1 factor model
b. The unweighted factor scoring model
c. The weighted factor scoring model
d. Both (a) and (b)
30. Which of the following is a scoring model of project selection?
c. The sacred cow
d. Average rate of return
5. Analyzing the Uncertainty of a Project
Although the firms try their best to come up with the best selection criterion, they
rarely come out with a single best solution. This is because of the uncertainty and risk
involved in carrying out the project. It is true that risk is inherent in every activity of
the project and no project manager can predict the behavior and intensity of the risk.
But the objective of the project manager is to reduce the impact of the risk on key
aspects such as project cost and project schedule. The result of a project activity
largely depends on: What the project manager does and How the business
environment affects the project?
The conditions under which the decisions are made by the project manager can be
classified into three categories: risk, uncertainty, and certainty. Under risk conditions,
the project manager finds the chance of occurrence of different states of nature and
payoff value of each state of nature. The expected value is calculated as sum of the
product of payoff value and the chance of occurrence of the state of nature.
In case of uncertain conditions, the chance of occurrence of each state of nature is not
known. No standard procedures are developed to make a decision under these
circumstances. Therefore, the project manager assigns subjective probabilities to each
state of nature to calculate the expected values of the projects. Thus the uncertain
problem is converted into a risk. In certain conditions, the project manager assumes
only a single state of nature (probability 1) and the expected project outcome becomes
the expected value.
A majority of the decisions made in project management come under uncertain
conditions and so the project manager assumes subjective probabilities for each state
of nature to find the expected values of the projects. In case of R& D projects where
little information is available, the uncertainties include uncertainties about timing and
scheduling the project, uncertainty about the direct outcome of the project and
uncertainty of side effects of the project.
Project Selection
135
The project manager therefore tries to reduce the uncertainty by preparing proforma
documents that estimate the profit and loss of the projects. Techniques like risk
assessment, simulation analysis and window-of-opportunity analysis provide useful
information in dealing with uncertainty.
Risk Assessment
Risk assessment aims at measuring the level of uncertainty associated with the various
parameters considered by decision-makers. Decision making becomes very difficult
when risk is coupled with an amount of uncertainty. In such situations, the project
manager carefully estimates the probability distributions for all the investments made
to calculate the likely returns. The probability distribution for the expected rate of
return is calculated by simulation technique.
Simulation Analysis
Simulation is a technique of imitating the behavior of some situation or process
(whether economic, military, or mechanical) by means of a suitably analogous
situation for the purpose of studying the characteristics of the variables in the
situation. It is useful for solving a business problem where values of several variables
are not known, or partly known. This technique coupled with sensitivity analysis gives
better understanding of several project variables.
Window-of-Opportunity Analysis
A firm takes up a project to create a new process or a product only when it feels that
there will be reasonable returns from the success of the project. In the initial stages of
product development, a project manager is not too sure of returns the new product or
process can bring into the firm. The only thing the project manager knows at this stage
is that the product will be technically viable.
Conventionally, firms developed a product and then tested its conformity to the
purpose of its creation. But this put high investments at stake as the economic viability
of the new process or the product was not certain. Modern day project managers are
inverting the conventional way of product development and are trying to find out the
cost and performance specifications that should be achieved by the new product or
process ideas before they are sent for R&D. So the project manager visualizes a
window -of- opportunity for the innovation that would be the result of the project.
According to this analysis, the project manager analyzes the current production
process in detail and notes down all the activities that would be improved by the
added innovation. Depending on this baseline data relating to the current process and
its performance, the project manager estimates the performance of the innovation as a
fraction of the baseline system. This makes the process of project selection easier for
the project manager.
Check Your Progress
31. Identify the technique that involves imitating the behavior of some situation or
process by using a similar situation in order to study the characteristics of the
variables in the situation.
a. Risk assessment
b. Simulation analysis
c. Window-of-opportunity analysis
d. Delphi technique
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32. The outcome of a project depends mostly on
i. the way the project is being carried out by the project manager.
ii. the recruitment policy of the organization.
iii. the business environment that affects the project.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
33. The conditions under which decisions are made by the project manager are
classified into three categories: risk, uncertainty, and certainty. Match these
categories with their respective characteristics.
i. Risk conditions
ii. Uncertain conditions
iii. Certain conditions
p. The project manager assumes a single state of nature.
q. The project manager finds out the chance of occurrence of different states of
nature and the payoff value of each state of nature.
r. The chance of occurrence of each state of nature is not known and no standard
procedures are developed to make a decision under these circumstances.
a. i/p, ii/q, iii/r
b. i/r, ii/p, iii/q
c. i/p, ii/r, iii/q
d. i/q, ii/r, iii/p
34. Under conditions of certainty, which of the following is true with regard to the
expected value?
a. The expected value is calculated as the sum of the product of payoff value and the
chance of occurrence of the state of nature.
b. Subjective probabilities are assigned to each state of nature in order to calculate
the expected value of the project.
c. The expected project outcome becomes the expected value of the project.
35. Identify the techniques that help in providing useful information in dealing with
uncertainty.
i. Risk assessment
ii. Simulation analysis
iii. Black box
iv. Window-of-opportunity analysis
a. Only i, ii, and iv
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137
36. Which of the following techniques involves measuring the level of uncertainty
associated with the various parameters considered by decision makers?
b. Risk assessment
c. Simulation analysis
d. Window-of-opportunity analysis
37. Which of the following statements is true regarding window-of-opportunity
analysis?
a. An analogous situation is used to imitate the behavior of some situation or
process for studying the characteristics of the variables in the situation.
b. The project manager analyzes the current production process in detail and notes
down all the activities that would be improved by the added innovation.
c. All the required and available inputs as well as the desired outputs are listed and
it is checked whether these outputs can be produced with the available inputs.
d. This technique involves measuring the level of uncertainty associated with the
various parameters considered by decision makers.
6. Project Proposal
Project proposal is the initial document that converts an idea or policy into details of a
potential project, including the outcomes, outputs, major risks, costs, stakeholders and
an estimate of the resourcing and time required. It is prepared after a careful
evaluation of several projects and the factors influencing each project. A project
proposal normally includes a summary statement, cover letter, justification section,
the technical description of the proposed work, budget and key personnel involved in
the project. Since the proposal is a letter aimed at convincing the authority to
commence the project, it should be prepared carefully. Sometimes the management
also asks the project manager to submit the project proposal in order to examine the
viability of the project.
Preparation of an in-house project proposal does not require much attention as the
document is prepared to send it to the top management of the firm. The document is
produced only as formality and the top management normally accepts it. This is
because the objectives, strategies, strengths, financial constraints of the organization
were already taken care of while selecting the project. An in-house project proposal
states the resource requirements of the project team. Once the top management
receives the proposal, it decides whether the project team should proceed with the
project or not. Here, the objective of the project proposal is to mention the project
requirements.
In the case of an outside agency, external sponsor or the government, the proposal
should be properly documented. It is also the project managers responsibility to
check if the outside customer can pay for the project being proposed. During the
1980s, several European engineering companies initiated several projects in Iraq, but
payments were not made because of the hostilities that broke out later. A proper
project proposal plays a crucial role in getting the project approved.
The proposal document should be simple, precise and well-structured. Generally, it
starts with an executive summary statement that describes the nature of the project
being proposed, to the concerned authority. This statement should not be too technical
to understand and it should describe scope of the project. The summary statement is
followed by a cover letter, which acts as a key marketing document.
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Before sending the proposal to the outside funder/agency, the following questions
have to be answered.
Which projects are to be chosen?
How to organize the proposal documentation process?
What strategy to be used in setting the bidding price?
How much time and costs can be spent for preparing the proposal document?
Every project proposal deals with four issues, namely:
Technical nature of the project
Plan of implementation
Plan of administration and logistics
Description of the group
Technical Nature of the Project
The major subsystems of the project and the organizations approach to each subsystem
should be noted down for complex projects. The techniques to meet the special technical
requirements of the client should be clearly stated in the project proposal.
Plan of Implementation
This part of the project proposal provides the estimates of the schedule, costs, materials
used for each major subsystem. Costs and time are then aggregated to estimate the total
cost and duration of the project. Gantt Charts, Critical Path Method (CPM), Program
Evaluation and Review Technique (PERT) are used to present the plan of
implementation for each major subsystem. The major phases of the project and their
estimated completion time are also provided to check the pace of implementation.
Plan of Administration and Logistics
The proposal provides a detailed description of how all the needed equipment, and
routing facilities are arranged. It also describes the administration procedures of all the
departments, the method of transportation of raw materials, performance measurement
of subcontractors, conduction of internal and external audits, and quality checks. This
section should also cover in detail how change orders are to be handled.
Description of the Group
A detailed list of the key project employees, their qualifications, their job descriptions
and their experience is provided in the description of the group section of the
proposal. The proposal should convince the outside agency or the sponsor that the
project team is capable of executing the project. In case of internal projects, the names
and designations of all project members is enough.
Example: General Rules for Project Selection
No single technique is sufficient to select a project. Following are some useful
rules to make better choices.
Rule 1: Be explicit about what is important in choosing projects
The process of selection should be based on well defined selection criteria. The
project manager should not be distracted by what an organization can pursue
rather, he should focus on what the organization needs to pursue.
Contd
Project Selection
139
Contd
Rule 2: Identify explicit procedures and stick to them
The project manager should develop a clear cut approach to select a project and
strictly adhere to it. The project manager should monitor the performance of the
key members to ensure exact implementation of the decisions taken.
Rule 3: Be ready to challenge all assertions
The project manager should be prepared to face risks in any form they might arise.
No activity results in profit unless there is an effort.
Rule 4: Constitute a good project selection team
An ideal team should be made up of individuals who represent the broad areas of
project management like engineering, product development, finance and marketing.
Rule 5: Involve key project personnel in the selection of a project
Key project personnel should be involved while selecting a project, as they can
better understand the rationale behind executing the project.
Adapted from J.Davidson Frame, "The New Project Management," Jossey-Bass publishers, San
Francisco, p.191-192.
Activity: Mohan Manufacturers Ltd., manufactures machine tools that can be used
in different equipment and machinery. Recently, the firm's management wanted to
take up a plant expansion project to meet the growing demand for a variety of
machine tools. Kishan Enterprises wanted to bid for this expansion project. The
managing director of Kishan Enterprises, Kumar Chandani, asked Ranga Chary, a
senior manager of the company, to prepare a project proposal to be sent to Mohan
Manufacturers Ltd. What is a project proposal? How can Ranga Chary prepare it?
Answer:
Check Your Progress
38. Which of the following issues are dealt with in any project proposal?
i. The technical nature of the project
ii. The plan of implementation
iii. The plan of administration and logistics
iv. A description of the project team
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39. Which of the following options is the initial document that converts an idea or
policy into details of a potential project, including the outcomes, outputs, major
risks, costs, stakeholders, and an estimate of the resources and time required?
a. Project plan
b. Project status report
c. Project proposal
d. Project progress report
40. In the project proposal, which of the following sections discusses the conduct of
internal and external audits and quality checks?
a. Plan of implementation
b. Plan of administration and logistics
c. Technical nature of the project
d. Both (b) and (c)
41. Identify the techniques that are used to prepare a plan of implementation for each
major subsystem of the project.
i. Gantt charts
ii. Nominal group technique
iii. Critical path method
iv. Program evaluation and review technique
7. Summary
Project selection is a systematic process of choosing a project idea for implementation
from the available alternative project ideas. The project manager attempts to decide
which idea to choose, which technology to develop, and which methodology to follow
in selecting a project.
Project selection models are broadly of two types: numeric and non-numeric.
Numeric models use numbers as inputs and non-numeric models use discussions,
suggestions to select a project.
Non-numeric models use inputs other than numerical data to select a project. These
models are constructed based on the subjective evaluation, ideas and opinions of the
project manager and the project team.
The project selection model should fulfill the following characteristic realism,
capability, cost, flexibility, ease of use, and easy computerization.
The conditions under which the decisions are made by the project manager can be
classified into three categories: risk, uncertainty, and certainty.
A majority of the decisions made in project management come under uncertain
conditions, and so the project manager assumes subjective probabilities for each state
of nature to find the expected values of the projects.
Project Selection
141
The project manager tries to reduce the uncertainty of a project by preparing proforma
documents that estimate the profit and loss of the projects. Techniques like risk
assessment, simulation analysis and window-of-opportunity analysis provide useful
information in dealing with uncertainty.
Project proposal is the initial document that converts an idea or policy into details of a
an estimate of the resourcing and time required. It is prepared after a careful
evaluation of several projects and the factors influencing each project.
8. Glossary
Average Rate of Return (or accounting rate of return): Method used to measure
the relationship between the average annual profits earned by a project and the
investments made in it.
Internal Rate of Return: The discount rate at which the present values of cash
outflows and cash inflows are equal.
Net Present Value: It is the net present value of all future cash flows from the project.
It is a method that compares the value of a rupee today with the value of the rupee in
the future.
Non-numeric Selection Models: A project selection model that uses inputs other
than the numerical data to select a project. The model uses discussions, suggestions to
select a project.
Numeric Selection Model: A project selection model that uses numbers as inputs to
select a project.
Payback Period: The time period during which a firm can recover the investments it
has made in a project.
Profitability Index (or benefit-cost ratio): The ratio of future cash benefits to the
initial outflows is called as profitability index.
Project Proposal: An initial document that converts an idea or policy into details of a
an estimate of the resources and time required.
Project Selection: A systematic process of choosing a project idea for
implementation from the available alternative project ideas.
Q-Sort Technique: A project evaluation and selection technique used to prepare a list
of priority projects.
Simulation: It involves imitating the behavior of some situation or process by using a
similar situation in order to study the characteristics of the variables in the situation. It
can also be defined as the method of solving decision-making problems by designing,
constructing, and operating a model of the real system.
1. The project manager should chose those projects that guarantee returns in the near
future with the help of a proper project selection model. What are the
characteristics that the project manager should look out for while choosing a
project selection model?
2. The responsibility to choose a right project lies only with the project manager. So,
the project manager studies various project selection models to choose the right
project. What are the basic project selection models? Explain the significance of
these models in choosing the project.
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3. Though firms come up with the best selection criterion, they rarely come out with
a single best solution due to the uncertainty and risk involved in carrying out the
project. In what ways can the project manager deal with the uncertainty involved
ina project?
4. The management may sometimes ask a project manager to submit a project
proposal to examine the viability of the project. What is a project proposal?
Explain the aspects that are covered in a project proposal.
1. (c) i/q, ii/r, iii/p
The model considered for selection of a project should consider all the relevant
factors that influence the decision of a project manager. It should also consider
the risks (technical, cost, time and performance risks) that the project may
encounter. The selection model that the project manager considers should be able
to help in arriving at the optimum decision taking into consideration all the risks
and constraints involved in the project. The model should be easy to modify or
should be capable of adjusting on its own to changes in the firms environment.
2. (b) Project selection
Project selection is a systematic process of choosing a project idea for
implementation from among the available alternatives. The project manager has
to be very careful in selecting the project. He/she should consider the objectives
and policies of the organization, the availability of resources, and the selection of
the right team to take up the project. Project control is the process of collecting
information related to the performance of the project system, comparing it with
the desired level of performance, and taking corrective action to decrease the gap
between the actual and the desired performance levels. Project risk analysis is the
analysis of the probability of certain undesirable events happening, and their
impact on achieving the project objectives. After the ideas have been collected,
the project manager has to screen them. The objective of screening is to drop the
poor ideas at the initial stages of new project development. It is a process of
rejection rather than a process of selection. Screening helps in rejecting the ideas
that cannot be considered for implementation.
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143
3. (c) Rigidity
Souder described the criteria to be used while choosing a project selection model.
He suggested that the project selection model should fulfill the following
characteristics: realism, capability, minimum cost, flexibility, ease of use, and
ease of computerization. The selection model should be flexible. It should be easy
to modify or should be capable of adjusting on its own to the changes in the
firms environment.
The various costs incurred on obtaining the right selection model should be kept
to a minimum. The costs associated with designing a selection model include data
generation costs, data processing costs, and storage costs. The objective here is to
identify the best selection model and optimize the costs incurred to select the
decision model based on the size of the project. Firms should also ensure that the
project costs do not exceed the revenues of the project.
Ineffective project selection is the most common reason for the failure of many
projects. This may occur due to ambiguity in the framing of objectives, absence
of planning, and a lack of team coordination. The project manager has to be very
careful in selecting a project.
Souder suggested that the project selection model should fulfill the following
characteristics -- realism, capability, minimum cost, flexibility, ease of use, and
ease of computerization. According to Souder, the selection model should
explicitly state the intentions of the project manager and the firm in selecting a
particular project; it should have the capability to evaluate future project
proposals without subjectivity, based on the expected returns of each project; it
should provide the desired results within the given conditions, taking into account
the firms interests; and it should be convenient to implement and easy to
communicate.
7. (b) i, ii, and iv
The project manager has to be very careful in selecting a project. He/she should
consider the objectives and policies of the organization, the availability of
resources, and the selection of the right team to take up the project. While
selecting a project, the project manager need not consider the number of new
employees who have joined the organization.
8. (b) Q-Sort technique
The Q-Sort technique is a useful evaluation and selection technique for preparing
a list of priority projects. A project manager collects the various project ideas and
then classifies them as good, fair, or poor. The projects are then further
subdivided and arranged in descending order (excellent to worst). The sorting
process is continued till the project manager succeeds in identifying the best
project. After sorting the project ideas, the best project is sent for financial
analysis before implementation.
9. (b) Non-numeric models
Non-numeric models use inputs other than numerical data, like discussions and
suggestions, to select a project. These models are constructed based on the
subjective evaluation, ideas, and opinions of the project manager and the project
team. Numeric models use numbers as inputs and non-numeric models use
144
discussions and suggestions to select a project. Numeric models are broadly
divided into two types, namely profit/profitability models and scoring models.
Net present value, average rate of return, internal rate of return, etc., are
profitability models. The unweighted 0-1 factor model, the unweighted factor
scoring model, and the weighted factor scoring are scoring models.
10. (b) Profitability index
Non-numeric models use inputs other than numerical data to select a project.
These models are constructed based on the subjective evaluation, ideas, and
opinions of the project manager and the project team. The non-numeric models
are sacred cow, extension of product line, operating necessity, competitive
necessity, comparative benefit, and the Q-Sort technique. The Q-Sort technique is
a useful evaluation and selection technique used to prepare a list of priority
projects. In the sacred cow model, firms select projects that enjoy the support of
higher officials. In the comparative benefit model, organizations have many
projects in hand and the top management chooses the most beneficial one from
among these.
11. (a) Sacred cow
In the sacred cow model, firms select the project that enjoys the support of higher
officials. The project is selected because the suggestion came from the top
management of the firm and resources are provided in accordance with their
interests. The project is considered sacred as everyone in the firm tries to make
the project a success.
12. (b) profitability index
The profitability index or cost-benefit ratio is the net present value of all cash
flows to the initial investment outlay. If the profitability index is greater than one,
then the project is profitable. If it is less than one, the project should be rejected.
13. (d) Only iii and iv
Payback period indicates how long the project takes to earn back the money spent
on it. Project managers select projects that have a lower payback period. The
payback model does not consider the cash flows after the payback period.
Therefore, this method cannot work on projects where the returns are high only in
the long run.
14. (b) Payback period
The payback period method is the simplest way of looking at one or more major
project ideas. Payback period indicates how long the project takes to earn back
the money spent on it. Profitability index or cost-benefit ratio is the net present
value of all cash flows to the initial investment outlay. Internal rate of return is
defined as the rate that discounts all cash flows of an investment to zero. In
average rate of return, the project manager selects the project that gives a
reasonable rate of return for the investment made.
15. (a) lower
the money spent on it. Project managers select the projects that have a lower
payback period.
Project Selection
145
16. (c)
investment Initial
The project manager selects the project that gives a reasonable rate of return for
the investment made. The average rate of return method is simple to calculate as
it uses readily available accounting information. A quick decision can be taken by
comparing the average rate of return values of various projects.
Average Rate of Return (ARR) =
Investment Initial
n Depreciato - Inflows Cash Annual
Depreciation using the straight-line method =
Life Useful
Value Salvage Cost
Numeric models make use of numbers as inputs. Numeric models are broadly of
two types --profit/profitability models and scoring models. The various
profit/profitability models are payback period, average rate of return, net present
value, internal rate of return, and profitability index.
18. (d) Profitability models are applicable in the short-run.
Profitability models reduce cash flows to their present value. These models are
simple to understand and use, and ensure clear decision making. However, these
models are applicable only in the short-run.
19. (c) Average rate of return
The profit/profitability models that a project manager follows are payback period,
average rate of return, internal rate of return, net present value, and profitability
index.
20. (d) more than 1.
21. (b) Profitability index
22. (c) Internal rate of return
Internal rate of return (IRR) is defined as the rate that discounts all the cash flows
of an investment to zero. It is the discount rate which makes the NPV of a project
zero. If the IRR of the project is greater than the minimum acceptable rate of
return, then the project is considered for selection.
23. (d) positive.
If the NPV of a project is positive, then the project can be accepted. If the NPV is
negative, then the project should be rejected.
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24. (b)
project of Cost
the money spent on it. The formula to find the payback period is
project of Cost
.
25. (b) The unweighted 0-1 factor model
In the unweighted 0-1 factor model, the management lists factors that are
normally considered in rating a project for selection. The management then
constitutes a team of raters who are familiar with the goals of the organization
and the firms potential project portfolio to select the project. The list of factors is
given to the team of raters and the project is selected based on the score given to
each project idea. The disadvantage with this method is that the raters can only
rate a particular project as qualified or not qualified.
26. (b) The unweighted factor scoring model
The disadvantage with the unweighted 0-1 factor model is that the raters can only
rate a particular factor as qualified or not qualified. The unweighted factor
scoring model overcomes this drawback by constructing a simple linear measure
of scale, normally a scale from 1 to 5. This scale enables the management to be
aware of the degree to which a project qualifies or does not qualify.
The iterative rating method is used as an alternative to the scoring models. In this
method, the project manager ranks all the projects based on a set of
predetermined attributes. The attributes that do not differentiate among the project
alternatives are ignored. The project that satisfies the most number of attributes is
finally selected.
28. (c) The project scores provide a relative measure and therefore, reflect the
projects utility.
Project scores provide only a relative measure. Such scores cannot exactly reflect the
utility of the project. The other options are all advantages of numeric scoring models.
29. (c) The weighted factor scoring model
In the weighted factor scoring model, the factors are weighted as per their
importance. Then scoring for each factor becomes the product of the factor
weight and the factor. The sum of all the factor scores gives the project score. The
Delphi or brainstorming technique is used to assign weights to each factor.
Weights are usually associated in the range of 0 to 1.
30. (b) The unweighted 0-1 factor model
Scoring techniques involve multiple criteria to select a project. In this model,
decisions are arrived at after discussions between the project team and the top
management. Some of the scoring models are the unweighted 0-1 factor model,
the unweighted factor scoring model, and the weighted factor scoring model. Q-
Sort technique is a useful evaluation and selection technique used to prepare a list
of priority projects. In the sacred cow model, firms select projects that enjoy the
support of higher officials. In average rate of return, the project manager selects
the project that gives a reasonable rate of return for the investment made.
Project Selection
147
31. (b) Simulation analysis
Techniques like risk assessment, simulation analysis, and window-of-opportunity
analysis provide useful information in dealing with uncertainty. Simulation
involves imitating the behavior of some situation or process (whether economic,
military, or mechanical) by means of a suitably analogous situation for the
purpose of studying the characteristics of the variables in the situation. The
Delphi technique is used to enhance the creativity of a group.
The result of a project activity depends largely on what the project manager does
(the way the project is being carried out), and on how the business environment
affects the project. It does not depend on the recruitment policy of the
organization.
33. (d) i/q, ii/r, iii/p
Under risk conditions, the project manager finds out the chance of occurrence of
various states of nature and the payoff value of each state of nature. Under
uncertain conditions, the chance of occurrence of each state of nature is not
known. No standard procedures are developed to take a decision under these
circumstances. Under certain conditions, the project manager assumes only a
single state of nature (probability 1) and the expected project outcome becomes
the expected value.
34. (c) The expected project outcome becomes the expected value of the project.
Under conditions of certainty, the expected project outcome becomes the
expected value of the project. Under conditions of risk, the expected value is
calculated as the sum of the product of the payoff value and the chance of
occurrence of the state of nature. Under conditions of uncertainty, subjective
probabilities are assigned to each state of nature in order to calculate the expected
value of the project.
35. (a) Only i, ii, and iv
analysis provide useful information in dealing with uncertainty. Black box is a
technique used to enhance the creativity of an individual. In the black box
technique, all the required and available inputs as well as the desired outputs are
listed. It is also checked whether these outputs can be produced by using the
available inputs.
36. (b) Risk assessment
analysis provide useful information in dealing with uncertainty. Risk assessment
aims at measuring the level of uncertainty associated with the various parameters
considered by the decision makers. Decision making becomes very difficult when
risk is coupled with an amount of uncertainty. In such situations, the project
manager carefully estimates the probability distributions for all the investments
made to calculate the likely returns. The probability distribution for the expected
rate of return is calculated by the simulation technique. Attribute listing is a
technique used to enhance the creativity in an individual.
148
37. (b) The project manager analyzes the current production process in detail
and notes down all the activities that would be improved by the added
innovation.
According to the window-of-opportunity analysis, the project manager analyzes
the current production process in detail and notes down all the activities that
would be improved by the added innovation. Option a discusses about
simulation analysis; option c discusses about black box, a technique used for
enhancing individual creativity; and option d discusses risk assessment.
A project proposal is an initial document that converts an idea or policy into
details of a potential project, including the outcomes, outputs, major risks, costs,
stakeholders, and an estimate of the resources and time required. Every project
proposal deals with four issues, namely the technical nature of the project, the
plan of implementation, the plan of administration and logistics, and a description
of the group.
39. (c) Project proposal
A project proposal is an initial document that converts an idea or policy into the
details of a potential project, including the outcomes, outputs, major risks, costs,
stakeholders, and an estimate of the resources and time required. A project plan is
a formal, approved document used to manage and control project execution. A
project status report is a report mentioning the status of achievements and
deviations from the resources that are spent and the plans that are scheduled. A
project progress report is a formal statement that gives a comparison between the
accomplishments achieved as the project progresses and the project plan.
40. (b) Plan of administration and logistics
The plan of administration and logistics in the project proposal provides a
detailed description of how all the needed equipment and routing facilities are
arranged. It also describes the administration procedures of all the departments,
the method of transportation of raw materials, performance measurement of
subcontractors, conduct of internal and external audits, and quality checks.
Gantt Charts, Critical Path Method (CPM), and Program Evaluation and Review
Technique (PERT) are the techniques used to prepare a plan for implementation.
Gantt charts display graphically the use of resources (machines, tanks, pipes,
operators, products) over a period of time. CPM is used to predict the project
duration by finding out which sequence of activities has the least amount of
scheduling flexibility. PERT is used for planning and scheduling projects so that
all the activities are completed in the shortest possible time. The nominal group
technique is used to enhance creativity in groups.
Following are the answers to the exercises given in the unit.
A. 5 years
Cost of the project = Rs. 1,000,000
Annual cash inflow from project = Rs. 200,000
Payback period =
project of Cost
=
200,000
1,000,000
= 5 years
Project Selection
149
B. 17%
Depreciation = Rs. 2,500 per annum.
Annual cash inflows = Rs. 5,000
Investment Initial
on Depreciati - Inflows Cash Annual
ARR =
15,000
2,500 - 5,000
= 16.67% = 17% (approximately)
C. 10%
Cost = Rs. 10,000
Salvage value = Rs. 4,000
Useful life = 3 years
Depreciation =
Life Useful
Value Salvage Cost
=
3
000 , 4 000 , 0 1
= Rs. 2,000 per annum.
Annual cash inflows = Rs. 3,000
Investment Initial
on Depreciati - Inflows Cash Annual
ARR =
10,000
2,000 - 3,000
= 10%.
Course Components
BLOCK I Project Management An Overview
Unit 1 Introduction to Project Management
Unit 2 Project Idea Generation and Screening
Unit 3 Market and Technical Analysis of Projects
Unit 4 Financial Analysis of Projects
Unit 5 Project Selection
BLOCK II Project Planning and Control
Unit 6 Management of Project Scope
Unit 7 Identifying Project Activities
Unit 8 Activities: Sequencing, Estimating Duration, and Scheduling
Unit 9 Project Review
Unit 10 Project Control
BLOCK III Project Implementation and Closing
Unit 11 Project Cost Management
Unit 12 Project Risk Management
Unit 13 Project Quality Management
Unit 14 Project Auditing
Unit 15 Project Closing
BLOCK IV Introduction to Operations Management
Unit 16 Operations Management and Operations Strategy
Unit 17 Forecasting Demand
Unit 18 Allocating Resources to Strategic Alternatives
Unit 19 Design of Production Processes
BLOCK V Design of Facilities and Operations Planning
Unit 20 Facility Location and Layout
Unit 21 Aggregate Planning and Capacity Planning
Unit 22 Fundamentals of Inventory Control
Unit 23 Purchase Management
Unit 24 Materials Management
BLOCK VI Operations Control
Unit 25 Operations Scheduling
Unit 26 Enterprise Resource Planning
Unit 27 Supply Chain Management
Unit 28 Just-In-Time (JIT) Manufacturing System
Unit 29 Productivity and Quality Management
Unit 30 Facilities and Maintenance Management
Block
II
PROJECT PLANNING AND CONTROL
UNIT 6
Management of Project Scope 1-25
UNIT 7
Identifying Project Activities 26-43
UNIT 8
Activities: Sequencing, Estimating Duration,
and Scheduling 44-93
UNIT 9
Project Review 94-112
UNIT 10
Project Control 113-148
Expert Committee
Hyderabad Hyderabad


Hyderabad


Prof. Vivek Gupta
Hyderabad

Hyderabad

Ms. Smita Singh
IU, Sikkim

Mr. Ch Syamala Devi
IU, Meghalaya

Hyderabad

IU, Mizoram
Aizawal

IU, Dehradun

Mr. Manoj Kumar De
IU, Tripura
Agartala






Block II
Project Planning and Control
The second block of the course on Project & Operations Management deals
with project planning and control. The block contains five units. The first unit
focuses on the management of the project scope. The second unit examines
the identification of the project activities. The third unit discusses activity
sequencing, duration estimation and activity scheduling. The fourth and fifth
units of the block explain project review and project control, respectively.
The first unit, Management of Project Scope, discusses the project initiation
process and defines project deliverables. The unit focuses on scope planning
and approval of the project overview statement. It also deals with the project
definition statement. The unit also provides an idea about scope verification
and scope change control.
The second unit, Identifying Project Activities, deals with the definition of an
activity. The unit explains work breakdown structure (WBS) and its
development. It also discusses the various tests for completeness of
decomposition of activities. Finally, the unit provides an idea about the
various approaches to defining deliverables in the WBS and about
representing the WBS.
The third unit, Activities: Sequencing, Estimating Duration, and Scheduling,
discusses the fundamentals of the project network diagram. The unit explains
activity sequencing and activity duration. The unit also deals with schedule
development and the various techniques for schedule development. Finally,
the unit discusses schedule control.
The fourth unit, Project Review, explains the importance of project review.
The unit discusses the various types of project reviews and the different stages
involved in project review. The unit also deals with project status review
meetings and the advantages of conducting them. Finally, the unit explains the
various types of project status meetings.
The fifth unit, Project Control, explains the fundamentals of project control.
The unit explains the objectives of control, control as a function of
management and differentiates between control and risk. The unit also
discusses the reasons for measuring duration and cost deviations. It deals with
ways to balance the control system and control change. The unit also defines
progress reporting system and describes the various types of project status
reports. It provides information on the graphical reporting tools and project
status review meetings. Finally, the unit explains the different ways to manage
risk and quality.
Unit 6
Management of Project Scope
Structure
1. Introduction
2. Objectives
3. Project Initiation
4. Defining Project Deliverables
5. Scope Planning
6. Approval of POS
7. Project Definition Statement
8. Scope Verification
9. Scope Change Control
10. Summary
11. Glossary
1. Introduction
In the last unit of the previous block, we have discussed about project selection. In this
unit, we will discuss the management of project scope. Scope is a brief and accurate
description of the end-products or deliverables to be expected from a project. It
describes all the activities that have to be performed and identifies the resources that
will be utilized for the successful completion of the project. Scope is also concerned
with target outcomes, prospective customers, outputs and the financial and human
resources required for completing the project.
The project manager and the client have to jointly discuss the objectives of the project.
Exchanging views and information will enable them to determine the purpose of the
project. This exchange of information will also help the project manager understand
the clients expectations of the project and make the client aware of the project
managers method for executing the project. On the basis of this discussion, the client
and the project manager prepare a project goal. They also identify a number of
objectives that will help them reach that goal. The project goals, together with the
objectives, determine the scope of the project.
This unit will discuss project initiation process and define project deliverables. It will
then discuss scope planning and approval of the project overview statement. Then it
will explain about the project definition statement. Finally, it would be discussing
about scope verification and scope change control.
2. Objectives
explain the project initiation phase.
define project deliverables.
explain scope planning.
2
find out how a project overview statement is approved.
discuss project definition statement.
explain the concepts of scope verification and scope change control.
3. Project Initiation
Projects are initiated only when an opportunity is recognized or when some need
arises. For example, a bank opens new branches in the countryside because of the
growing demand for banking services in rural areas. A company starts a project for
training its employees in Total Quality Management because of a business need. A
construction firm starts a project for a new type of structure because of a clients
request. An electronics firm starts a new project for developing Internet ready-TVs
due to technological advancement. The Election Commission of India conducts
elections to meet a statutory requirement. In other words, projects are initiated
because of specific requirements.
4. Defining Project Deliverables
The Project Management Body of Knowledge (PMBOK) defines a project deliverable
as any measurable, tangible, verifiable outcome, result, or item that must be produced
to complete a project or a part of a project. A list of project deliverables is jointly
prepared by the project manager and the client. This list of project deliverables is also
called Conditions of Satisfaction.
The list of project deliverables is developed in four steps. They are: request,
clarification, response and agreement.
Request
In the first step, the client requests the project manager to undertake a project as per
his/her requirements.
Clarification
In the second step, the project manager explains what he/she has understood by the
request made by the client. This step is over only when the client feels that the project
manager has understood the request made by him/her.
Response
In the third step, the project manager explains what he/she can do to fulfill the clients
request. He/she informs the client of his/her capabilities, his/her schedule, and fees for
undertaking the project.
Agreement
Based on the project managers response, both parties continue their discussions. If both
parties are still willing to ahead with the project, they establish the project norms in this step.
Finally, both parties examine each others requests closely to determine how the
project should be executed. The final agreement is documented in the Project
Overview Statement.
Activity: Krishna Rajan Electric Company, one of the leading electrical companies
in India, wanted to establish the ERP systems throughout the firm. The project of
implementing the ERP systems was given to Indosoft Systems Private Limited.
Stephen Richards, the project manager of Indosoft Systems Private Limited and
Ramesh Atul, a senior manager from Krishna Rajan Electric Company discussed
what is to be accomplished in the project. They exchanged their views and ideas
and finally listed the project deliverables. What is a deliverable? Discuss the steps
involved in the process of defining deliverables.
Contd
3
Contd
Answer:
Check Your Progress
1. In which of the following stages do the project manager and the client discuss
about going ahead with the project and establishing project norms?
a. Request
b. Clarification
c. Response
d. Agreement
2. Identify the statement that is not true with regard to project scope.
a. Project scope is a brief and accurate description of the end products or
deliverables to be expected from a project.
b. It describes all the activities that have to be performed and identifies the resources
that will be utilized for the successful completion of the project.
c. It is concerned with target outcomes, prospective customers, outputs, and the
financial and human resources required for completing the project.
d. Only the project goals determine the scope of the project.
3. The objectives of a project should be jointly discussed by the project manager and
the client. Such a discussion would
i. enable the project manager and the client to determine the purpose of the project.
ii. help the project manager understand the clients expectations of the project.
iii. make the client aware of the project managers method of executing the project.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
4. From the given sequences, identify the correct sequence of steps in which a list
of project deliverables is developed.
a. Request Agreement Response Clarification
b. Clarification Response Agreement Request
c. Request Clarification Response Agreement
d. Response Agreement Request Clarification.
4
5. ___________ describes all the activities that have to be performed and identifies
the resources that will be utilized for the successful completion of the project.
a. Project phase
b. Project scope
c. Project control
d. Project deliverable
6. Identify the step in which the project manager explains what he/she can do to
fulfill the clients request. In this step, the project manager informs the clients of
his/her capabilities, schedule, and fees for undertaking the project.
a. Request
b. Clarification
c. Response
d. Agreement
7. Conditions of Satisfaction is an expression used to represent
a. the scope of the project.
b. the list of project deliverables.
c. exchange of views between the project manager and the client.
d. the objectives of the project.
8. The final agreement between the project manager and the client regarding the
project is documented in the
a. project plan.
b. aggregate project plan.
c. project progress report.
d. project overview statement.
9. In which of the following steps in developing the list of deliverables does the
project manager explain what he/she has understood by the request made by the
client?
a. Request
b. Clarification
c. Response
d. Agreement
5. Scope Planning
Scope planning involves development of the Scope Statement. The project manager
uses tools like product analysis, cost/benefit analysis, and expert judgment to develop
the scope of a project.
Product analysis is a technique for understanding the features and functions of a
product. Techniques like Value Analysis and Quality Function Deployment help
the project manager gain more information regarding the project. By increasing
his/her knowledge of the projects product, the project manager can define the scope
of the project more precisely. A cost/benefit analysis is necessary for studying the
various tangible and intangible costs and benefits associated with the project. The
project manager also consults experts to determine the scope of a project.
5
Scope of a Project
The scope of a project can be divided into product scope and project scope.
Product scope details all the functions and features that are to be included in a product
or service of a project. Project scope, however, details the work to be done to deliver
a required product with specific features. The tools and techniques for managing
product scope vary with the nature of the project.
Drafting the Project Overview Statement
The scope of a project is documented in the Project Overview Statement. The
Project Overview Statement (POS) is also referred to as Initial Project Definition,
Document of Understanding, Project Scope Statement or Statement of Work.
The Project Overview Statement should be very specific. For example, Build a
website like Amazon.com, is not a scope statement because it does not provide
guidance for building the site. A good scope statement would identify the goal of the
project and describe how that goal can be achieved. It should be expressed in a clear
and precise manner so that all the project stakeholders understand what the project is
all about. POS should describe what the project is, why it is being taken up, and what
value it brings to the firm. All future decisions regarding the execution of the project
and allocation of necessary resources will be based on the POS.
A Project Overview Statement is not a static document. As the project progresses, it
has to be revised or redefined. This is because over time the situation may change and
the POS should be documented accordingly. Depending on the circumstances, it can
be modified or rewritten, taking into consideration the opinions of all the project
stakeholders. The scope statements of large, technological projects often have to be
modified because of the high rate of technological change. The POS should be able to
resolve any conflicts and misunderstandings that may arise among the project
members.
Parts of POS
In general, the Project Overview Statement consists of five parts project problem/
opportunity; project goal; project objectives; success criteria; and assumptions, risks,
and obstacles.
The POS first identifies the reasons for undertaking the project and then proceeds to
identify the projects goal. The project goal is further broken down into a number of
project objectives. The POS also mentions the criteria for the success of the project
and the various risks, obstacles involved in the execution of the project.
State the Project Problem/Opportunity
The first part of a Project Overview Statement (POS) states the problem or
opportunities that the project is going to address. This statement need not be defined
rigidly. It should be written in such a way that all project stakeholders are able to
understand it.
The gravity of the problem or the business value of the opportunity stated in this part
will play a major role in getting the attention of the top management. Some of the
situations that give rise to the problems or opportunities that form the basis of POS are
discussed below.
Existing problem/opportunity areas: The POS can address any of the problems that
the firm faces and offer a full or partial solution to the problems. If there are any
opportunities in the market, the POS should explain how the firm can take advantage
of the situation.
6
Customer request: Any of the requests made by the firms internal or external
customers can be mentioned in the list of deliverables of a POS. The POS is thus a
useful tool for forwarding customer requests to top management.
Corporate initiative: Employees are encouraged to submit their project ideas in a POS
format. Senior management can then prioritize these proposals and identify the best
proposal or idea for further consideration.
Mandated requirements: A change in customer preferences or legal requirements
may also make a firm take up a project. The POS describes how the firm is going to
respond to these mandatory requirements.
Project Goal
In the second part of the POS, the project goal is defined on the basis of the
problem/opportunity stated in the first part of the POS. A project should have a goal
that can catch the attention of top management.
The project goal forms the purpose of the project and provides guidance to the entire
project team. It helps everyone understand what the project is expected to accomplish.
It is also a point of reference for clarifying questions that may arise about the scope of
the project. The goal of the project should be stated clearly and precisely. Anyone
who reads it should be able to understand it without any additional explanation from
the project manager. Technical jargon, if used, should be explained.
The goal statement should be specific and easy to remember. The firm should be in a
position to implement every point mentioned in the statement. The project goal
statement should not mention any specific dates for starting or completing the project.
The goal statement should be SMART, where S represents specific (specific in
addressing the purpose of the project); M represents measurable (measurable
indicators of the projects progress should be established); A represents assignable
(assignable to a person to complete it); R represents realistic (states what can
realistically be done with the available resources); and T represents time-relatedness
(time required for completing the project).
Project Objectives
The third part of the POS defines the objectives of the project. An objective statement
is a more detailed version of the goal statement. These project objectives specify the
exact boundaries of the project goal.
The project manager should ensure that the objective statement covers the following
aspects of the project an outcome (a statement of what the project is going to
achieve), a time period (the expected start and completion date), a measure (the
parameters for measuring the projects success), and an action plan (A plan for
meeting the projects objectives).
Example: Sample Project Overview Statement
Project Name: Project Manager: Project Code:
Start Date: End Date:
Problem/Opportunity Statement :
Project Goal Statement:
Contd
7
Contd
Project Objectives Statement :
Success Criteria:
Assumptions, Risks and Obstacles:
Prepared by Date Approved
by
Date
Check Your Progress
10. Identify the statement that is not true with regard to the project goal in the
project overview statement.
a. The project goal forms the purpose of the project and provides guidance to the
entire project team.
b. The goal of the project should be stated clearly and precisely.
c. The project goal statement should mention specific dates for starting or
completing the project.
d. The goal statement should be specific and easy to remember.
11. Initial project definition, document of understanding, and statement of work are
alternative terms used for
a. project overview statement
b. project plan
c. project scope statement
d. Both (a) and (c)
12. Which of the following statements is false regarding the project overview
statement (POS)?
a. POS should describe what the project is, why it is being taken up, and what value
it brings to the firm.
b. All future decisions regarding the execution of the project and allocation of
necessary resources will be based on the POS.
c. A POS is a static document that need not be changed, revised, or redefined.
d. The POS should be able to resolve any conflicts and misunderstandings that may
arise among project members.
13. Identify the parts of a project overview statement.
i. Project goals and objectives
ii. Assumptions, risks, and obstacles
iii. Success criteria
iv. Project problem/opportunity
8
14. Which of the following options do not form part of the process of stating the
problems or opportunities in the project overview statement?
i. The statement should explain the reason for taking up the project.
ii. The statement should be written in such a way that all the project stakeholders are
able to understand it.
iii. The statement should state the outcome and the time period of the project.
iv. The statement should address the existing problems or opportunities faced by the
organization.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. Only iii and iv
15. Identify the techniques among the following options that the project manager uses
to develop the scope of a project.
i. Product analysis
ii. Black box
iii. Cost/benefit analysis
iv. Expert judgment
16. Identify the characteristics of a good project overview statement (POS).
i. The POS should be very specific.
ii. The POS should identify the goal of the project.
iii. The POS is a static document that need not be changed, revised, or redefined.
iv. The POS should be expressed in a clear and precise manner so that all the project
stakeholders understand what the project is all about.
a. Only i, ii, and iv
17. The problems or opportunities stated in the project overview statement form the
basis for
a. defining the project scope.
b. defining the project goal.
c. screening the project.
d. conducting the technical analysis of the project.
18. Identify the statements that are true regarding the scope of a project.
i. The scope of a project can be divided into product scope and project scope.
ii. Product scope details all the functions and features that are to be included in a
product or service of a project.
9
iii. Project scope details the work to be done to deliver a required product with
specific features.
iv. The tools and techniques for managing product scope vary with the recruitment
policy of the organization.
Success Criteria
The fourth part of the POS explains why the project is being taken up. It describes the
business value of the project to the project firm and indicates when the project can be
said to have successfully achieved its objectives. While preparing this part, the project
manager should ensure that the success criteria are quantifiable and measurable. The
success criteria of a project can be: increase in revenue, increase in market
capitalization, etc. The success criteria should identify the exact benefits that the
project can bring to the firm. Success criteria can also be presented in terms of
quantifiable statements like reduced turnaround time to service a customer, decreased
error rates, etc.
On the basis of the success criteria, the top management determines the business value
of the project and allocates resources accordingly. For example, the success criteria
can be written as follows: launching this innovative product in place of the present
product will increase the firms sales by 5 percent. If the top management of the firm
is satisfied with the success criteria mentioned in the POS, it may ask the project
manager to explain, in detail, how he plans to achieve the business value identified in
the POS (i.e. an increase in the firms sales). If top management is not satisfied with
the success criteria mentioned in the POS, it might reject the project.
Assumptions, Risks and Obstacles
The fifth section of the POS mentions all the organizational or environmental factors
that may affect the outcome of the project. The project manager uses this section of
the POS to alert senior management about the risks or obstacles that may influence the
projects activities. This part of the POS also mentions the contingency plans to be
prepared to reduce the impact of the above risks on the project.
Some aspects of projects that are risk prone are discussed below.
Technological aspects: If the project firm does not have any experience in handling
new technology, then the project manager should not choose technology-related
projects. Since it is difficult to manage technical projects, non-technical firms do not
encourage such projects.
Environmental aspects: To design a good POS, the project manager should
understand the environment in which the project operates. Suppose the project
sponsor suddenly leaves the project, the POS should solve this problem by
recommending an alternative sponsor. It should also discuss how the right people can
be acquired to work in crucial areas of the project.
Interpersonal aspects: Good interpersonal relationships among project team members
are essential for the success of any project. All interpersonal problems should be
brought to the attention of top management.
10
Cultural aspects: The POS should mention how the proposed project is suitable for
the firm. If the project deliverables are completely different from what the firm is
producing, then the project may not be accepted by top management.
Causal relationships: The solutions provided for correcting project problems depend
on several assumptions. So, the project manager should mention the variables that are
likely to affect the assumptions made in the project.
Attachments to POS
Usually, project managers submit a POS that is only one page long. But top managers
often request a more detailed POS that provides additional information about the
business value of the project. Apart from the POS, the top management usually
requests the project manager to submit risk analysis and financial analysis reports.
These reports help managers assess the economic value of the project.
Risk Analysis
This report describes the various risks associated with proposed project activities,
their probability of occurrence and their severity. Particularly, in highly technical
projects, the project manager should explain all the possible risks and their likely
impact on project results. Formal procedures should also be mentioned to effectively
deal with these risks in the POS.
This analysis also describes risk identification techniques, risk quantification, and
other risk control measures. The project manager also prepares a contingency plan for
dealing with risks. The top management of the firm analyzes all these risks before
accepting the project.
Financial Analysis
The project manager also submits a financial analysis of the proposed project as an
attachment to the POS. The following financial aspects of a project are analyzed:
Feasibility Analysis: A feasibility analysis is conducted to ensure that the proposed
project is financially viable. To do so, a project manager must;
1. Define the problem/opportunity clearly
2. Define the scope of the project, what it includes and what it does not include
3. Identify alternative solutions for the problems
4. Rank the alternative solutions
5. State the expected time and costs required
6. Project the profits from the project
7. List the recommendations.
A thorough examination of the solution and the various alternatives will help the
project manager win the confidence of top management.
Return on investment: The return on investment is the revenue likely to be generated
over a life period of the project against the investments made into the project. Since
return on investment is numerically expressed, it is easy for top management to
identify the most profitable project.
Cost/benefit analysis: The cost/benefit analysis explains the economic and social
justification for the proposed project. But it is difficult to analyze project costs and
benefits as some intangible benefits cannot be quantified. Due to this, it is very
difficult for the project manager to assess all the costs and benefits of the project. The
top management uses its judgment to assess the project and decide whether it should
accept it.
11
Break-even analysis: Through this analysis, the project manager determines when the
project will arrive at a no profit-no loss situation. The top management accepts the
project if the expected time for reaching a break-even situation is less than the
threshold time it has in mind.
Activity: The management of Gayatri Machine Works has decided to set up a unit
that manufactures the machine tools required for the firm. Srikanth Reddy, the in-
charge of this project, has prepared the project scope statement and sent it to the
top management for approval. The top management called Reddy and asked him to
submit more reports regarding the feasibility and economic value of the project.
What are the reports that Reddy should include with the project scope statement?
Explain their significance.
Answer:
Check Your Progress
19. Identify the financial analysis technique that explains the economic and social
justification for the proposed project.
a. Feasibility analysis
b. Return on investment
c. Cost/benefit analysis
d. Break-even analysis
20. Which of the following options is used by the project manager to determine when
the project will arrive at a no profit-no loss situation?
a. Feasibility analysis
b. Return on investment
c. Cost/ benefit analysis
d. Break-even analysis
21. Identify the statement that is not true regarding risk analysis reports.
a. The risk analysis report describes the various risks associated with proposed
project activities, their probability of occurrence, and their severity.
b. Risk analysis describes risk identification techniques, risk quantification, and
other risk control measures.
c. The risk analysis report does not include any mention of the formal procedures to
deal with the risks in the project overview statement.
d. Both (a) and (b)
22. Environmental, technological, and interpersonal aspects may affect the outcome
of the project. These are mentioned under the ____________ section of the
project overview statement.
12
a. project goal
b. success criteria
c. project problem/ opportunity
d. assumptions, risks, and obstacles
23. Return on investment is
a. the sum of the approved cost estimates (including any overhead allocation) for
activities completed during a given period.
b. total costs incurred (direct and indirect) in accomplishing work during a given
time period.
c. the revenue likely to be generated over the life period of the project against the
investments made in it.
d. the measurable, tangible, and verifiable outcome or result that must be produced
to complete a project.
24. Arrange the following options based on the sequence in which the project
manager conducts a feasibility analysis of the project.
i. Rank the alternative solutions
ii. Define the scope of the project, what it includes and what it does not
iii. Define the problem/opportunity clearly
iv. State the expected time and costs required
v. List the recommendations
vi. Project the profits from the project
vii. Identify alternative solutions for the problems
a. iii-i-vii-ii-v-iv-vi
b. iii-ii-vii-i-iv-vi-v
c. iii-v-ii-iv-vi-i-vii
d. iii-iv-vi-v-i-vii-ii
25. Which among the following analyses is/are used to assess the economic value of
the project?
a. Risk analysis
b. Financial analysis
c. Critical path method
d. Both (a) and (b)
6. Approval of POS
After preparing the POS, the project manager sends it to top management for
approval. Top management examines the proposed project to see if it adds any
business value to the firm. The project manager can be asked some questions by the
management regarding the content of the POS. For example, management may ask the
project manager to expand or contract the scope of the project. They can also question
the validity of the financial analysis and ask the project manager to justify some of his
statements. Depending on the explanation given by the project manager, management
will decide if the project is worth undertaking.
13
Approval of the POS indicates that
Top management is interested in undertaking the project
The client feels that the project has been understood and a satisfactory solution has
been offered
Top management feels that the project is well defined.
The management may ask the project manager to identify the resources necessary for
executing the project. Estimates of time and cost can be provided later by the project
manager during the detailed planning stage.
Participants in the Approval Process
The project manager, project team members, project clients, top management of the
firm and functional heads are the important participants in the project approval
process.
Project Manager
The role of the project manager is crucial. He should draft the POS in such a way that
top management can easily understand it. Moreover, he should persuade management
to approve the project. He should direct the entire project team and close the project
through satisfying the client.
Project Team Members
Usually, the project manager has some prospective team members in mind. He can
consult these members and use their expertise to develop the POS or review the
already prepared POS.
Project Clients
Since the project must be acceptable to the project client, the role of the project client
is very significant. Sometimes the project client himself behaves like a project
manager, when he is fully aware of the project.
Top Management of the Firm
Since top management provides guidance to the firm, their approval is a must for the
project.
Functional Heads
Project deliverables can be produced only when several functions are properly
coordinated. The cooperation of the functional heads is necessary to make the project
a success. For example, if attaining a required level of quality is an important project
deliverable, the contribution of the head of the quality department is important for
making the project a success.
7. Project Definition Statement
The Project Definition Statement (PDS) is similar to the POS, but the people who are
involved in the preparation of the statement are different. When preparing the PDS,
the project manager discusses with the project team members, not the project client.
However, the PDS has the same five parts-structures as the POS: project
problem/opportunity, project goal, project objectives, success criteria, and
assumptions, risks, and obstacles.
The PDS provides more detailed information about the project as it is used as a
reference point by the project team for executing the project. The PDS keeps the entire
project team moving in the right direction and also provides guidance to new project
team members.
14
Unlike the POS, the PDS is circulated only among the members of the project team.
As a result, technical jargon is used in the document. Since the POS does not the
provide project teams the level of detail required, PDS works as a more useful tool in
project execution.
Activity: A state government gave WindSoft the project of developing a wide area
network connecting all district offices to facilitate e-governance in the state.
Richard Williams, the project manager from WindSoft and the IT Secretary of the
state government, Amar Singh, discussed scope of the project. Later, both of them
documented the scope of the project in the form of a Project Overview Statement.
Williams then prepared a Project Definition Statement after consulting his project
team members. Explain the importance of a Project Overview Statement and how
is it different from a Project Definition Statement? Do you think both documents
are necessary for a particular project?
Answer:
Check Your Progress
26. Identify the statement that is not true regarding the approval of the project
overview statement (POS).
a. The top management feels that the project is well defined.
b. The top management is interested in undertaking the project.
c. The client feels that the project has been understood and a satisfactory solution
has been offered.
d. The top management wants the estimates of time and cost to be provided by the
project manager in the POS.
27. Identify the statement that is not true regarding the project definition statement
(PDS).
a. The PDS provides more detailed information about the project as it is used as a
reference point by the project team for executing the project.
b. While preparing the PDS, the project manager holds discussions with the project
client.
c. The PDS keeps the entire project team moving in the right direction and also
provides guidance to new project team members.
d. Both (a) and (c)
28. Which of the statements explain the role of the project manager in the approval of
the project overview statement (POS)?
i. The project manager should draft the POS in such a way that the top management
can easily understand it.
ii. The project manager persuades the management to approve the project.
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iii. The project manager directs the entire project team.
iv. The project manager closes the project by satisfying the client.
8. Scope Verification
The Project Management Body of Knowledge (PMBOK) defines scope verification
as a process that formalizes the acceptance of the project scope by the project
stakeholders. Here, the project manager reviews the fully or partially completed
deliverables (called work results) to ensure that they have been completed as per the
specifications. The documents that describe the projects products or services are also
reviewed by the project manager during scope verification phase.
The project manager also examines and tests the project processes and products to
assess their conformity to project requirements. The project can formally be said to
have started only after scope verification. The formal acceptance of a project and its
deliverables is then distributed to the concerned parties.
9. Scope Change Control
Scope change control is the process of controlling the changes in the project scope
that occur at various stages of the project life cycle. Scope change control involves:
managing the factors that cause scope changes to see that changes are advantageous to
the project; and identifying the changes in the scope.
Scope change control must be integrated with other control processes (time control,
cost control, etc.). Project managers use information collected from various
documents to control scope change. They are outputs of Work Breakdown Structure
(WBS), performance reports and change requests.
The Work Breakdown Structure (WBS) is a deliverable-oriented grouping of project
elements that organizes and defines the total scope of the project. Performance reports
organize and summarize the information gathered and provide information on scope
performances (e.g. which interim products have been completed and which have not).
Change requests occur in different ways. They may be external or internal to the
project, oral or written, legally mandated or optional. These changes may expand or
shrink the project scope. Changes in government regulations and new rulings (by the
courts) are some of the external events that can change the scope of a project. Errors
made in defining a projects product (functions, characteristics, etc.) and errors made
in defining the projects scope (using a list of deliverables in place of WBS) constitute
internal reasons that lead to changes in project scope.
Scope change also occurs when a new process that adds value to the project become
available. For example, some new technology that could improve the execution of the
project may become available after the project has been initiated. Naturally, the
project manager would like to take advantage of the technological change to add value
to the project.
The project manager uses a Scope change control system to control changes to the
scope of a project. The scope change control system defines the procedures by which
the scope of a project can be changed. The scope change control system includes
paper work, tracking systems, and levels of approval necessary for authorizing the
changes.
16
Performance techniques like variance analysis, trend analysis, and earned value
analysis help the project manager assess the magnitude of the variations that occur.
The project manager then notes down all the causes of the variations and takes
corrective action.
The scope changes made to the already approved plans (technical plans, financial
plans etc.) are also updated. Then all project stakeholders are informed of the changes.
The causes of variances and the corrective actions taken are documented for future
reference.
Example: Sample Scope Change Request Form
Scope Change Number: An arbitrary numbering scheme, usually 1, 2, 3.... Also,
some coding scheme for categorizing the scope change request.
Requested By: Who requested the scope change?
Date Reported: When was the change requested?
Status: Usually Pending, On Hold, In Progress, Complete, Not Approved
Assigned To: Who is assigned to investigate the scope change?
Date Resolved: When was the request resolved?
Scope Change Description: Describe the change in sufficient detail so that others
can understand the scope change request.
Business Benefit: Why is the request being made? What is the benefit from a
business perspective?
Implications of not making the Change: Describe the consequences if the change
is not made.
Impact Analysis to the Project: Describe how the change would be incorporated
into the project, as well as the impact on the project in terms of cost, effort and
duration.
Alternatives: If there are any alternatives, note them here, along with their impact
on cost, effort and duration.
Final Resolution: Briefly describe how the scope change was resolved.
Approval from Sponsor for Final Resolution: Signifies that the Project Sponsor
agrees to the resolution, including any budget, effort and / or duration implications.
Adapted from http://www.tenstep.com.
Check Your Progress
29. ___________ is a deliverable-oriented grouping of project elements that
organizes and defines the total scope of the project.
a. Change requests
b. Performance reports
c. Work breakdown structure
17
30. Scope verification is
a. the process of controlling the changes in the project scope that occur at various
stages of the project life cycle.
b. a process that formalizes the acceptance of the project scope by the project
stakeholders.
c. the process of developing a scope statement as a basis for all future decisions to
be taken on the project.
d. a process that involves decomposing the major deliverables into smaller, more
manageable components to provide better control.
31. Identify the statement that is not true with regard to change requests.
a. Change requests are always external to the organization.
b. Change requests always expand the scope of the project.
c. Changes in government regulations, errors in the projects product, etc. are some
of the events that can change the scope of a project.
d. Both (a) and (b)
32. Identify the statement that is not true regarding scope change control.
a. Scope change control involves identifying the changes in scope.
b. Scope change control controls the changes to the project schedule.
c. Scope change control involves managing the factors that cause scope changes to
see that the changes are advantageous to the project.
d. Scope change control requires repeated execution with other control processes
like time control, cost control, quality control, etc.
33. All the following documents provide information to the project manager to
control scope change except:
a. contract files.
b. change requests.
c. performance reports.
d. outputs from work breakdown structure.
34. __________ is the process of controlling the changes in the project scope that
occur at various stage of the project life cycle.
a. Quality control
b. Schedule control
c. Scope change control
d. Risk response control
35. Identify the techniques that help the project manager in assessing the magnitude
of the variations that occur.
i. Simulation analysis
ii. Trend analysis
iii. Variance analysis
iv. Earned value analysis
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36. Identify the reports that organize and summarize the information gathered and
provide information on scope performances.
a. Change requests
b. Performance reports
10. Summary
Projects are initiated only when an opportunity is recognized, when some need arises,
or because of specific requirements.
A project deliverable is any measurable, tangible, verifiable outcome, result, or item
that must be produced to complete a project or a part of a project.
A list of project deliverables, known as the conditions of satisfaction, is jointly
prepared by the project manager and the client. The list is developed in four steps:
request, clarification, response, agreement.
Scope planning involves development of the scope statement. The project manager
uses tools like product analysis, cost/benefit analysis, and expert judgment to develop
the scope of a project.
The scope of a project is documented in the project overview statement (POS). After
preparing the POS, the project manager sends it to top management for approval.
The project definition statement is similar to the POS, but the people who are
involved in the preparation of the statement are different. That is, the project manager
discusses with the project team members, and not the project client.
Scope verification is a process that formalizes the acceptance of the project scope by
the project stakeholders. The project manager reviews the fully or partially completed
deliverables to ensure that they have been completed as per the specifications.
Scope change control is the process of controlling the changes in the project scope
that occur at various stages of the project life cycle.
Scope change control involves managing the factors that cause scope changes to see
that changes are advantageous to the project; and identifying the changes in the scope.
11. Glossary
Conditions of satisfaction: A list of project deliverables, which is jointly prepared by
the project manager and the client.
Cost Benefit Analysis: The economic and social justification for the proposed
project.
Project Definition Statement: It is similar to a project overview statement, and it
provides more detailed information about the project as it is used as a reference point
by the project team for executing the project.
Project deliverable: Any measurable, tangible, verifiable outcome, result, or item
that must be produced to complete a project or a part of a project.
Project Overview Statement: A document that describes the scope of a project.
Scope Change Control: The process of controlling the changes in the project scope
that occur at various stages of the project life cycle.
Scope Planning: The process of developing a scope statement as a basis for all future
decisions to be taken on the project.
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Scope Verification: A process that formalizes the acceptance of the project scope by
the project stakeholders.
Scope: A brief and accurate description of the end products or deliverables to be
expected from a project. It describes all the activities that have to be performed and
identifies the resources that will be utilized for the successful completion of the project.
Work Breakdown Structure: A deliverable-oriented grouping of project activities
that organizes and defines the total scope of the project.
1. The scope of a project is a brief and accurate description of the deliverables to be
expected from a project. Define project deliverables. What are the steps involved
the development of a list of project deliverables?
2. The project manager uses various tools like product analysis, and consults experts
to determine the scope of a project. How can the project manager develop the
project scope? What is a project overview statement (POS)? Describe the
different parts of and attachments to a POS.
3. After preparing the POS, the project manager sends it for approval. Give the
reasons as to why a POS needs to be approved. Who are all involved in the
approval process of a POS?
4. More than the POS, a project definition statement (PDS) works as a very useful
tool in project execution. What is a PDS? How is it different from a POS?
5. The project scope needs to be formally accepted by the project stakeholders and
also controlled at various stages in the project life cycle. How is the acceptance
process of the project scope taken up? Considering that changes may occur, how
is the project scope change controlled by the project manager?
1. Prasanna Chandra, Projects, McGraw Hill, Seventh Edition, 2009.
4. Harold Kerzner, Project Management-A Systems Approach to Planning,
Following are the answers to the Check Your Progress questions given in the Unit.
1. (d) Agreement
The list of project deliverables is developed in four stages, namely request,
clarification, response, and agreement. In the agreement stage, based on the
project managers response, both the parties (the client and the project manager)
continue their discussions and arrive at an agreement. If both are still ready to go
ahead with the project, they establish the project norms in this stage. Finally, both
the parties examine each others requests closely in order to determine how the
project should be executed.
20
2. (d) Only the project goals determine the scope of the project.
Project scope is a brief and accurate description of the end products or
deliverables to be expected from a project. It describes all the activities that have
to be performed and identifies the resources that will be utilized for the successful
completion of the project. It is concerned with target outcomes, prospective
customers, outputs, and the financial and human resources required for
completing the project. The client and the project manager prepare a project goal.
They also identify a number of objectives that will help them reach that goal. The
project goals, together with the objectives, determine the scope of the project.
Exchange of views between the project manager and the client regarding the
objectives of the project will enable them to determine the purpose of the project.
It will help the project manager understand the clients expectations and make
the client aware of the project managers method of executing the project.
4. (c) Request Clarification Response Agreement
clarification, response, and agreement. In the request stage, the client requests
the project manager to undertake a project as per his/her requirements. In the
clarification stage, the project manager explains what he/she has understood by
the request made by the client. In the response stage, the project manager
explains what he/she can do to fulfill the clients request. In the agreement stage,
based on the project managers response, both the parties continue their
discussions and arrive at an agreement.
5. (b) Project scope
Project scope describes all the activities that have to be performed for the
successful completion of the project and identifies the resources that will be
utilized for the purpose. A project phase is a collection of related project
activities, which results in the production of one or more major project
deliverables. Project control is the process of collecting information related to
the performance of the project system, comparing it with the desired level of
performance, and taking corrective action to decrease the gap between the actual
and the desired performance levels. A project deliverable refers to any
measurable, tangible, verifiable outcome or result that must be produced to
complete a project.
6. (c) Response
clarification, response, and agreement. In the response stage, the project manager
explains what he/she can do to fulfill the clients request. He/she informs the
client of his/her capabilities, his/her schedule, and fees for undertaking the
project.
7. (b) the list of project deliverables.
The project manager and the client jointly prepare a list of project deliverables.
A project deliverable, as defined by the Project Management Body of
Knowledge (PMBOK), is any measurable, tangible, verifiable outcome, result,
or item that must be produced to complete a project or a part of a project. This
list of project deliverables is also called the Conditions of Satisfaction. The
other options are wrong.
21
8. (d) project overview statement.
clarification, response, and agreement. In the agreement stage, both parties
continue their discussions and arrive at an agreement. If both are still willing to
go ahead with the project, they establish the project norms in this step. Finally,
both the parties examine each others requests closely in order to determine how
the project should be executed. The final agreement is documented in the
Project Overview Statement. A project plan is a formal, approved document
used to manage and control project execution. An aggregate project plan is a
concise statement of all project activities. A project progress report is a formal
statement that gives a comparison between the project progress,
accomplishments, and the project plan.
9. (b) Clarification
clarification, response, and agreement. In the request stage, the client requests
the project manager to undertake a project as per his/her requirements. In the
clarification stage, the project manager explains what he/she has understood by
the request made by the client. In the response stage, the project manager
explains what he/she can do to fulfill the clients request. In the agreement stage,
based on the project managers response, both the parties continue their
discussions and arrive at an agreement.
10. (c) The project goal statement should mention specific dates for starting or
completing the project.
The project goal forms the purpose of the project and provides guidance to the
entire project team. The project goal statement should be specific, measurable,
assignable, realistic, and time-related. It should not mention specific dates for
starting or completing the project. Time-related information about the project is
mentioned in the project objectives of the project overview statement.
The scope of the project is documented in the project overview statement. The
project overview statement is also referred to as initial project definition,
document of understanding, project scope statement, or statement of work.
12. (c) A POS is a static document that need not be changed, revised, or
redefined.
The scope of a project is documented in the project overview statement (POS). A
POS is not a static document. As the project progresses, it has to be revised or
redefined. The reason behind this is that over time, the scenario may change, and
the POS should be documented accordingly.
In general, the project overview statement consists of five parts: project
problem/opportunity; project goal; project objectives; success criteria; and
assumptions, risks, and obstacles. The POS first identifies the reasons for
undertaking the project, and then proceeds to identify the projects goal. The
project goal is further broken down into a number of project objectives. The POS
also mentions the criteria for the success of the project, and the various risks and
obstacles involved in the execution of the project.
22
The first part of a project overview statement (POS) states the problem or
opportunities that the project is going to address. This statement need not be
defined rigidly. It should be written in such a way that all project stakeholders are
able to understand it. Statements regarding the outcome and the time period of the
project are defined in the project objectives of the POS. Statements about the
reason for taking up the project are explained in the success criteria of the POS.
The project manager uses tools like product analysis, cost/benefit analysis, and
expert judgment to develop the scope of a project. Product analysis is a
technique for understanding the features and functions of a product. Techniques
like value analysis and quality function deployment help the project manager
gain more information about the project. A cost/benefit analysis is necessary for
studying the various tangible and intangible costs and benefits associated with
the project. The project manager also consults experts to determine the scope of
a project. This technique is called expert judgment. Black box is a technique
used to develop creativity in individuals.
16. (a) Only i, ii, and iv
The scope of a project is documented in the project overview statement (POS).
The POS should be very specific. A good scope statement would identify the
goal of the project and describe how it can be achieved. It should be expressed
clearly and precisely so that all the project stakeholders understand what the
project is about. A POS is not a static document. As the project progresses, it has
to be revised or redefined. POS should describe what the project is, why it is
being taken up, and what value it brings to the firm. All future decisions
pertaining to the execution of the project and allocation of necessary resources
will be based on the POS.
17. (b) defining the project goal.
The project goal is defined on the basis of the problems/opportunities stated in
the first part of the project overview statement. The other options are defined or
carried out before drafting a project overview statement.
The scope of a project can be divided into product scope and project scope.
Product scope details all the functions and features that are to be included in a
product or service of a project. Project scope details the work to be done to
deliver a required product with specific features. The tools and techniques for
managing product scope vary with the nature of the project.
19. (c) Cost/benefit analysis
The cost/benefit analysis explains the economic and social justification for the
proposed project. Feasibility analysis is conducted to ensure that the proposed
project is financially viable. The return on investment is the revenue likely to be
generated over the life period of the project against the investments made in it.
Break-even analysis is used by the project manager to determine when the project
will arrive at a no profit-no loss situation.
20. (d) Break-even analysis
Break-even analysis is used by the project manager to determine when the
project will arrive at a no profit-no loss situation. Feasibility analysis is
conducted to ensure that the proposed project is financially viable. The return on
investment is the revenue likely to be generated over the life period of the project
against the investments made in it. The cost/benefit analysis explains the
economic and social justification for the proposed project.
23
21. (c) The risk analysis report does not include any mention of the formal
procedures to deal with the risks in the project overview statement.
The risk analysis report describes the various risks associated with proposed
project activities, their probability of occurrence, and their severity. This analysis
also describes risk identification techniques, risk quantification, and other risk
control measures. Formal procedures should also be mentioned to effectively
deal with these risks in the POS.
22. (d) assumptions, risks, and obstacles
The project overview statement consists of five parts: project
problem/opportunity, project goal, project objectives, success criteria, and
assumptions, risks, and obstacles. The assumptions, risks, and obstacles section
mentions all the organizational or environmental factors that may affect the
outcome of the project. Some of the aspects of projects that are risk prone are
technological aspects, environmental aspects, interpersonal aspects, cultural
aspects, causal relationships, etc.
23. (c) the revenue likely to be generated over the life period of the project
against the investments made in it.
The return on investment is the revenue likely to be generated over the life
period of the project against the investments made in it. The return on investment
is numerically expressed, which makes it easy for the top management to
identify the most profitable project. Actual cost of work performance is the total
costs incurred (direct and indirect) in accomplishing work during a given time
period. Budgeted cost of work performance is the sum of the approved cost
estimates (including any overhead allocation) for activities completed during a
given period. Any measurable, tangible, and verifiable outcome or result that
must be produced to complete a project is called a project deliverable.
24. (b) iii-ii-vii-i-iv-vi-v
A feasibility analysis is conducted to ensure that the proposed project is
financially viable. Following are the steps involved in conducting a feasibility
analysis: define the problem/opportunity clearly; define the scope of the project,
what it includes and what it does not; identify alternative solutions for the
problems; rank the alternative solutions; state the expected time and costs
required; project the profits from the project; and list the recommendations.
Risk analysis and financial analysis reports help managers assess the economic
value of the project. The risk analysis report describes the various risks
associated with the proposed project activities, their probability of occurrence,
and their severity. Financial analysis includes a feasibility analysis, return on
investment, a cost/benefit analysis, and a break-even analysis. The critical path
method is used in schedule development. It is a network analysis technique used
to predict the project duration by finding out which sequence of activities (the
critical path) has the least amount of scheduling flexibility.
26. (d) The top management wants the estimates of time and cost to be provided
by the project manager in the POS.
After preparing the POS, the project manager sends it to the top management for
approval. The top management examines the proposed project to see if it adds any
business value to the firm. Approval of the POS indicates that the top
management is interested in undertaking the project, that the client feels that the
project has been understood and a satisfactory solution offered, and that the top
management feels that the project is well defined. Estimates of time and cost are
provided later by the project manager during the detailed planning stage.
24
27. (b) While preparing the PDS, the project manager holds discussions with the
project client.
The PDS is similar to the POS, but the people who are involved in the
preparation of the statement are different. While preparing the PDS, the project
manager holds discussions with the project team members and not the project
client. The PDS provides more detailed information about the project as it is
used as a reference point by the project team for executing the project.
The role of the project manager is crucial. He/she should draft the POS in such a
way that the top management can easily understand it. He/she should persuade
the management to approve the project. He/she should direct the entire project
team and close the project by satisfying the client.
29. (c) Work breakdown structure
The work breakdown structure (WBS) is a deliverable-oriented grouping of
project elements that organizes and defines the total scope of the project. Change
requests are changes that may expand or shrink the project scope. Performance
reports organize and summarize the information gathered and provide
information on scope performances.
30. (b) a process that formalizes the acceptance of the project scope by the
project stakeholders.
The Project Management Body of Knowledge (PMBOK) has defined scope
verification as a process that formalizes the acceptance of the project scope by
the project stakeholders. Scope change control is the process of controlling the
changes in the project scope that occur at various stages in the project life cycle.
Scope planning is the process of developing a scope statement as a basis for all
future decisions to be taken on the project. Scope definition involves
decomposing the major deliverables into smaller, more manageable components
to provide better control.
Change requests can be external as well as internal to the organization. They
may contract or expand the scope of the project. Changes in government
regulations and new rulings (by the courts) are some of the external events that
can change the scope of a project. Errors made in defining a projects product
(functions, characteristics, etc.) and errors made in defining the projects scope
(using a list of deliverables in place of WBS) are the internal reasons that lead to
changes in project scope.
32. (b) Scope change control controls the changes to the project schedule.
Scope change control is the process of controlling the changes in the project
scope that occur at various stages of the project life cycle. Scope change control
involves managing the factors that cause scope changes to see that the changes
are advantageous to the project and identifying the changes in the scope. Scope
change control must be integrated with other control processes like time control,
cost control, quality control, etc. Schedule control controls the changes to the
project schedule.
33. (a) contract files.
Project managers use information collected from various documents to control
scope change. These documents include outputs of work breakdown structure,
performance reports, and change requests. Contract files are a set of indexed
documents developed to include the various documents in the final project
records.
25
34. (c) Scope change control
scope that occur at various stages of the project life cycle. Schedule control has
similar functions as scope change control except that it controls changes to the
project schedule. Quality control is the process of scrutinizing specific project
results in order to check their compliance with quality standards. Risk response
control is the process of implementing a risk management plan to address the
various risk factors associated with the project.
35. (c) Only ii, iii, and iv
scope that occur at various stages of the project life cycle. Performance
techniques like variance analysis, trend analysis, and earned value analysis help
the project manager in assessing the magnitude of the variations that occur.
Simulation analysis is an advanced technique used for conducting risk analysis.
36. (b) Performance reports
Performance reports organize and summarize the information gathered and
provide information on scope performances. Change requests are changes that
may expand or shrink the project scope. The work breakdown structure (WBS) is
a deliverable-oriented grouping of project elements that organizes and defines
the total scope of the project.
Unit 7
Identifying Project Activities
Structure
1. Introduction
2. Objectives
3. Activity Definition
4. Work Breakdown Structure
5. Developing a WBS
6. Test for Completeness of Decomposition of Activities
7. Approaches to Defining Deliverables in the WBS
8. Representing the WBS
9. Summary
10. Glossary
1. Introduction
In the previous unit, we have discussed the management of project scope. In this unit,
we will discuss the identification of the project activities. Identifying project activities
is an important step in the project planning phase after the project scope statement has
been defined. The Work Breakdown Structure (WBS) is a useful tool for the project
manager in identifying the project activities. It illustrates how each activity of the
project contributes to the whole project in terms of budget, schedule and performance.
It also lists the vendors/subcontractors associated with specific activities of the
project. Software packages like Microsofts Project 2000 can generate the WBS
automatically.
A WBS is initially developed with the limited data available and subsequently revised
when additional information is received. This gives the project manager a clear idea of
what the end product of the project will be, and the overall process by which it will be
created. Firms follow different approaches to developing work breakdown structures.
The decomposition of the activities is continued till the lower activities satisfy some
specified criteria. The planned WBS is then communicated to other project members
and further modifications are done as and when required.
This unit will deal with the definition of an activity. We will discuss the WBS and its
development. We shall then move on to discuss the various tests for completeness of
decomposition of activities. Finally, we would be discussing the various approaches to
defining deliverables in the WBS, and about representing the WBS.
2. Objectives
define an activity.
explain a work breakdown structure (WBS), and .
developing a WBS.
27
test for completeness of decomposition of activities.
approaches to defining deliverables in the WBS.
representing the WBS.
3. Activity Definition
An activity is an element of work performed during the course of a project. A project
involves a number of interrelated activities. In general, activities share the following
characteristics each activity is of a definite duration; each activity uses resources
such as people, materials or facilities; and each activity has a cost associated with it.
A project consists of a series of activities. Every activity of the project has an activity
that goes before it, or one that goes after it, and sometimes both. An activity that must
be completed immediately before the start of another activity is called a predecessor
activity. An activity that immediately succeeds another activity and which cannot be
started until the earlier one has been completed, is called a successor activity. Two
activities which are taken up at the same time are called concurrent activities. Activity
definition involves identification of specific activities that must be performed in order
to produce project deliverables.
4. Work Breakdown Structure
The Project Management Body of Knowledge (PMBOK) defines work breakdown
structure (WBS) as a deliverable-oriented grouping of project activities that organizes
and defines the total scope of the project. A deliverable is any measurable, tangible,
verifiable outcome or result that must be produced to complete a project or part of a
project. The WBS helps the project manager to ensure that the project includes all the
activities needed, and that the project includes no unnecessary activity.
The breaking down of work into hierarchy of activities and tasks is called
decomposition. The project goal statement is shown at the top of the WBS as a Level
0 activity. This Level 0 activity is decomposed into Level 1 activities. The completion
of all Level 1 activities means completion of Level 0 activity. Similarly an activity at
level n is said to be completed when its decomposed activities at Level n+1 are
completed.
The decomposition process makes it easy for the project manager to estimate the
duration of the activity, the resources required, and the costs incurred. The
decomposition is done to such an extent that each lower activity should satisfy the test
of completeness.
Factors Considered in Developing a WBS
The project manager must keep in mind the following issues while designing a WBS:
1. Every activity in the WBS should produce a single tangible deliverable.
2. Every activity at any level of the WBS is an aggregation of all its subordinate
activities listed immediately below it.
3. Each activity should be unique and distinct from other activities of the project.
4. The activities should be decomposed logically from higher levels to lower levels.
5. There should be some flexibility in the WBS development process, as the WBS
might be updated when the project scope changes.
6. The WBS must specify the important reporting points (e.g., review meetings,
monthly reports, test reports etc.) The activities should be compatible with
organizational and accounting structures.
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Uses of WBS
The uses of WBS are given below:
Thought process tool: The WBS improves the thought process of the project
manager and his team by designing the entire project in a structured manner. It helps
them to see how the project work can be defined and managed.
Architecture tool: The WBS provides a complete picture of the project and
represents how various activities are related to one another.
Planning tool: The WBS provides a series of activities to be performed to complete
the project. It helps the project manager estimate resources required and build a
schedule for the whole project.
Project status reporting tool: The WBS can also be used as a tool to report the status
of the project. Completion of lower level activities implies the completion of the
corresponding activities at one level above. Completion of some higher level activities
indicates completion of project milestone events and these are reported to the top
management and the project client.
Check Your Progress
1. All the given statements are true regarding work breakdown structure (WBS)
except:
a. WBS is a useful method of schedule development for the project manager.
b. WBS lists the vendors/subcontractors associated with specific activities of the
project.
c. WBS illustrates how each activity of the project contributes to the whole project
in terms of budget, schedule, and performance.
d. WBS is initially developed with the limited data available and is subsequently
revised when additional information is received.
2. ___________ involves breaking down of work into a hierarchy of activities and
tasks.
a. Crashing
b. Decomposition
c. Fast tracking
d. Solicitation
3. Identify the step in the project planning phase that immediately follows the
defining of the project scope statement.
a. Financial analysis
b. Project selection
d. Identifying project activities
4. Which of the following options acts as a planning tool and a project status
reporting tool?
a. Critical path method
b. Work breakdown structure
c. Program evaluation and review technique
d. Graphical evaluation and review technique
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5. ___________ is an element of work performed during the course of a project.
a. Event
b. Node
c. Slack
d. Activity
6. Which of the following statements are not true with regard to an activity?
i. An activity is an element of work performed during the course of a project.
ii. A project involves a number of independent and unrelated activities.
iii. An activity has a cost associated with it.
iv. An activity does not have a definite duration.
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
7. An activity that must be completed immediately before the start of another
activity is called
a. a successor activity.
b. a predecessor activity.
c. a concurrent activity.
d. Both (b) and (c)
8. The work breakdown structure (WBS) helps the project manager ensure that
i. the project includes all the activities needed.
ii. the interdependency relationships are identified and documented.
iii. the project includes no unnecessary activity.
iv. specific activities are identified that must be performed in order to produce
project deliverables.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. Only iii and iv
9. _____________ involves identifying specific activities that must be performed in
order to produce project deliverables.
a. Scope planning
b. Activity definition
c. Scope definition
d. Activity sequencing
10. An activity at level n is said to be completed when
a. all activities are completed.
b. its decomposed activities at level n are completed.
c. its decomposed activities at level n+1 are completed.
d. its decomposed activities at level n-1 are completed.
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11. Which of the following is wrongly stated as a factor to be considered for
developing a work breakdown structure (WBS)?
a. Each activity should be unique and distinct from other activities of the project.
b. The activities should be decomposed from lower levels to higher levels.
c. Every activity in the WBS should produce a single tangible deliverable.
d. There should be some flexibility in the WBS development process.
12. A successor activity is
a. an activity that must be completed immediately before the start of another
activity.
b. an activity that immediately follows another activity and which cannot be started
until the earlier one has been completed.
c. an activity taken up at the same time as another activity.
13. From the following options, identify the goals of decomposition.
i. Developing the schedule
ii. Estimating the duration of the activity
iii. Estimating the resources required
iv. Estimating the costs incurred
14. Two activities that are taken up at the same time are called __________ activities.
a. predecessor
b. successor
c. concurrent
5. Developing a WBS
The process of developing a WBS can be top-down or bottom-up approach.
Top-down Approach
In this approach, the project goal level is decomposed to lower levels until the project
manager and his team are satisfied that the work has been sufficiently well defined.
The decomposition is continued till the activities of lower level satisfy the test of
completeness.
Once all the activities are identified, the project manager ensures that each project
activity is described in detail, with the time, cost, material, and labor requirements for
each activity being estimated. This is because allocation of resources is easier at the
activity level rather than at the project level. The sum of all resources allocated for all
project activities provides the total resource requirements for the project.
After the activities are described, the project manager puts them in sequence, so that a
schedule can be drawn up for the entire project. The project manager analyzes the
dependencies among the various project activities to see how many of the activities
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can be taken up simultaneously. If some of the activities can be carried out
simultaneously, it reduces the total project duration. There are two variations in the
top-down approach. These are the team approach and subteam approach.
Team approach: In this approach, the entire project team works on all parts of the
WBS. A suitably qualified person is given the responsibility of decomposing each
Level 1 activity. As the entire team is involved in developing the WBS, members can
take note of discrepancies as and when they occur and take corrective measures.
Subteam approach: In this approach, the planning team is divided into as many
subteams as there are Level 1 activities. Each team is led by an expert who
decomposes the Level 1 activity assigned to his team, taking into consideration the
suggestions made by his team members. The process is continued till each lower level
activity of WBS meets the test for completeness of decomposition.
Bottom-up Approach
Here, as in top-down approach, the entire planning team prepares the first level
breakdown. Then the team is divided into as many groups as there are Level 1
activities. Each group makes a list of all the activities that must be completed to
complete one Level 1 activity. This is done by getting group members to identify
different activities and present these to the group. Every activity that the group thinks
is appropriate, is put down on a slip of paper. Once all the ideas are exhausted, related
activities are grouped together and the final list is submitted to the planning team. The
planning team prepares the final work breakdown structure by removing redundant
activities and adding missing activities. The drawback in this approach is that the
activities are not defined properly.
Activity: The management of Power Oil Ltd., wanted to take up a project of
constructing a refinery. The management appointed Surya Narayana as the project
manager and asked him to develop the Work Breakdown Structure (WBS) of the
project. Narayana, with his team members, prepared the projects goal statement.
This project goal was broken down to lower level activities till the entire project work
was defined. What kind of approach did Narayana follow to develop the WBS of the
project? At what level can the breaking down of the activities be stopped?
Answer:
Example: Project Risk and WBS
For projects that are likely to be exposed to higher risks, the WBS should be very
detailed. Each activity faces a different kind of risk and so the project manager
must identify the nature and level of risk that is likely to arise for each project
activity. Certain risks are specific to certain activities. For instance, breakdown risk
is specific to machinery and equipment. An activity like the documentation of
expenses does not face such a risk. Any negligence in dealing with these risks will
have a detrimental effect on the project.
Contd
32
Contd
The WBS, by breaking down the project activities, helps identify and mitigate
several risks. For instance, the risk involved in the activity of getting permits from
the regulatory authorities is high. Since it affects several other WBS activities, the
project manager has to analyze its impact on all the other WBS activities. To
effectively deal with the risks involved in the project activities, the project manager
defines a risk plan that describes the contingency activities that must succeed the
risk affected activities.
Some of the questions that the project manager must answer while considering the
project risk for each WBS activity are:
Is the technology changing faster than the pace of the project? Can the project
include the latest technological innovations?
Will the quality of the project activities be evaluated through testing and
inspection?
Does the firm have enough manpower, facilities and resources to produce the
required deliverables?
Have the risks of social pressures, government approval, understanding among
team members been identified?
Adapted from Project Management Institute Practice Standard for Work Breakdown Structures,
Exposure draft version, 2000, Published by Project Management Institute,Inc., p. 15-16.
6. Test for Completeness of Decomposition of Activities
Preparing an appropriate WBS is of critical importance in planning the project. The
project manager should ensure that no unnecessary activity is included in the WBS
and that all the activities that are necessary to meet the ultimate project goals are
included.
The decomposition of the project activities should be continued till all the lower level
project activities fulfill the following conditions.
1. The activity must be measurable
2. It must have clearly defined start/end events
3. It must have a clear deliverable
4. The time/cost of the activity must be measurable
5. The duration of the activity must be in acceptable limits
6. The activity must be independent
If any activity does not satisfy all the six conditions, it should be further decomposed.
The criteria for completeness are discussed in greater detail below.
Measurable
The project manager can ask for the current status of an activity anytime during the
project. So, the status of the activity should be easy to measure. Let us assume the
transportation activity in a building construction project takes 15 days, if 5 trucks are
engaged. Assuming that the trucks are at equal capacity, the extent of completion of
the activity can be measured at any point of time. The measure of the activitys
completion is the proportion of the work completed for a given time period.
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Bounded
Each activity should have clearly distinguishable start and end events. Once the start
event has occurred, the project manager assumes that the activity has begun. The
deliverable should result once the last event occurs. For example, the printing activity
of a book starts when papers are loaded into the printing machine and it is completed
once all the printed papers are collected. If the activity is not properly bounded, then
the activity has to be further decomposed.
Deliverable
Every activity, on completion, should produce a result or outcome. The deliverable is
a visible proof of the completion of an activity. The outcome could be a document, or
a physical product. The next activity can be started only when the predecessor activity
produces the desired outcome.
Simplicity in Estimating Cost/Time
Every activity in a WBS should have an estimated time and cost of completion. By
dividing the activities into lower level activities, a project manager can arrive at
reasonably accurate cost and time estimates for all the activities listed in the WBS. If
it is difficult to estimate the cost/ time of an activity, it should be further broken down.
Acceptable Duration Limit
In general, the duration of an activity is kept less than two weeks. Even for big
projects, the activities are decomposed further till each activity has an acceptable
duration. In the case of repetitive operations, further decomposition of activities is not
required. For example, if we want to produce 1000 units and it requires a time period
of 10 weeks, the activity need not be further broken down into five activities with
each activity producing 200 units. But long durations for activities is not
recommended, as a delay in that activity can seriously disturb the entire project
schedule.
Activity Independence
Each activity in the project should be independent. Once the work on an activity
begins, it should be amenable to being continued till completion, without need for
additional inputs and information. However, an activity can be scheduled in parts on
the basis of resource availability.
The WBS is decomposed to such a level that the lower level activities should allow
for the effective planning, control, and performance measurement. In order to plan for
adequate resources, the project manager examines the following details:
Is all the work planned for an activity capable of producing the required deliverable?
Is it practically feasible to manage the individual work assignments with the WBS
structure?
What kind of an approach is to be adopted for identifying project activities: a top-
down approach or a bottom-up approach?
How will work be assigned to an individual and controlled to receive the required
deliverables?
How will the budgets be allocated for each project activity? How are the budgets
proposed for the increments of work?
How will the status of the project work activity be determined?
34
Check Your Progress
15. Decomposition of the project activities should be continued till all the lower level
project activities fulfill certain conditions. Some of these conditions are:
i. The activity must be measurable.
ii. The activity must be dependent on the other activities.
iii. The activity must have a clear deliverable.
iv. The duration of the activity must be within acceptable limits.
16. Which of the following statements is true regarding the top-down and bottom-up
approaches of developing a work breakdown structure (WBS)?
a. Activities are clearly defined in the bottom-up approach.
b. In the top-down approach, the project goal level is decomposed to lower levels
until the project manager and his/her team are satisfied that the work has been
sufficiently well defined.
c. Team approach and sub-team approach are variations in the bottom-up approach.
d. All of the above
7. Approaches to Defining Deliverables in the WBS
There are several approaches to defining the deliverables and building the WBS for a
project. The three main types of approaches are noun-type approaches, verb-type
approaches and organizational approaches.
Noun-type Approaches
There are two types of noun type approaches used in developing a WBS. They are i)
physical decomposition, and ii) functional decomposition.
Physical Decomposition
In this approach, the deliverables of the project work are defined in terms of physical
components that make up the deliverable. For example, in a project for manufacturing
a lathe machine, the project will involve the manufacture of physical components like
gears, gear belts, motor, machine base, fixtures, supporting blocks, shafts, cutting
tools and dimension scales. All these components are to be produced to make the end
product and the WBS will represent the manufacture of all the above physical
components. The project manager can use Gantt charts that depict the duration of each
activity as rectangular bars. The length of the rectangular bar represents the duration
of each project activity and these are arranged in proper sequence.
Functional Decomposition
In the functional noun-type approach, the same cutting machine project is built on the
functional requirements of the machine like manufacturing of gear system, conveyor
system, motor system, work piece rotating system and dimension checking system.
The WBS lists the functions to be performed to produce the end product.
35
Verb-type Approaches
The verb-type approach defines the project deliverables in terms of the actions to be
performed to produce them. The design-build-test-implement approach and
objectives approach are the two types of verb- type approaches.
Design-Build-Test-Implement Approach
Assume a project that has to produce an innovative cutting machine. Here, all the
features that are to be added to the current cutting machine are designed, built, tested
and then implemented. Gantt charts are drawn that have lengths corresponding to the
duration of each design, build, test and implement stage of the project.
Objectives Approach
The project manager reports completion of project activity on the basis of attainment
of some project objectives. The objective approach is similar to the design-build-test-
implementation approach and is used when progress reports are to be prepared at
various stages of the project. Clear-cut objectives are set for each activity and the
progress in meeting these objectives is measured. But setting objectives and
measuring their completion levels is difficult.
Organizational Approaches
Organizational approaches define project deliverables in terms of organizational units.
Geographical, departmental, and business functional approaches are the important
organizational approaches.
Geographical Approach
If the project is dispersed geographically, then the project work is partitioned
geographically. For example, a National Highway construction project requires
construction activity at different locations simultaneously. So, the project is divided
according to locations and any of the noun or verb- type approaches is used at each
location.
Departmental Approach
In the departmental approach, the project work is first divided department wise. Any
other approach can be used later in each department. Complex projects undertaken by
a single firm usually follow the departmental approach at the earlier stages. Resource
allocation becomes simpler this way, as each department will take care of the work
assigned to it.
Business Functional Approach
According to this approach, the project work is divided based on business functional
areas. The project work is divided into several business processes and an appropriate
approach is followed for each process later. This approach has same uses that of
departmental approach, but the difficulty in this process lies in integrating all the
deliverables from various processes.
Activity: The management of Midwest Automobiles Ltd., decided to launch a bike
with tubeless tyres and disk brakes on both front and rear wheels, which ensured
more safety. The concept was developed by the firms R&D department. The
management appointed Gauri Prasad as the project manager. As part of his
planning, Prasad wanted to define the deliverables of the project by developing the
work breakdown structure of the project. What are the different types of
approaches that Prasad can use to build a WBS?
Contd
36
Contd
Answer:
8. Representing the WBS
Work Breakdown Structures can be represented in different ways. Whatever the
structure type, the project goal that states the purpose of the project has to be written
at the top. Then it is divided into various activities, called Level 1 activities. The
activities that do not satisfy the test for completeness are further divided into several
activities again and they are called Level 2 activities. The process is continued till all
the activities satisfy the six criteria for completion, described earlier.
Whatever is the type used for representation, the main issue in representing the WBS
is to know whether the work required to achieve the desired outcome and meet the
project objectives has been captured in enough detail to identify the resources, assign
the responsibilities, and set the activities in sequence.
Example: WBS for a Telecom Project
1.0 CONCEPT/FEASIBILITY
1.1 Develop Concept/Marketing Plan
1.2 Conduct Market Analysis
1.3 Conduct Technical Analysis
1.4 Develop Prototype
1.5 Prepare Product Development Plan/ Cost/ Schedule
2.0 REQUIREMENTS
2.1 Develop End-User Requirements
2.2 Develop Application Requirements
2.3 Develop Infrastructure (Systems) Requirements
2.4 Develop Operations /Maintenance Requirements
2.5 Develop Service Requirements
3.0 DECISION
3.1 Present Prototype
3.2 Present Financial Statements & Time Schedule
Contd
37
Contd
3.3 Present Technical Capabilities
3.4 Obtain Financial Commitment
3.5 Go/ No-Go Decision (Milestone)
4.0 DEVELOPMENT
4.1 Develop End-User Systems
4.2 Develop Application
4.3 Develop Infrastructure Systems and Network
4.4 Develop Operations/Maintenance Structure
4.5 Develop Service Plan
5.0 TEST
5.1 Develop Test Plans for Each Aspect/ Element
5.2 Conduct Tests
5.3 Validate Results
5.4 Perform Corrective Action (as necessary)
5.5 Conduct Retesting
5.6 Revalidate Results
6.0 DEPLOY
6.1 Conduct a Trial Test
6.2 Conduct First Live Test
6.3 Complete Deployment
7.0 LIFE CYCLE
7.1 Conduct Customer Training & Education
7.2 Obtain Customer Acceptance
7.3 Perform Support & Maintenance
Adapted from Project Management Institute Practice Standard for Work Breakdown Structures,
Exposure draft version, 2000, Published by Project Management Institute,Inc., p.69-70.
Check Your Progress
17. Identify the approach which is not used to define the deliverables and build the
work breakdown structure for a project.
a. Noun-type approach
b. Verb-type approach
c. Dividend capitalization approach
d. Organizational approach
38
18. From the following, identify the verb-type approaches that are used to define
i. The objectives approach
ii. The departmental approach
iii. The business functional approach
iv. The design-build-test-implement approach
a. Only i and ii
b. Only i and iv
c. Only ii and iii
d. Only iii and iv
19. Physical decomposition and functional decomposition are used to develop a work
breakdown structure. These are
a. noun-type approaches
b. verb-type approaches
c. organizational approaches
20. All of these are organizational approaches used to define project deliverables
except
a. the business functional approach.
b. the functional decomposition approach.
c. the geographical approach.
d. the departmental approach.
21. Identify the approach that is used to define the project deliverables in terms of the
actions to be performed to produce them.
a. Noun-type approach
b. Verb-type approach
c. Organizational approach
d. Departmental approach
22. SafeQuip is a two-wheeler manufacturing company, specializing in the
manufacture of environment-friendly vehicles. The company has taken up a
project to manufacture an environment-friendly car. The project manager of the
company has developed a work breakdown structure that represents the
manufacture of components like internal combustion engine, braking system,
battery, gear box, doors, tires, etc. All these components have to be manufactured
in order to make the car. Which of the following approaches has the project
manager used to define the project deliverable?
a. The business functional approach
b. The physical decomposition approach
c. The functional decomposition approach
d. The design-build-test-implement approach
39
23. In which of the following approaches are the deliverables of the project defined in
terms of the components that make them up?
a. The business functional approach
b. The departmental approach
c. The physical decomposition approach
d. The functional decomposition approach
9. Summary
An activity is an element of work performed during the course of a project. A project
involves a number of interrelated activities.
Activities generally, share the following characteristics each activity is of a definite
duration; each activity uses resources such as people, materials or facilities; and each
activity has a cost associated with it.
The Project Management Body of Knowledge defines work breakdown structure
(WBS) as a deliverable-oriented grouping of project activities that organizes and
defines the total scope of the project.
A deliverable is any measurable, tangible, verifiable outcome or result that must be
produced to complete a project or part of a project.
The WBS helps the project manager to ensure that the project includes all the
activities needed, and that the project includes no unnecessary activity. The process of
developing a WBS can be top-down or bottom-up approach.
The criteria for completeness of decomposition of activities are that an activity should
be measurable, bounded, deliverable, simple in estimating cost and time, should have
an acceptable duration limit, and be independent.
There are several approaches to defining the deliverables and building the WBS for a
project. The three main types of approaches are: noun-type approaches, verb-type
approaches, and organizational approaches.
WBSs can be represented in different ways. Whatever the type of representation, the
main issue in representing the WBS is to know whether the work required to achieve
the desired outcome and meet the project objectives has been captured in enough
detail to identify the resources, assign the responsibilities, and set the activities in
sequence.
10. Glossary
Activity Definition: Identifying the specific activities that must be performed in order
to produce the various project deliverables.
Deliverable: Any measurable, tangible, verifiable outcome, or result that must be
produced to complete a project.
Work Breakdown Structure: A deliverable-oriented grouping of project activities
that organizes and defines the total scope of the project.
1. A project involves a number of interrelated activities. Define an activity.
2. Identifying project activities is an important step in the project planning phase,
which can be done with the help of a work breakdown structure (WBS). Define a
WBS. What factors should be considered while designing a WBS? How is a WBS
useful for a project manager?
40
3. The process of developing a WBS can be top-down or bottom-up approach.
Explain these approaches in detail. What are the various ways in which a WBS
can be represented?
4. While preparing a WBS, it is important that the project manager should ensure
that no unnecessary activity is included in the WBS, and that all the necessary
ones are included. How can the project manager ensure that all the activities are
decomposed completely?
5. There are several approaches to defining the deliverables and building the WBS
for a project. What are these approaches? Describe them in detail.
1. (a) WBS is a useful method of schedule development for the project manager
WBS is a useful tool for the project manager in identifying the project activities,
and not for schedule development. It lists the vendors/subcontractors associated
with specific activities of the project. It also illustrates how each activity of the
project contributes to the whole project in terms of budget, schedule, and
performance. A WBS is initially developed with the limited data available and is
subsequently revised when additional information is received.
2. (b) Decomposition
The breaking down of work into a hierarchy of activities and tasks is called
decomposition. Crashing refers to decreasing the total project duration after
analyzing a number of alternatives to determine how to get the maximum
duration compression for the least cost. In fast tracking, the project manager
attempts to reduce the project duration by doing project activities in parallel.
Solicitation is the process of gathering information in the form of bids,
quotations, and proposals from qualified vendors to satisfy the project needs.
3. (d) Identifying project activities
Identifying project activities is the step in the project planning phase that
immediately follows the defining of the project scope statement. After a pool of
project ideas has been generated, the project manager screens the ideas. Once the
project ideas have been screened, they are evaluated for marketability and
technical and financial feasibility. After all these stages, a project idea is chosen
for implementation from the available alternative project ideas.
41
4. (b) Work breakdown structure
The work breakdown structure (WBS) acts as a planning tool. It provides a series
of activities to be performed to complete the project. It helps the project manager
to estimate the resources required and build a schedule for the whole project. The
WBS can also be used as a tool to report the status of the project. Completion of
lower level activities implies the completion of the corresponding activity at one
level above. Completion of some higher level activities indicates completion of
project milestone events and these are reported to the top management and the
project client. The critical path method, program evaluation and review technique,
and graphical evaluation and review technique are used by the project manager to
develop schedules.
5. (d) Activity
An activity is an element of work performed during the course of a project. An
event is a time-oriented reference point that signifies the start or end of an
activity. It is also called a node. Slack is the difference between the latest event
time and earliest event time.
An activity is an element of work performed during the course of a project. A
project involves a number of interrelated activities. Each activity is of a definite
duration. Each activity uses resources such as people, materials, or facilities.
Each activity has a cost associated with it.
7. (b) a predecessor activity.
A project consists of a series of activities. An activity that must be completed
immediately before the start of another activity is called a predecessor activity.
An activity that immediately succeeds another activity and which cannot be
started until the earlier one has been completed is called a successor activity.
Two activities which are taken up at the same time are called concurrent
activities.
The work breakdown structure (WBS) is a deliverable-oriented grouping of
project activities that organizes and defines the total scope of the project. It helps
the project manager ensure that the project includes all the activities needed and
excludes any unnecessary activity. Activity sequencing is the process of
identifying and documenting interdependency relationships. Activity definition
involves identifying specific activities that must be performed in order to produce
9. (b) Activity definition
Activity definition involves identifying specific activities that must be performed
in order to produce project deliverables. Scope planning is the process of
developing a scope statement as a basis for all the future decisions to be taken on
the project. Scope definition involves grouping all major project outputs into
more manageable components so as to improve the accuracy of cost, time, and
resource estimations; defining a standard for measuring performance; and
controlling and assigning responsibilities. Activity sequencing is the process of
identifying and documenting interdependency relationships.
10. (c) its decomposed activities at level n+1 are completed.
An activity at level n is said to be completed when its decomposed activities at
level n+1 are completed. That is, an activity at level 0 is said to be completed
only when an activity at level 1 is completed.
42
11. (b) The activities should be decomposed from lower levels to higher levels.
The project manager should consider the following factors while designing a
WBS the WBS should produce a single tangible deliverable; each activity
should be unique and distinct from other activities of the project; the activities
should be decomposed logically from higher levels to lower levels; there should
be some flexibility in the WBS development process, etc.
12. (b) an activity that immediately follows another activity and which cannot be
started until the earlier one has been completed.
A project consists of a series of activities. An activity that immediately succeeds
another activity and which cannot be started until the earlier one has been
completed is called a successor activity. An activity that must be completed
Two activities which are taken up at the same time are called concurrent
activities.
13. (d) Only ii, iii, and iv
The decomposition process makes it easy for the project manager to estimate the
duration of the activity, the resources required, and the costs likely to be
incurred. Schedule development is concerned with determining a realistic start
and finish time for project activities. Some of the methods used for schedule
development are: critical path method, program evaluation and review technique,
and graphical evaluation and review technique.
14. (c) concurrent
A project consists of a series of activities. Two activities which are taken up at
the same time are called concurrent activities. An activity that must be completed
An activity that immediately succeeds another activity and which cannot be
started until the earlier one has been completed is called a successor activity.
The decomposition of the project activities should be continued till all the lower
level project activities fulfill the following conditions the activity must be
measurable; the activity should have a clearly defined start/end events; the
activity must have a clear deliverable; the time/cost of the activity must be
measurable; the duration of the activity must be in acceptable limits; and the
activity must be independent.
16. (d) In the top-down approach, the project goal level is decomposed to lower
levels until the project manager and his/her team are satisfied that the work
has been sufficiently well defined.
In the top-down approach of developing a WBS, the project goal level is
decomposed to lower levels until the project manager and his/her team are
satisfied that the work has been sufficiently well defined. The decomposition is
continued till the activities of the lower level satisfy the test of completeness.
Activities are not properly defined in the bottom-up approach. The team
approach and sub-team approach are variations in the bottom-up approach.
17. (c) Dividend capitalization approach
There are three main approaches that are used to define the deliverables and
build the work breakdown structure for a project. These are the noun-type
approach, the verb-type approach, and the organizational approach. The dividend
capitalization approach is used for calculating the cost of external equity.
43
18. (b) Only i and iv
The verb-type approach defines the project deliverables in terms of the actions to
be performed to produce them. The design-build-test-implement approach and the
objectives approach are the two types of verb-type approaches. The departmental
approach and business functional approach are types of organizational
approaches.
19. (a) noun-type approaches
Physical decomposition and functional decomposition are noun-type approaches
used in developing a work breakdown structure. In the physical decomposition
approach, the deliverables of the project work are defined in terms of the physical
components that make them up. In functional decomposition, the deliverables of
the project work are defined in terms of the functions that are required to be
performed to produce the end product.
20. (b) the functional decomposition approach.
Organizational approaches define project deliverables in terms of organizational
units. Geographical, departmental, and business functional approaches are
organizational approaches. The functional decomposition approach is a noun-
type approach.
21. (b) Verb-type approach
The verb-type approach defines the project deliverables in terms of the actions to
be performed to produce them. The design-build-test-implement approach and
the objectives approach are verb-type approaches. The departmental approach is
a type of organizational approach. In this approach, the project work is first
divided department-wise. Any other approach can be used later in each
department. Complex projects undertaken by a single firm usually follow the
departmental approach at the earlier stages. Resource allocation becomes simpler
this way, as each department will take care of the work assigned to it.
22. (b) The physical decomposition approach
The project manager of SafeQuip has developed the work breakdown structure
by defining the components used to create the deliverable. This approach of
defining the deliverables of the project work in terms of physical components
that make up the deliverable is called as the physical decomposition approach.
According to the business functional approach, the project work is divided based
on business functional areas. In functional decomposition, the deliverables of the
project work are defined in terms of the functions that are required to be
performed to produce the end product. In the design-build-test-implement
approach, all the features that are to be added to the project deliverable are
designed, built, tested, and then implemented.
23. (c) Physical decomposition approach
In the physical decomposition approach, the deliverables of the project work are
defined in terms of the physical components that make them up. According to
the business functional approach, the project work is divided based on business
functional areas. In the departmental approach, the project work is first divided
department-wise later any other approach can be used in each department. In
functional decomposition, the deliverables of the project work are defined in
terms of the functions that are required to be performed to produce the end
product.
Unit 8
Activities: Sequencing, Estimating Duration, and
Scheduling
Structure
1. Introduction
2. Objectives
3. Fundamentals of Project Network Diagram
4. Activity Sequencing
5. Activity Duration
6. Schedule Development
7. Techniques for Schedule Development
8. Schedule Control
9. Summary
10. Glossary
1. Introduction
In the previous unit, we have discussed how to identify the project activities. In this
unit, we will discuss how to sequence activities, estimate their duration, and schedule
them. After the project activities are identified, they are represented in a project
network diagram. The project manager sequences the project activities, estimates the
duration and then schedules the activities. The project manager sequences the project
activities by understanding the dependencies among them. He prepares the duration
estimates of each project activity with the help of duration estimates from other
projects, historical information, expert advice, etc.
The project manager schedules the project activities to estimate the start and finish
dates of each project activity, to arrive at the duration of the project. He can take help
from two important techniques: Program Evaluation and Review Technique (PERT)
and Critical Path Method (CPM) to schedule the project. Schedule control deals with
the study of factors that influence and change the project schedules. It aims at
managing changes to complete the project within the estimated schedule.
This unit will deal with the fundamentals of the project network diagram. We will
discuss activity sequencing and activity duration. We shall then move on to discuss
schedule development and the various techniques for schedule development. Finally,
we would be discussing schedule control.
2. Objectives
understand the fundamentals of project network diagram.
define activity sequencing and activity duration.
know about the techniques for schedule development.
define schedule control.
Activities: Sequencing, Estimating Duration, and Scheduling
45
3. Fundamentals of Project Network Diagrams
According to the Project Management Body of Knowledge (PMBOK), a project
network diagram is a schematic representation of the project activities and the logical
relationships (dependencies) among them. The diagram helps the project manager in
sequencing, scheduling and controlling the project. It represents all the project
activities, the sequence in which they have to be performed, the duration of each
activity, the interdependencies among various activities and the criticality
(significance) of each activity.
The project network diagram helps the project manager in project planning by
detailing the project activities, estimating the required resources, and displaying the
inter-relationships among activities. The diagram helps to determine the start and end
dates of each activity during scheduling and it also provides insights into possible
trade-offs while controlling the project.
A good project network diagram should answer the following questions:
1. What is the estimated completion time of a project?
2. How does a delay in an activity affect the expected completion time?
3. How can the expected completion time of a project be reduced, if additional
resources are available?
Activity and Node
The project network diagram is represented by a series of activities and nodes. An
activity is a specific task or operation required to do a project. It is depicted by an
arrow. A node (also called an event), is a time oriented reference point that signifies
the start or end of an activity. It is represented by a circle.
The difference between an activity and a node is that the activity represents the
passage of time and the nodes are points in time that denote the starting or ending of a
specific activity. In the diagram, activity A is represented with i and j as the starting
and ending nodes. The activity can also be written as i j. Event i is called the tail
event and event j is called the head event.
Dummy activity: An activity of zero duration that is used to represent the logical
relationship in the network diagram is called a dummy activity. Dummy activities do
not consume any resources, but are used to maintain the proper precedence
relationship between the activities that are not connected by the nodes. It is
represented by a dashed line headed by an arrow.
For example, in a project, A and B are concurrent activities. Activity C is dependent
on A and activity D is dependent on both A and B. Then the project manager uses a
dummy activity X to represent the relationship between activity A and activity D.
46
Dependencies in the Project Network Diagram
A dependency is a relationship that exists between a pair of activities. There are four
types of activity dependencies that describe the relationship between any pair of
activities. They are finish to start, start to start, start to finish and finish to finish.
Finish to Start
Finish to start dependency states that activity A must be completed before activity B
can begin. If activity A is obtaining raw material and activity B is inspecting the raw
material, then activity B can be performed only after the completion of activity A.
Therefore, the dependency is finish to start.
Start to Start
Start to start dependency states that activity B can be started only if activity A has
begun. This can be explained with the help of the previous example that is the
inspection activity can be started and continued once the raw materials start coming.
Subsequently, both activities go on in parallel.
Start to Finish
Start to finish dependency states that activity B must start before activity A can finish.
For example, if a firm wants to develop a new information system to replace the
existing one, the firm has to confirm that the new system is well operating. When the
new system starts to work (activity B), the existing system can be discontinued
(activity A).
Finish to Finish
Finish to finish dependency states that activity A must finish before activity B
finishes. For example, data feed operation (activity B) cannot be finished until the
collection of data (activity A) is completed.
Activity: John Robertson, the project manager-in-charge of construction of a
hospital, identified the following project activities: selecting the administrative
staff, selecting the site, selecting the equipment, designing a layout, bringing
them to the site, recruiting the medical staff and other support staff, purchasing
medical equipment, constructing the hospital, installing the equipment,
developing an information system and training the support staff to use it. To
construct a project network diagram, Robertson needs to know the dependencies
among various activities of the project. What is a dependency? What are the
different types of dependencies? Explain the dependencies among various
activities of the project.
Answer:
47
Check Your Progress
1. In a certain project, collection of data is an activity and the entry of data into an
information system is another activity. The activity of data entry cannot end until
the collection of data is completed. This is an example of
a. finish to start dependency.
b. start to finish dependency.
c. finish to finish dependency.
d. start to start.
2. A dummy activity in a project network diagram represents the _____________ in
the network diagram.
a. necessary time delays
b. logical relationship
c. allocation of resources
d. crashing of an activity
3. Given here is a list of activities that have to be carried out after the project
activities have been identified. Identify the correct sequence of these activities.
i. The project manager schedules the project activities to estimate the start and
finish dates of each project activity to arrive at the duration of the project.
ii. The project manager prepares duration estimates of each project activity with the
help of duration estimates from other projects, historical information, expert
advice, etc.
iii. The project manager sequences the project activities by understanding the
dependencies among them.
a. ii-i-iii
b. i-iii-ii
c. iii-ii-i
d. iii-i-ii
4. Which of the following is a schematic representation of project activities and the
logical relationships or dependencies among them?
a. Control chart
b. Project network diagram
5. ___________ is a specific task or operation required to do a project.
a. Event
b. Node
c. Slack
d. Activity
6. An activity can also be represented as i-j. i is called the ____________ and j
is called as the ______________.
a. tail event, head event
b. head event, tail event
c. head event, dummy activity
d. dummy activity, tail event
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7. A dummy activity is one that has
a. zero duration.
b. the lowest duration.
c. the highest duration.
8. In a project network diagram, j denotes
a. the starting node.
b. an activity.
c. the ending node.
d. Both (a) and (c)
9. In a project network diagram, a node is
a. a time-oriented reference point that signifies the start or end of an activity.
b. represented by an arrow.
c. a specific task or operation required to do a project.
d. also called as a float.
10. Which of the following statements correctly differentiates between an activity
and a node?
a. An activity is represented by a circle while a node is represented by an arrow.
b. An activity represents the passage of time while the nodes are points in time that
denote the starting or ending of a specific activity.
c. An activity is a time-oriented reference point that signifies the start and end of a
node while a node is an element of work performed during the course of a project.
d. All of the above
11. Consider two activities A and B. Start to start dependency between these two
activities states that
a. Activity B must start before activity A can finish.
b. Activity A must finish before activity B finishes.
c. Activity B can be started only if activity A has begun.
d. Activity A should be completed before activity B can begin.
12. Activity B must start before activity A can finish. This is called
a. start to start dependency
b. start to finish dependency
c. finish to finish dependency
d. finish to start dependency
13. Identify the statements that are true regarding a dummy activity.
i. A dummy activity is an activity of zero duration that is used to represent the
logical relationship in the network diagram.
ii. Dummy activities do not consume any resources.
iii. Dummy activities are used to maintain the proper precedence relationship
between the activities that are not connected by the nodes.
iv. Dummy activities are represented by circles in a project network diagram.
49
14. Identify the statement that is not true regarding a project network diagram.
a. A project network diagram is a schematic representation of the project activities
and the logical relationships among them.
b. The project network diagram helps the project manager in sequencing,
scheduling, and controlling the project, but does not explain how a delay in an
activity affects the expected completion time.
c. The project network diagram represents all the project activities, the sequence in
which they have to be performed, the duration of each activity, the
interdependencies among various activities, and the criticality of each activity.
d. The project network diagram helps to determine the start and end dates of each
activity during scheduling, but does not provide insights into the possible trade-
offs while controlling the project.
15. In a project, activity A should be completed before activity B can begin. This is
called
a. finish to start dependency.
b. start to finish dependency.
c. finish to finish dependency.
d. start to start.
16. In a project network diagram, a node is also called a/an _________.
a. activity
b. event
c. slack
4. Activity Sequencing
Once the project activities are identified using the work breakdown structure, the
project manager prepares an activity list of the project. He puts all the activities down
in a logical sequence to arrive at the project end-product. Several project management
software packages like Project 2000 provide sequencing of activities to achieve the
project end product. While sequencing the activities, the project manager has to study
various aspects such as the description of the end product, mandatory and
discretionary dependencies among the activities, external dependencies, other
constraints and assumptions of the project.
While analyzing the product description, the project manager has to consider the
physical characteristics of the product and the logical sequencing of the activities to
achieve the end product. The product description is generally less detailed in early
phases of the project and it is progressively elaborated later.
The project manager analyzes the mandatory and discretionary dependencies among
the various project activities. Mandatory dependencies are those that are inherent in
the nature of project. Here, the dependency between activities is certain. For example,
new machinery is erected only when the layout has been finalized. Mandatory
dependency is also called as hard logic. Therefore the dependency among the
activities is mandatory. Discretionary dependencies are those dependencies of the
project that are defined by the project team. Discretionary dependencies are defined
by the knowledge of the best practices and the standard procedures followed for
certain activities in the project. This dependency is also called as soft logic or
preferred logic.
50
The project manager also has to analyze the dependencies among project activities
with external activities. For example, voter identity cards should be distributed before
the elections. Therefore, the activity of holding elections is dependent on the
distribution activity. The sequencing of activities is also affected by several other
constraints and assumptions made by the project manager regarding the project.
Methods of Activity Sequencing
The project manager considers all the above issues to sequence the project activities.
The project manager sequences all the project activities in an appropriate manner and
represents them in the project network diagram. Some of the methods of activity
sequencing are given below. Figure 8.1 represents the various activity relationships in
ADM and PDM methods.
Figure 8.1: Activity Relationships in ADM and PDM Methods
Arrow Diagram Method (ADM)
In this method, the network diagram is constructed using arrows to represent the
activities and connecting them at nodes to show the dependencies. This method uses
finish-to-start dependencies only to explain the logical relationships. This method is
also called as Activity-On-Arrow (AOA) method.
Precedence Diagram Method (PDM)
In this method, the network diagram is constructed using nodes to represent the
activities and connecting them with arrows to represent the dependencies. This
method uses all four types of dependencies. This method is also called as Activity-On-
Node (AON) method.
Conditional Diagramming Methods
The project manager also uses conditional diagramming methods like GERT
(Graphical Evaluation and Review Technique) and system dynamics that represent
non-sequential activities like loops (where activities are repeated again and again) or
conditional branches (e.g. a design update is required only when errors are found in
the inspection). PDM and ADM cannot represent loops and conditional branches.
Activity: The project of installing milling machines involves activities A, B, C and
D. Raghavendra, the project manager, identifies the relationship among the
activities: activities B and C cannot begin until activity A has been completed;
activity D cannot begin until activities B and C have been completed. How can he
represent these relationships in a project network diagram using the Arrow
Diagram Method (ADM) and Precedence Diagram Method (PDM)?
Contd
51
Contd
Answer:
Check Your Progress
17. In a certain project, activity B and activity C cannot begin until activity A has
been completed. How is this activity relationship represented using the activity-
on-arrow method of activity sequencing?
a.
b.
c.
d.
18. Discretionary dependencies are
i. Those dependencies among project activities that are inherent in the nature of the
project.
ii. Those dependencies among project activities that are defined by the project team.
iii. Those dependencies among project activities that are certain or mandatory.
iv. Also called preferred logic.
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
19. Which of the following aspects should the project manager consider while
analyzing the product description?
i. The physical characteristics of the product
ii. The dependencies among the various project activities
iii. The logical sequencing of the activities to achieve the end product
iv. The dependencies among the project activities with external activities
52
a. Only i and iii
b. Only i and iv
c. Only ii and iii
d. Only iii and iv
20. Which conditional diagramming method represents non-sequential activities like
loops and conditional branches to sequence project activities?
a. The Arrow Diagram Method (ADM)
b. The Precedence Diagram Method (PDM)
c. The Graphical Evaluation and Review Technique (GERT)
d. All of the above
21. The arrow diagram method
a. is also called activity-on-node method.
b. makes use of all the four types of dependencies.
c. involves constructing the network diagram using arrows to represent activities
and connecting them at nodes to show the dependencies.
d. involves constructing the network diagram using nodes to represent the activities
and connecting them with arrows to represent the dependencies.
22. ___________ are dependencies that are inherent in the nature of the project.
a. Preferred logic
b. Mandatory dependencies
c. Discretionary dependencies
d. Both (a) and (b)
23. Which of the following statements are true regarding the precedence diagram
method used to sequence activities?
i. The precedence diagram method is also called activity-on-arrow method.
ii. The network diagram is constructed using nodes to represent the activities and
connecting them with arrows to represent the dependencies.
iii. All the four types of dependencies start to start, start to finish, finish to start,
and finish to finish, are used.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
24. From the following options, identify the methods/techniques used for activity
sequencing.
i. Arrow diagram method
ii. Critical path method
iii. Precedence diagram method
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
53
25. Which of the following aspects should the project manager keep in mind while
sequencing the activities to achieve the projects end product?
i. Description of the end product
ii. Mandatory and discretionary dependencies among the activities
iii. External dependencies
iv. Constraints and assumptions of the project
a. Only i and ii
5. Activity Duration
After the project activities are sequenced, the project manager estimates the duration
of each activity to calculate the duration of the entire project. The duration of an
activity is the time period required to complete the activity. As it is not possible for a
person to work continuously, the project manager may include some time allowance
while estimating activity duration. He assigns these allowances based on his
experience, the difficulty involved in the activity, the ability of the workman to
execute it, etc. It is assumed that an average performer completes an activity in the
estimated duration with his normal performance.
The activity duration is not synonymous with work effort. Suppose an activity takes
30 days to complete, we cannot assume that the effort is made for 30 days, even
though the activity duration is 30 days. For example, if the activity is to consult an
external expert for the given problem, the actual consultation time is only about 3
hours, but the duration assigned for the activity will be about 30 days considering the
time required to find the expert, discuss the matter and solve the problem.
Activity duration could also be influenced by the amount of resources allocated.
Generally speaking, more the resources, the shorter the duration of the activity. For
example, if more number of people are included to work on a project, then the project
can be completed on or before time. However, it cannot be assumed that the
relationship between activity duration and resources allocated is completely
proportional. Thus, the project manager has to allocate more resources till the crash
point is arrived at. Beyond this point, it is not possible to reduce the duration of an
activity.
The actual duration of activities may vary from the estimates. Therefore, the project
manager has to see to it that there is as little deviation as possible. The different skill
levels of manpower employed, unexpected events like acts of nature, vendor delays,
power failures, or misunderstanding the nature of work are some of the causes for
variations of actual activity durations from the estimates.
Methods of Estimating Activity Duration
The project manager uses the techniques given below to estimate the appropriate
duration of the project activities.
Similarity to Other Activities
Some project activities may be similar to activities in other projects. In such cases, the
estimates of activity duration can be taken from those activities. This is normally
followed in case of administration activities that are common for all projects.
54
Historical Data
The actual durations of successful projects in the past can be used to estimate the
duration of the activity. Larger firms maintain an extensive database of activity
duration history that records the estimated time, actual time, reasons for time overrun
(if there was one), characteristics of the activity, the skill levels of the people, etc.
Whenever firms wish to assign duration estimations, they refer to historical data and
find the duration estimate and actual time.
Expert Advice
In case of highly technical activities, the project manager can consult a technical
expert to estimate the activity duration. He can also consider the advice of vendors
and other non-competing firms to assign the duration estimates.
Delphi Method
In this method, the project manager forms a group of people and asks them to estimate
the duration of an activity, after describing the nature and characteristics of the
activity. The estimates of each participant are then collected. Those participants whose
estimations are very high or very low are asked to explain the reasons for their
estimates.
The project manager then discusses with all the group members to know why their
estimates are higher or lower than estimates of the other participants. He then asks the
participants to write down new estimates of duration after the discussion. This process
continues until the entire group arrives at a particular estimate. In general, this method
is followed when expert advice is not available.
Three- Point Method
The duration of an activity may vary even when the same activity is repeated in
similar conditions. Therefore the project manager considers three types of estimates in
this method.
They are:
1. Optimistic time
2. Pessimistic time
3. Most Likely time
Optimistic time (t
0
)
Optimistic time is the minimum amount of time within which an activity can be
completed. It is possible to complete an activity within the optimistic time only when
the external environment is extremely favorable.
Pessimistic time (t
p
)
Pessimistic time is the maximum amount of time required to complete an activity.
This happens when the external environment is unfavorable.
Most Likely time(t
m
)
It is the time that is the best guess for an activity completion neither optimistic nor
pessimistic.
Expected time (t
e
)
The project manager arrives at the expected time based on the above estimates. The
project manager calculates the estimate of duration of an activity as,
55
6
p
t
m
4t
o
t
e
t
The expected time of an activity cannot be more than the pessimistic time of that
activity. However, it can be more than the optimistic time. The expected time of an
activity is more than, less than, or equal to the most likely time of that activity.
Wide Band Delphi Method
A combination of the Delphi method and the three point method is referred to as the
Wide Band Delphi method. In this method, the members are asked to give an
optimistic time, a pessimistic time, and the most probable time, instead of a single
estimate. Then the project manager follows the Delphi method and determines the
duration estimate.
Check Your Progress
26. Which of the following time is not included in calculating the variance of a
project?
a. Optimistic time
b. Pessimistic time
c. Most likely time
27. The _______________ refers to a point beyond which it is not possible to reduce
the duration of an activity.
a. node
b. slack
c. free float
d. crash point
28. If a, b, c are the optimistic, pessimistic, and most likely times of an activity, then
the variance of the activity is calculated as
a.
36
2
a c
b.
36
2
c a
c.
36
2
c b
d.
36
2
a b
29. The duration of a project activity can be estimated by:
i. taking estimates of duration of similar activities in other projects.
ii. taking the actual durations of successful projects in the past.
iii. consulting a technical expert to estimate activity duration.
iv. forming a group of people and asking them to estimate the duration of the activity
after describing the nature and characteristics of the activity.
56
30. Identify the method of estimating the duration of an activity in which the
members are asked to give an optimistic time, a pessimistic time, and the most
probable time, instead a single estimate.
a. Expert advice
b. Delphi method
c. Three-point method
d. Wide Band Delphi method
31. Match the following types of estimates with their descriptions.
i. Optimistic time
ii. Pessimistic time
iii. Most likely time
p. The maximum amount of time required to complete an activity
q. The time that is the best guess for an activity completion
r. The minimum amount of time within which an activity can be completed
a. i/q, ii/r, iii/p
b. i/r, ii/p, iii/q
c. i/q, ii/p, iii/r
d. i/r, ii/q, iii/p
32. If a, b, and c represent optimistic time, most likely time and pessimistic time of an
activity respectively, then the expected time of an activity is calculated as
a.
6
c b a
b.
6
c 4b a
c.
6
c b 4a
d.
6
4c b a
33. Which of the following statements is not true about the expected time of an
activity?
a. It can be more than the optimistic time of that activity.
b. It can be less than the most likely time of that activity.
c. It can be more than the pessimistic time of that activity.
d. It can be more than the most likely time of that activity.
57
Exercise
A. The optimistic, pessimistic, and most likely times of an activity are 5 days, 12
days, and 7 days, respectively. Calculate the expected time of an activity.
6. Schedule Development
Schedule development is concerned with determining a realistic start and finish time
for project activities. It aims to match project resources like machinery, materials and
labor with project activities over time. Good scheduling eliminates production
problems, facilitates timely procurement of raw materials, and ensures project
completion on time. Otherwise, it may lead to delays in project activity, loss of
inventory and cost overruns.
The project manager should be aware of the resources and the quantity of these
resources needed at every stage of the project. He has to prepare a resource pool
description that contains details of all the project resources and their allocation to
project activities.
The project manager prepares two types of calendars; project calendars and resource
calendars to schedule the project. Project calendars emphasize the completion time of
the project activities. Suppose it is estimated that the project is to be completed in
7,200 hours in normal working conditions. Then schedules are prepared based on the
time estimates. The project manager assumes that 60% of the project is accomplished,
if 4,320 hours are spent on the project. Most of the projects are scheduled based on
project calendars.
Resource calendars schedule the project on the basis of the resources used. The focus
here is on scheduling and utilizing specific resources effectively. For example, a
construction project requires 1200 bags of cement. If 360 bags have been used, the
project manager can assume that 30% of the work has been done. Here, the project
manager concentrates on whether the specific resources are being used effectively or
not. Project calendars are concerned with how various project resources are consumed
over a period of time. Resource calendars deal with how a specific resource or specific
category of resources is spent over a period of time.
7. Techniques for Schedule Development
The project manager can use some of the following methods for schedule
development:
1. Critical Path Method (CPM)
2. Program Evaluation and Review Technique (PERT)
3. Graphical Evaluation and Review Technique
These methods are used:
1. To estimate the completion time of the project
2. To find out if the project is behind, ahead of or on schedule.
3. To compare the actual resources spent with the planned resources at any stage of
the project.
4. To study activities that are critical for project completion and activities that can
be delayed without delaying project completion.
5. The project network diagram is used in schedule development.
58
Construction of a Network Diagram
Before assigning the duration estimates, the project manager sequences all the
activities and then gives numbers to all nodes.
Numbering Nodes
Step 1: Assign the starting event as 0.
Step 2: Assign the next number to any unnumbered event whose predecessor events
are already numbered.
Repeat Step 2 until all events are numbered.
The basic scheduling computations of a project can be grouped under three heads:
Forward pass, backward pass, and calculation of floats.
Forward Pass
The forward pass computation finds the earliest start and earliest finish times for each
activity; or the earliest expected occurrence time for each node. The computation
starts with an assumed earliest occurrence time of zero for the initial project event.
The earliest starting time for activity (i,j) is the earliest event time of the tail event. i.e.
ES
ij
= E
i
.
The earliest finish time for activity (i,j) is the earliest starting time plus the activity
duration, t
ij
i.e, EF
ij
= ES
ij
+ t
ij
Event is just a time oriented reference point. Events will have only the earliest time
and latest time. The earliest time is obtained in the forward pass, and the latest time is
obtained in the backward pass. But every activity will have earliest start time, earliest
completion time in forward pass and latest start time and latest finish time in
backward pass.
Suppose an activity A is connected between two events i and j, and duration of the
activity is 5 units of time. Then the earliest start time of activity A is 0 and the earliest
completion time is 5. Also, the earliest time of event i is 0, and the earliest time of
event j is 5.
Earliest event time for event j is the maximum of earliest finish time of all activities
leading into that activity.
E
j
= Maximum {E
i
+ t
ij
}.
Consider the network diagram, where three activities are leading into event m.
59
Here, the earliest event time at m, is the maximum of the earliest finish times of all
the activities ending into that activity.
Thus, E
m
is the maximum of
{(ES
im
+ t
im
), (ES
jm
+ t
jm
), and (ES
km
+ t
km
)}
Backward Pass
The backward computation finds the latest start and completion times of each activity
without affecting the total project duration. Here the calculation starts at the end
node and ends with the first node. The total project duration is taken as the latest
time of the end node.
Latest finish time for activity (i,j) is the latest event time of event j. i.e., LF
ij
= L
j
Latest starting time for activity (i,j) is the difference between the latest completion
time of (i,j) and the activity duration. i.e., LS
ij
= LF
ij
t
ij
Latest event time for event i is the minimum of the latest start time of all activities
starting from that the event i.
L
i
= Minimum {LF
ij
t
ij
}.
Consider the network diagram, where three activities are beginning at the event i.
The latest event time of event i is calculated as:
Minimum of {(LF
ij
t
ij
), (LF
im
t
im
), (LF
il
t
il
)}
Calculation of Floats
There are three types of floats. They are:
1. Total float
2. Free float
3. Independent float
Total Float
This is the amount of time by which the completion of an activity can be delayed
beyond its expected earliest completion time without affecting the overall project
duration. It is calculated as the difference between the latest start time and the earliest
start time of a project activity.
Total float= LS
ij
ES
ij
= (L
j
t
ij
) ES
ij
= (L
j
E
i
) t
ij
60
Free Float
This is the amount of time by which the completion of an activity can be delayed beyond
the earliest finish time without affecting the earliest start of a subsequent activity.
Free float= Earliest event time of event j Earliest event time for event i activity
time (i,j)
= (E
j
E
i
) t
ij
Independent Float
This is the amount of time by which the start of an activity can be delayed without
affecting the earliest start of any activities following immediately.
Independent float= (E
j
L
i
) t
ij
Event Slacks
For an event, slack is the difference between the latest event time and earliest event
time. For an event i, slack = L
i
E
i
For an activity (i, j), the slack of event j is called head slack, and the slack of event i is
called tail slack.
Head slack = L
j
E
j
Tail slack = L
i
E
i
The values of free float and independent float can be expressed in terms of head and
tail slacks.
Free float = E
j
E
i
t
ij
= L
j
E
i
- t
ij
(L
j
E
j
)
= Total float Head slack
Independent float = (E
j
L
i
) t
ij
= E
j
E
i
t
ij
( L
i
E
i
)
= Free float Tail slack
The Various floats and slacks of an activity (i,j) can be represented in the following
manner:
61
Example 8.1
Suppose a project has seven activities A, B, C, D, E, F, and G. The predecessor
activity (ies) of a particular activity and duration estimates of all project activities are
given in Table 8.1.
Table 8.1: Project Activities and Duration Estimates
Predecessor Activity Duration
A --- 6
B A 1
C --- 8
D C 5
E B, C 9
F D, E 12
G F 3
The network diagram for the given project activities is shown in Figure 8.2 (a). Here,
activity X is a dummy activity. Each node is assigned a certain number that is written
on the top half of the circle. The earliest completion time is represented on the bottom
left and the latest completion time on the bottom right of the circle.
Figure 8.2 (a): Project Network Diagram
Note: X is a dummy activity
The network is depicted using the Activity-On-Arrow method.
The earliest and latest event times are to be calculated now, in order to complete the
project network diagram and fill in the Earliest Time (E
i
) and Latest Time (L
i
) (for
each node) in Table 8.2 (a).
Let us assume that the unit of time is days.
Forward Pass Computation: To determine the Earliest Time (E
i
) of each event (node)
from 0 to 6.
For Event 0, Earliest Time, E
0
= 0.
Since Event 0 simply signifies the start of the project, E
0
will always be 0.
(The computation starts with an assumed earliest occurrence time of zero for the
initial project event.)
62
For Event 1, E
1
= 0 + 6 = 6.
Event 1 can occur as soon as Activity A is completed. Activity A starts at Event 0 and
takes 6 days for completion [Refer to Table 8.1 or Figure 8.2(a)].
So, earliest occurrence of Event 1
= Earliest occurrence of Event 0 + Duration of Activity A
= E
0
+ 6 = 0 + 6 = 6 days.
(Earliest event time for event j is the maximum of earliest finish time of all activities
leading into that event.)
Using formula, this is represented as, E
1
= E
0
+ t
A
= 0 + 6 = 6 days.
Similarly, E
2
= E
0
+ t
C
= 0 + 8 = 8 days, as Event 2 can occur as soon as Activity C is
completed.
Event 3 denotes the situation that Activity E can start. For this, predecessor activities
B and C should be over (Refer Table 8.1). From the project network diagram, this can
also be viewed as the condition that activity B and dummy activity X (which follows
Activity C) should be over.
Earliest completion of Activity B = E
1
+ Time taken by Activity B = 6 + 1 = 7 days.
Earliest completion of Activity C = E
0
+ Time taken by Activity C = 0 + 8 = 8 days.
(From the project network diagram, earliest completion of dummy activity X = E
2
+ 0
= 8 + 0 = 8 days.)
So, earliest event time of Event 3 = E
3
= Max (7, 8) = 8 days.
(Earliest event time for event j is the maximum of earliest finish time of all activities
leading into that event.)
Using formula, the above calculation is represented as;
E
3
= Max [(E
1
+ t
B
), (E
2
+ t
X
)] = Max [(6 + 1), (8 + 0)] = 8 days.
Similarly, E
4
= Max [(E
3
+ t
E
), (E
2
+ t
D
)] = Max [(8 + 9), (8 + 5)] = 17 days.
E
5
= E
4
+ t
F
= 17 + 12 = 29 days.
E
6
= E
5
+ t
G
= 29 + 3 = 32 days.
Table 8.2 (a): Earliest and Latest Times
Node Earliest Time Latest Time
0 0 0
1 6 7
2 8 8
3 8 8
4 17 17
5 29 29
6 32 32
63
Backward Pass Computation: To determine the Latest Time (L
i
) of each event (node)
from 0 to 6. Here, Node 6 represents project completion. The backward pass is done,
without affecting the total project duration. That is, the earliest occurrence of the
last node in the network is also taken as the latest occurrence of that node. Therefore,
L
6
= E
6
= 32 days.
Now, we work backwards from Event 6, following the two rules given below:
When a node is the starting point (tail) for only one activity (e.g., nodes 1, 3, 4, 5), the
latest time for the node is the latest start time of the activity starting from that event.
This is computed as the difference between the latest event time of the head node and
the activity duration.
That is,
L
5
= L
6
t
G
= 32 3 = 29
L
4
= L
5
t
F
= 29 12 = 17
L
3
= L
4
t
E
= 17 9 = 8
When an event (node) is the starting point of two (or more) activities, as in node 0 or
node 2; the latest time for the node is the minimum of the latest start times of the
activities starting from the event. This is mathematically represented below.
L
2
= Min [(L
3
t
X
), (L
4
- t
D
)] = Min [(8 - 0), (17 - 5)] = 8 days.
L
1
= L
3
t
B
= 8 1 = 7 days.
L
0
= Min [(L
1
t
A
), (L t
C
)] = Min [(7 - 6), (8 - 8)] = 0 days.
Calculation of Floats:
Total float:
For activity A, the total float is,
(L
i
E
j
) t
ij
= (7 0) 6 = 1.
For activity B, the total float is = (8 6) 1= 1.
For activity C, the total float is = (8 0) 8 = 0.
Similarly, total float values can be determined for all the activities.
Free float:
For activity A, the free float is,
Total float Head slack = 1 (7 6) = 0.
For activity B, the free float is, 1 (8 7) = 0.
For activity C, the free float is, 0 (8 8) = 0.
Similarly, free float values can be determined for all the activities.
Independent float:
For activity A, the independent float is,
Free float Tail slack = 0 (0 0) = 0.
For activity B, the free float is, 1 (7 6) = 0.
For activity C, the free float is, 0 (0 0) = 0.
Similarly, independent float values can be determined for all activities.
64
Table 8.2 (b): Floats of the Project Activities
Activity Duration Total Float
(L
i
E
j
) t
ij
Free Float (Total
Float Head
Slack)
Independent Float
(Free Float Tail
Slack)
A 6 1 0 0
B 1 1 0 0
C 8 0 0 0
X - 0 0 0
D 5 4 4 4
E 9 0 0 0
F 12 0 0 0
G 3 0 0 0
Figure 8.2 (b): Project Network Diagram
The critical path of the project is the longest path through the network. The length of
the critical path gives the shortest allowable time for the completion of the project.
This helps the project manager to concentrate and prioritize critical activities while
allocating project resources.
From Figure 8.2 (b) and Table 8.2 (b), the critical path is C X E F G (indicated
in the figure by thick arrows). Therefore, the project takes at least 32 time units
(8+0+9+12+3=32) for completion.
Table 8.3: Floats of the Project Activities
Activity Duration Total Float
(L
j
-E
i
)-t
ij
Free Float
(Total Float
Head Slack)
Independent
Float (Free Float
Tail Slack)
A
B
C
D
E
F
G
X
6
1
8
5
9
12
3
-
1
1
0
4
0
0
0
0
0
1
0
4
0
0
0
0
0
0
0
4
0
0
0
0
65
Check Your Progress
34. The project manager develops the project schedule on the basis of the raw
materials consumed in a project. What type of schedule development calendar is
this?
a. Project calendar
b. Resource calendar
c. Resource pool description
35. Methods like the critical path method, the program evaluation and review
technique, and the graphical evaluation and review technique are used to:
i. Estimate the completion time of the project
ii. Find out if the project is behind, ahead of, or on schedule.
iii. Compare the actual resources spent with the planned resources at any stage of the
project.
iv. Study activities that are critical for project completion and activities that can be
delayed without delaying project completion.
36. Match the following types of floats with their descriptions.
i. Total float
ii. Free float
iii. Independent float
p. The amount of time by which the completion of an activity can be delayed
beyond the earliest finish time without affecting the earliest start of a subsequent
activity.
q. The amount of time by which the start of an activity can be delayed without
affecting the earliest start of any activities following immediately.
r. The amount of time by which the completion of an activity can be delayed
duration.
a. i/p, ii/r, iii/q
b. i/r, ii/p, iii/q
c. i/q, ii/r, iii/p
d. i/r, ii/q, iii/p
37. Which of the following statements is not correct for an activity in a project
network diagram?
a. Total float is the difference between the latest start time and the earliest start time
of a project activity.
b. Slack is the difference between the latest event time and earliest event time.
c. Free float is the difference between total float and head slack.
d. Independent float is the difference between total float and tail slack.
66
38. Which of the following methods is not used for developing schedules?
a. The Critical Path Method
b. The Work Breakdown Structure
c. The Program Evaluation and Review Technique
d. The Graphical Evaluation and Review Technique
39. For an activity (i, j), the difference between the latest finish time and the earliest
finish time represents
a. head slack.
b. tail slack.
c. activity duration.
d. total float.
40. Identify the techniques used for scheduling the project.
i. Black box
ii. Critical path method
iii. Realized yield method
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
Exercises
B. A project network diagram has three activities A, B, and C. All these activities
lead into event x.
The earliest start times of activities A, B and C are 3 days, 5 days, and 7 days,
respectively. The duration estimates of these activities are 5 days, 7 days, and 11
days, respectively. What would be the earliest event time at X?
C. The earliest start, earliest finish, latest start and latest finish times of an activity P
are given below: The duration of activity P is 7 units. What is the total float, free
float and independent float of activity P?
67
D. The earliest start, earliest finish, latest start and latest finish times of an activity A
are given below: The duration of activity A is 8 units. What is the total float of
activity A?
Critical Path Method (CPM)
Critical Path Method is a network analysis technique used to predict the project
duration by finding out which sequence of activities (the critical path) has the least
amount of scheduling flexibility. In this method, the project manager identifies the
critical activities of the project that constitute the critical path of the project.
Critical activities are those activities whose total float value is 0. This means, any
delay in the critical activity results in a delay in the entire project to the same extent.
The project manager identifies a series of critical activities from the beginning of the
project to its completion. The series of critical activities is called the critical path of
the project.
The critical path of the project is the longest path through the network. The length of
the critical path gives the shortest allowable time for the completion of the project.
This helps the project manager to concentrate and prioritize critical activities while
allocating project resources.
Program Evaluation and Review Technique (PERT)
The duration estimates in this technique are probabilistic. The project manager
considers optimistic, pessimistic and the most likely completion time of each activity
rather than a single estimate as in the Critical Path Method.
The project manager calculates the expected time (t
e
) for each activity as,
6
p
t
m
4t
o
t
e
t ,
Where, t
o
, t
p
, and t
m
are the optimistic, pessimistic and most likely completion times
of a project activity.
The methodology of PERT is explained below:
Step 1: Develop a list of project activities, and identify all their immediate
predecessors.
Step 2: Calculate time estimates for each activity as
6
p
t
m
4t
o
t
e
t
Step 3: Calculate the earliest start time and earliest finish time for each activity, based
on the expected time.
Step 4: Identify the critical path of the network taking into consideration those
activities whose total float value is 0 and determine the expected project duration.
Step 5: Calculate the standard deviation of the project. The standard deviation is a
square root value of project variance. The variance of a project activity is calculated as
(t
p
t
o
)
2
/ 36, and the project variance is the sum of variances of all project activities.
68
Step 6: The square root value of project variance gives the standard deviation of the
project. Calculate the value of z as,
z = (Due date Expected date of completion) / (Standard deviation of the project).
Where, z is the number of standard deviations the due date lies from the mean or
expected date.
Step 7: Using the standardized normal distribution table, determine the probability of
meeting a specific completion date for the obtained z value.
Step 8: Crash or compress the project to the extent possible.
Example 8.2
The pessimistic, most likely, and optimistic times (in number of days) of the activities
in a particular project are given below, along with the predecessor activities. Find the
probability of completing the project in 26 days.
Figure 8.3 (a): Project Network Diagram
Figure 8.3 (a) is the network diagram for the given project. The critical path of the
project is A-C-E and the expected project completion time is 24 days.
Activity Predecessor(s) t
o
t
m
t
p
A - 6 8 10
B A 2 3 10
C A 10 11 18
D A, B 3 4 11
E A, C 4 4 4
The expected completion time of an activity is calculated as:
6
p
t
m
4t
o
t
e
t
The variance of an activity is calculated as:
36
2
o
t
p
t
The expected completion time of all project activities, and their variances are given
below.
69
Activity Expected Time Variance
A* 8 0.44
B 4 1.78
C* 12 1.78
D 5 1.78
E* 4 0
* denotes critical activity.
As the critical path is A-C-E, the expected project completion time (expected time) for
A-C-E = 8 + 12 + 4 = 24 days.
Therefore, expected project completion time = 24 days.
The total variance of the project (considering all activities) =
0.44 + 1.78 + 1.78 + 1.78 + 0 = 5.78
Therefore, standard deviation ( ) of the project 5.78 = 2.4
The probability of completing the project by 26 days is the probability of completing
the project in less than or equal to 26 days.
For x = 26, the corresponding value of the standard normal variate z is
z = (Due date Expected date of completion) / (Standard deviation of the project)
= (26-24)/2.4 = 0.83
P(x < 26)
2.4
24 26
z P
P(z < 0.83)
0.83) z P(0 0) z P(
(From the standardized normal distribution function, F(z) table, the area under the
normal curve corresponding to z = 0.83 is 0.2967.) Refer to Figure 8.3 (b).
Figure 8.3 (b): Calculation of Probability
70
0.5 + 0.2967
0.7967
Hence, the probability of completing the project in 26 days is 0.7967.
Note: In standard normal distribution, probability of completing the project in
expected time ( ) will always be 0.5. As due date (26 days) is more than (24 days),
probability of completion will definitely be greater than 0.5.
Check Your Progress
41. Which of the following statements is not true regarding the critical path method?
a. It is used to predict the project duration by finding out which sequence of
activities (the critical path) has the least amount of scheduling flexibility.
b. The critical path of the project is the shortest path through the network.
c. The length of the critical path gives the shortest allowable time for the completion
of the project.
d. Both (b) and (c)
42. ______________ is a network analysis technique used to predict the project
duration by finding out which sequence of activities has the least amount of
scheduling flexibility.
a. Crashing
b. Fast tracking
c. Decomposition
d. Critical path method
Exercises
(Questions E-G)
Nishant International has taken up an overseas project. The optimistic, most likely,
and pessimistic times of the activities in the project are given here.
Activity Optimistic time Most likely time Pessimistic time
A 2 8 12
B 3 5 10
C 4 7 18
D 3 9 16
E 5 8 14
E. Calculate the expected time of completion of the project.
F. Calculate the total variance of the project.
G. Find out the probability of completing the project in 27 days.
H. Saharsh is the project manager of a company currently working on a software
project. The expected project completion time is 28 days and the standard
deviation of the project is 2.56. What is the probability of Saharsh finishing the
project in 30 days?
71
I. The variances of the critical activities of a project are 0.2, 0.6, 0.5, and 0.7. What
is the standard deviation of the project?
J. The optimistic, pessimistic, and most likely times of an activity are 3, 10, and 7
days, respectively. Calculate the variance of the activity.
Graphical Evaluation and Review Technique (GERT)
Graphical Evaluation and Review Technique is similar to PERT, except that it allows
multiple project activities by the way of looping and branching project activities.
Suppose an activity fails due to some unavoidable reasons, then the project manager
has to look for alternative ways to obtain the end result.
Similarly, some of the activities may not be carried out at all, some may be partially
carried out and some that may be repeated. PERT cannot show alternative plans in a
single network diagram. GERT overcomes these problems as it shows alternative
ways to continue the project.
Duration Compression Techniques
When the project manager finds that the expected completion time of the project is
more than the desired time, he attempts to reduce the project duration using some
duration compression techniques like crashing, fast tracking, etc.
Crashing
Crashing refers to decreasing the total project duration after analyzing a number of
alternatives to determine how to get the maximum duration compression for the least
cost. Here, the project manager reduces the project duration by allotting more
resources, subcontracting some activities, using more labor, etc. The project manager
considers the time-cost trade-offs for all project activities. These trade offs reveal how
the duration of a project activity is reduced with additional costs. Normally, the
project manager focuses on time-cost trade offs for the critical activities of the project
as they play a major role in deciding the project completion time.
Some people argue that crashing may decrease the quality of a project. As all project
activities cannot be completed just by adding more resources, the project manager
should ensure that the quality of the project end product does not suffer as a result of
crashing. Activities like planning and inspection are not crashed, in general, because
they have an effect on the quality of the project output.
The following are the types of activities that are considered for crashing:
1. A critical activity of the project.
2. An activity of longer duration.
3. An activity that has low per unit crash cost.
4. An activity that does not cause any quality problems, if crashed
5. An activity that is labor intensive.
The crashing procedure is explained below:
Constraints:
The maximum extent of crashing of an activity is given as part of the problem
statement. (For instance, in Example 8.3, activity 12 can be crashed by a maximum
of 2 weeks, from 8 to 6 weeks).
Activities of the critical path(s) are to be crashed, in order to reduce the total project
time.
72
Steps:
1. Identify the sequence of activities and prepare a network diagram. Each activity
should list the details of normal cost, normal time, crash cost and crash time.
2. Compute the critical path of the project network.
3. Calculate the crashing cost for all project activities using the formula:
Crash slope =
time Crash time Normal
cost Normal cost Crash
4. The most effective way of crashing, is to start with the activity in the critical path
having minimum crash slope, that is, minimum additional cost per unit of
reduction in time. If possible, the other critical path activities can also be crashed
in the ascending order (lowest to highest) of the crash slope. At each step of
crashing, an activity can be crashed to the extent possible, such that the relevant
path continues to be a critical path.
5. While crashing a project, if we get new critical paths in addition to the original
critical path, subsequent crashing should be done in such a way that there is
reduction of time along all these parallel critical paths so that the total project
duration decreases.
6. The crashing process is continued till further crashing is not possible, or it does
not result in the reduction of project duration.
7. For different project durations, the total cost of the project is calculated,
including both critical and non-critical activities, and including both direct
(normal, crashing) and indirect costs.
This will be clearer in the explanation of Example 8.3.
Example 8.3
The normal costs and crash costs, and the normal times and crash times of all project
activities in a particular project are given below. Assume that indirect costs of the
project are Rs. 40 per week. Find out the optimum project duration and the minimum
cost of the project.
Activity Immediate
Predecessor
Normal Crash
Cost Time Cost Time
1--2 -- 1500 8 2000 6
1--4 -- 2000 10 3000 7
2--3 1--2 1100 6 1500 4
2--5 1--2 900 8 1500 5
4--6 1-4 and 2-3 300 12 400 8
5--6 2--5 500 5 800 4
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The per unit crash cost (also called crash slope) for each activity is calculated as:
Crash slope =
For each activity, the crash slope and the maximum possible reduction in time are
tabulated as shown below.
Activity Crash Slope
(Crashing Cost per Week)
Maximum Reduction in Time
1 - 2 250 2
1 - 4 333.3 3
2 - 3 200 2
2 - 5 200 3
4 - 6 25 4
5 - 6 300 1
For clarity of understanding, we use a simplified network diagram without start time
and finish time.
Figure 8.4 (a): Network Diagram Before Crashing
From network diagram 12.4 (a) we can identify three paths ( activity 3-4 is a dummy
activity and does not consume any resource).
Path A: 1-2-3-4-6 = 8+6+12 = 26 weeks
Path B: 1-4-6 = 10+12 = 22 weeks
Path C: 1-2-5-6 = 8+8+5 = 21 weeks
Critical path = Path A = 26 weeks
Total cost = Direct Cost + Indirect Cost
= Rs. (1500 + 2000 + 1100 + 900 + 300 + 500) + (Rs. 40 26)
= Rs. 6300 +Rs. 1040
= Rs. 7340
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Among the critical path activities (1- 2, 2 3, and 4 6), crash slope is minimum for
activity 4-6 i.e. Rs. 25 per week. So we will first crash activity 4-6. We can crash it to
the maximum extent of four weeks [Refer to network diagram 16.4 (b)].
Figure 8.4 (b): Network Diagram After Crashing
Path A: 1-2-3-4-6 = 8+6+8 = 22 weeks
Path B: 1-4-6 = 10+8 = 18 weeks
Path C: 1-2-5-6 = 8+8+5 = 21 weeks
Path A continues to be the (only) critical path.
Crashing cost at this stage, for 4 weeks = Rs. 25 4 = Rs. 100
Total Cost = Direct cost (before crashing) + Crashing Cost + Indirect cost
= Rs. 6300 + Rs. 100 + (Rs. 40 22)
= Rs. 6300 + Rs. 100 + Rs. 880
= Rs. 6400 + Rs. 880
= Rs. 7280
Among the critical path activities (1- 2, 2 3, and 4 6), 4 6 cannot be crashed
further. Among the remaining critical activities 1 2 and 2 3, crash slope is
minimum for activity 2-3 at Rs. 200 per week. So we can next crash activity 2-3, by a
maximum of 2 weeks. [Refer to network diagram 16.4 (c)]
Figure 8.4 (c): Network Diagram After Crashing
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Path A: 1-2-3-4-6 = 8+4+8 = 20 weeks
Path B: 1-4-6 = 10+8 = 18 weeks
Path C: 1-2-5-6 = 8+8+5 = 21 weeks
But then Path A 1-2-3-4-6 will no longer be a critical path; the critical path will
change to path C 1-2-5-6, i.e., 21 weeks.
To ensure that Path A also continues to be one of the critical paths, we should crash 2-
3 by only 1 week (and not 2 weeks). Again refer network diagram 16.4 (c).
Path A: 1-2-3-4-6 = 8+5+8 = 21 weeks
Path B: 1-4-6 = 10+8 = 18 weeks
Path C: 1-2-5-6 = 8+8+5 = 21 weeks
Both path A & path C become parallel critical paths.
Crashing cost at this stage, for 4 weeks of 4-6 and 1 week of 2-3
= Rs. (25 4) + (200 1)
= Rs. 300
= Rs. 6300 + Rs. 300 + (Rs. 40 21)
= Rs. 6300 + Rs. 300 +Rs. 840
= Rs. 6600 + Rs. 840
= Rs. 7440
Now activity 1-2 is common to both the critical paths (1-2-3-4-6 and 1-2-5-.6) and this
activity can be crashed to the maximum extent of 2 weeks [Refer to network diagram
16.4 (d)].
Figure 8.4 (d): Network Diagram After Crashing
Path A: 1-2-3-4-6 = 6+5+8 = 19 weeks
Path B: 1-4-6 = 10+8 = 18 weeks
Path C: 1-2-5-6 = 6+8+5 = 19 weeks
Both path A & path C continue to be the parallel critical paths.
Crashing cost at this stage, for 4 weeks of 4-6, and 1 week of 2-3, and 2 weeks of 1-2
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= Rs. (25 4) + (200 1) + (250 2)
= Rs. 800
= Rs. 6300 + Rs. 800 + (Rs. 40 19)
= Rs. 6300 + Rs. 800 +Rs. 760
= Rs. 7100 + Rs. 760
= Rs. 7860
In Path A (1-2-3-4-6), the only critical activity that has further potential for crashing is
2-3, to an extent of 1 week. In addition to this, as path C is also critical, we should
crash some activity of path C (1-2-5-6) also by 1 week, to reduce the project duration
by 1 week. Of the two activities 2-5 and 5-6 that have scope for crashing, the crash
slope is minimum for activity 2-5 (Rs. 200/week) when compared to 5-6 (Rs.
300/week). So we will crash 2-5 by 1 week.
Path A: 1-2-3-4-6 = 6+4+8 = 18 weeks
Path B: 1-4-6 = 10+8 = 18 weeks
Path C: 1-2-5-6 = 6+7+5 = 18 weeks
Now all the three paths are parallel critical paths.
Crashing cost at this stage, for 4 weeks of 4-6, and (1+1) week of 2-3, and 2 weeks of
1-2, and 1 week of 2-5
= Rs. (25 4) + (200 2) + (250 2) + (200 1)
= Rs. 1200
= Rs. 6300 + Rs. 1200 + (Rs. 40 18)
= Rs. 6300 + Rs. 1200 +Rs. 720
= Rs. 7500 + Rs. 720
= Rs. 8220
As all the three paths are critical and there is no further scope for crashing in Path A
(1-2-3-4-6), there is no further scope for reduction in project duration.
Project
Duration
Direct Costs Indirect
Costs
Total Costs
Before crashing Crashing costs
26 6300 - 1040 7340
22 6300 100 880 7280
21 6300 300 840 7440
19 6300 800 760 7860
18 6300 1200 720 8220
Therefore, optimum project duration is 22 weeks, when the total cost incurred is
minimum, i.e., Rs. 7280.
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Fast Tracking
In this technique, the project manager attempts to reduce the project duration by doing
project activities in parallel. Suppose activity B can be started only after the
completion of activity A in normal conditions. But the project manager can start both
activities at the same time, but makes modifications to activity B as per the changes in
activity A. This ultimately reduces the duration of the entire project.
For example, the software code is normally written only after the design is approved.
But both the activities are started at the same time and the final code is written only
after the software design is approved by the top management. However, this technique
requires modifications, reworking, etc.
Resource Leveling
CPM and PERT techniques assume that the project has unlimited resources, and they
can be assigned for project activities. However, in reality, project resources are
usually limited. Sometimes activities may be delayed because of the non-availability
of resources.
So, the project manager sequences the project keeping in mind the availability of
resources, which forces him to recalculate the activity schedules. Normally, the
project manager assigns the available resources to the critical activities first as they
play a major role in determining the total completion time of a project.
Check Your Progress
43. Which of the following options are called duration compression techniques in
project management?
i. Crashing
ii. Fast tracking
iii. Critical path method
a. Only i and ii
b. Only i and iv
c. Only ii and iii
d. Only iii and iv
44. ____________ refers to decreasing the total project duration after analyzing a
number of alternatives to determine how to get the maximum duration
compression for the least cost.
a. Fast tracking
b. Crashing
c. Decomposition
45. Identify the correct formula to calculate the crash slope in project crashing.
a.
cost Crash cost Normal
b.
time Normal time Crash
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c.
time Normal time Crash
cost Crash cost Normal
d.
46. Which of the following statements is not true regarding the graphical evaluation
and review technique?
a. It is similar to the program evaluation and review technique.
b. It allows multiple project activities by the way of looping and branching project
activities.
c. It does not show alternative plans in a single network diagram.
d. Both (a) and (b
47. Identify the activities that should not be considered for crashing.
a. Activities that are labor intensive.
b. Activities that are of longer duration
c. Activities that have a high per unit crash cost
d. Activities that do not cause any quality problems, when crashed
Exercise
K. If the normal cost and crash cost of an activity A are Rs. 2,500 and Rs. 3,000 and
the normal time and crash time are 9 and 7 days respectively, then what is the
crash slope of activity A?
8. Schedule Control
The project manager has to ensure that all the project activities are being carried out as
per the schedules. Schedule control studies all the factors that affect project schedules.
Schedule control determines the schedule changes and manages to complete them
within the desired duration. Based on the changes, the project manager updates the
project schedules.
The project manager has to consider the project schedule, performance reports, and
change requests while controlling the schedule. The project schedule represents the
planned start and expected finish dates for each project activity. It provides a basis for
the project manager to measure the schedule performance. Performance reports
provide information about schedule performance and point out whether the activities
are proceeding as per the planned schedule or not. The project manager initiates
controls to complete all the activities within the desired time. He considers the change
requests made by the project stakeholders, which may be verbal or written. These
change requests may be for extension or acceleration of project schedules.
The project manager uses techniques like schedule change control system, and
performance measurement in controlling the project schedule. The schedule change
control system describes the procedures by which project schedules can be modified.
The methods include redrawing the project network diagrams, and understanding the
proposed changes. Performance measurement systems assess the effective completion
of the project activity in the normal duration. They calculate the magnitude of
variation that may occur for each project activity.
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Software packages like Project 2000 also help the project manager in controlling the
project schedules by continuously studying the planned and actual time periods of
each project activity. Sometimes additional planning is required when the project
manager thinks that it is important to incorporate certain changes in the project. The
project manager then revises the duration estimates, modifies the sequence of
activities and analyzes alternative schedules.
Check Your Progress
48. _________ deals with the study of factors that influence and change the project
schedules and aims at managing changes to complete the project within the
estimated schedule.
a. Crashing
b. Fast tracking
c. Schedule control
d. Schedule development
9. Summary
According to the Project Management Body of Knowledge, a project network
diagram is a schematic representation of the project activities and the logical
relationships (dependencies) among them.
The project network diagram helps the project manager in sequencing, scheduling,
and controlling the project. It represents all the project activities, the sequence in
which they have to be performed, the duration of each activity, the interdependencies
among various activities and the criticality (significance) of each activity.
Once the project activities are identified using the work breakdown structure, the
project manager prepares an activity list of the project. He puts all the activities down
in a logical sequence to arrive at the project end-product. This is known as activity
sequencing.
The project manager sequences all the project activities in an appropriate manner and
represents them in the project network diagram. Some of the methods of activity
sequencing are arrow diagram method, precedence diagram method, and conditional
diagramming method.
After activity sequencing, the project manager estimates the duration of each activity
to calculate the duration of the entire project. The duration of an activity is the time
period required to complete the activity.
Schedule development is concerned with determining a realistic start and finish time
for project activities. It aims to match project resources like machinery, materials, and
labor with project activities over time.
Some of the methods used by project managers for schedule development are: Critical
Path Method (CPM), Program Evaluation and Review Technique (PERT), and
Graphical Evaluation and Review Technique.
Through schedule control, the project manager ensures that all the project activities
are being carried out as per schedule. It determines the schedule changes and manages
to complete them within the desired duration.
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10. Glossary
Activity Sequencing: It is the process of identifying and documenting
interdependency relationships.
Activity: An activity is an element of work performed during the course of a project.
Arrow Diagram Method: A network diagram constructed using arrows to represent
the activities and connecting them at nodes to show the dependencies. This method is
also called as activity-on-arrow (AOA) method.
Crashing: It refers to decreasing the total project duration after analyzing a number of
alternatives to determine how to get the maximum duration compression for the least
cost.
Critical Path Method: It is a network analysis technique used to predict the project
duration by finding out which sequence of activities (the critical path) has the least
amount of scheduling flexibility.
Dummy Activity: An activity of zero duration that is used to represent the logical
relationship in the network diagram is called a dummy activity.
Fast Tracking: Compressing the project schedule by overlapping activities that
would normally be done in sequence.
Finish to Finish: Finish to finish dependency states that activity A must finish before
activity B finishes.
Finish to Start: Finish to start dependency states that activity A must be completed
before activity B can begin.
Free Float: This is the amount of time by which the completion of an activity can be
delayed beyond the earliest finish time without affecting the earliest start of a
subsequent activity.
Independent Float: This is the amount of time by which the start of an activity can
be delayed without affecting the earliest start of any activities following immediately.
Most Likely Time: It is the time that is the best guess for an activity completion
either optimistic or pessimistic.
Node: It is a time-oriented reference point that signifies the start or end of an activity.
It is represented by a circle.
Optimistic Time: Optimistic time is the minimum amount of time within which an
activity can be completed. It is possible to complete an activity within the optimistic
time only when the external environment is extremely favorable.
Pessimistic Time: Pessimistic time is the maximum amount of time required to
complete an activity. This happens when the external environment is unfavorable.
Precedence Diagram Method (PDM): In this method, the network diagram is
constructed using nodes to represent the activities and connecting them with arrows to
represent the dependencies. This method is also called as activity-on-node (AON)
method.
Project Network Diagram: It is a schematic representation of the project activities
and the logical relationships (dependencies) among them.
Schedule Development: Evaluating activity sequences, activity durations, and
resource requirements to develop a project schedule.
Slack: Slack is the difference between the latest event time and earliest event time.
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Start to Finish: Start to finish dependency states that activity B must start before
activity A can finish.
Start to Start: Start to start dependency states that activity B can be started only if
activity A has begun.
Total Float: This is the amount of time by which the completion of an activity can be
delayed beyond its expected earliest completion time without affecting the overall
project duration.
1. After the project activities are identified, they are represented in a project network
diagram. What is a project network diagram? Explain the fundamental concepts
involved in a project network diagram.
2. The project manager sequences the project activities by understanding the
dependencies among them. How are the activities of a project sequenced? What
are the various methods of sequencing the project activities?
3. After the project activities are sequenced, the project manager estimates the
duration of each activity to calculate the entire project duration. Explain in detail
the methods involved in the estimation of the activity duration.
4. Scheduling eliminate production problems, facilitates timely procurement of raw
materials, and ensures project completion on time. How is a schedule developed?
Explain briefly the techniques involved in schedule development. How can the
schedule be controlled?
1. (c) finish to finish dependency
Finish to finish dependency states that activity A must finish before activity B
finishes. In the given example, collection of data is an activity and entry of data
into an information system is another activity. The activity of data entry cannot
end until the collection of data is completed. Therefore, it is an example of finish
to finish dependency.
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2. (b) logical relationship
An activity of zero duration that is used to represent the logical relationship in the
network diagram is called a dummy activity. Dummy activities do not consume
any resources, but are used to maintain the proper precedence relationship
between the activities that are not connected by the nodes. They are represented
by a dashed line headed by an arrow.
3. (c) iii-ii-i
After the project activities have been identified, they are represented in a project
network diagram. The project manager sequences the project activities, estimates
the duration, and then schedules the activities. The project manager sequences the
project activities by understanding the dependencies among them. He/she then
prepares the duration estimates of each project activity with the help of duration
estimates from other projects, historical information, expert advice, etc. Finally,
the project manager schedules the project activities in order to estimate the start
and the finish dates of each project activity. This scheduling helps him/her in
arriving at the duration of the project.
4. (b) Project network diagram
A project network diagram is a schematic representation of the project activities
and the logical relationships (dependencies) among them. The diagram helps the
project manager in sequencing, scheduling, and controlling the project. It
represents all the project activities, the sequence in which they have to be
performed, the duration of each activity, the interdependencies among various
activities, and the criticality (significance) of each activity. A control chart is a
graphical representation of the results of a process over a period of time. A work
breakdown structure is a deliverable-oriented grouping of project activities that
organizes and defines the total scope of the project.
5. (d) Activity
An activity is an element of work performed during the course of a project. It is
depicted by an arrow. An event is a time-oriented reference point that signifies the
start or end of an activity. It is also called a node and is represented by a circle.
Slack is the difference between the latest event time and earliest event time.
6. (a) tail event, head event
The project network diagram is represented by a series of activities and nodes. An
activity is a specific task or operation required to do a project. A node is a time-
oriented reference point that signifies the start or end of an activity. An activity
can be represented with i and j as the starting and ending nodes, respectively.
The activity can also be written as ij. Event i is called the tail event and event
j is called the head event.
7. (a) zero duration.
resources, but are used to maintain proper precedence relationship (start to start,
start to finish, finish to start, or finish to finish) between the activities that are not
connected by the nodes. They are represented by a dashed line headed by an
arrow.
8. (c) the ending node.
In a project network diagram, an activity can be represented with i and j as the
starting and ending nodes, respectively. The activity can also be written as i j.
Event i is called the tail event and event j is called the head event.
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9. (a) a time-oriented reference point that signifies the start and end of an
activity.
A node, also known as an event, is a time-oriented reference point that signifies
the start or end of an activity. It is represented by a circle. An activity is a specific
task or operation required to do a project.
10. (b) An activity represents the passage of time while the nodes are points in
time that denote the starting or ending of a specific activity.
An activity is an element of work performed during the course of a project while
a node is a time-oriented reference point that signifies the start and end of an
activity. An activity represents the passage of time and the nodes are points in
time that denote the starting or ending of a specific activity. An activity is
depicted by an arrow while a node is represented by a circle.
11. (c) activity B can be started only if activity A has begun.
Start to start dependency states that activity B can be started only if activity A has
begun. This can be explained with the help of the previous example that is, the
inspection activity can be started and continued once the raw materials start
coming. Subsequently, both activities go on in parallel.
12. (b) start to finish dependency
Start to finish dependency states that activity B must start before activity A can
finish. For instance, if a firm wants to develop a new information system to
replace the existing one, the firm has to confirm that the new system is operating
well. When the new system starts working (activity B), the existing system can be
discontinued (activity A).
any resources, but are used to maintain the proper precedence relationship
between the activities that are not connected by the nodes. They are represented
by a dashed line headed by an arrow.
14. (d) The project network diagram helps to determine the start and end dates
of each activity during scheduling, but does not provide insights into the
possible trade-offs while controlling the project.
A project network diagram is a schematic representation of the project activities
and the logical relationships (dependencies) among them. The diagram helps the
project manager in sequencing, scheduling, and controlling the project. It
represents all the project activities, the sequence in which they have to be
performed, the duration of each activity, the interdependencies among various
activities, and the criticality (significance) of each activity. It helps to determine
the start and end dates of each activity during scheduling. It also provides insights
into the possible trade-offs while controlling the project.
15. (a) finish to start dependency.
Finish to start dependency states that activity A must be completed before activity
B can begin. If activity A involves obtaining raw material and activity B involves
inspecting the raw material, then activity B can be performed only after the
completion of activity A. Therefore, the dependency is finish to start.
16. (b) event
An event is a time-oriented reference point that signifies the start or end of an
activity. It is represented by a circle and is also called as a node. An activity is an
element of work performed during the course of a project. It is depicted by an
arrow. Slack is the difference between the latest event time and earliest event time.
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17. (b)
In the given project, activities B and C cannot begin until activity A has been
completed. Option (b) correctly represents this activity relationship if the arrow
diagram or activity-on-arrow method is used. Option (d) is also correct if the
activity relationship is represented using the precedence diagram or activity-on-
node method.
While sequencing the activities, the project manager analyzes the mandatory and
discretionary dependencies among the various project activities. Mandatory
dependencies are those that are inherent in the nature of project. In these, the
dependency between the activities is certain or mandatory. Discretionary
dependencies are those dependencies of the project that are defined by the project
team. Using certain best practices or standard procedures in the project are
examples of discretionary dependencies. This dependency is also called as soft
logic or preferred logic.
19. (a) Only i and iii
While analyzing the product description, the project manager has to consider the
physical characteristics of the product and the logical sequencing of the activities
to achieve the end product. The product description is generally less detailed in
the early phases of the project and is progressively elaborated on later.
20. (c) Graphical Evaluation and Review Technique (GERT)
Conditional diagramming methods like the Graphical Evaluation and Review
Technique (GERT) and system dynamics represent non-sequential activities like
loops (where activities are repeated again and again) or conditional branches
(e.g., a design update is required only when errors are found in the inspection).
PDM and ADM cannot represent loops and conditional branches.
21. (c) involves constructing the network diagram using arrows to represent
activities and connecting them at nodes to show the dependencies.
In the arrow diagram method, the network diagram is constructed using arrows to
represent the activities and connecting them at nodes to show the dependencies.
This method uses finish-to-start dependencies only to explain the logical
relationships. This method is also called Activity-On-Arrow (AOA) method.
Options (a), (b), and (d) pertain to the precedence diagram method.
22. (b) Mandatory dependencies
While sequencing the activities, the project manager analyzes the mandatory and
discretionary dependencies among the various project activities. Mandatory
dependencies are those that are inherent in the nature of project. For instance, in
order to install a new machine, it is necessary for the plant layout to be finalized.
Therefore, in this case, the dependency among the activities is certain or
mandatory. Mandatory dependency is also called as hard logic. Discretionary
dependencies are those dependencies of the project that are defined by the project
team. This kind of dependency is also called preferred logic.
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In the precedence diagram method, the network diagram is constructed using
nodes to represent the activities and connecting them with arrows to represent the
dependencies. This method uses all four types of dependencies and is also called
the activity-on-node method. The arrow diagram method is also called the
activity-on-arrow method.
The project manager sequences all the project activities in an appropriate manner
and represents them in the project network diagram. Methods like the arrow
diagram method and the precedence diagram method are used for activity
sequencing. In the arrow diagram method, the network diagram is constructed
using arrows to represent the activities and connecting them at nodes to show the
dependencies. In the precedence diagram method, the network diagram is
constructed using nodes to represent the activities and connecting them with
arrows to represent the dependencies. The critical path method and the program
evaluation and review technique are methods that the project manager uses to
develop schedules.
After identifying the project activities using the work breakdown structure, the
project manager prepares an activity list of the project. The activities are
sequenced in order to obtain the project end product. While sequencing the
activities, the project manager has to study various aspects such as the description
of the end product, mandatory and discretionary dependencies among the
activities, external dependencies and other constraints and assumptions of the
project.
26. (c) Most likely time
Optimistic time (t
0
) is the minimum amount of time within which an activity can
be completed. Pessimistic time (t
p
) is the maximum amount of time required to
complete the activity. The variance of an activity is calculated as
36
2
o
t
p
t
,
where, t
p
= pessimistic time and t
o
= optimistic time. Most likely time (t
m
) is the
time that is the best guess for the completion of an activity (neither optimistic nor
pessimistic). It is not included in the calculation of the variance.
27. (d) crash point
The crash point is a point beyond which it is not possible to reduce the duration of
an activity. The project manager has to allocate more resources till the crash point
is arrived at. A node is a time-oriented reference point that signifies the start or
end of an activity. Slack is the difference between the latest event time and
earliest event time. Free float is the amount of time by which the completion of an
activity can be delayed beyond the earliest finish time without affecting the
earliest start of a subsequent activity.
28. (d)
36
2
a b
The variance of an activity is calculated as
36
2
o
t
p
t
86
where t
p
= pessimistic time and t
o
= optimistic time. In the given question, for a
certain activity, the pessimistic time (t
p
) is given as b and the optimistic time (t
o
)
is given as a. So, the variance of the activity would be
36
2
a b
.
The project manager can use various techniques to estimate the appropriate
duration of the project activities. The duration of an activity can be estimated by:
taking estimates of the duration of similar activities in other projects; taking the
actual durations of successful projects in the past; consulting a technical expert to
estimate the activity duration; and forming a group of people and asking them to
estimate the duration of the activity after describing the nature and characteristics
of the activity. Some of methods used for this purpose are the Delphi method,
expert advice, the three-point method, and the wide band Delphi method.
30. (d) Wide Band Delphi method
In the expert advice method, the project manager consults a technical expert to
estimate the activity duration. In the Delphi method, the project manager forms a
group of people and asks them to estimate the duration of an activity after
describing the nature and characteristics of the activity. In the three-point method,
the project manager estimates the activity duration by considering three estimates
optimistic, pessimistic, and most likely times, and then calculates the expected
time of completion of an activity. The Wide Band Delphi method is a
combination of the Delphi method and the three-point method. In this method,
the members are asked to give an optimistic time, a pessimistic time, and the most
probable time, instead of a single estimate. Then, the project manager follows the
Delphi method and determines the duration estimate.
31. (b) i/r, ii/p, iii/q
According to the three-point method of estimating the duration of project
activities, the project manager considers three types of estimates optimistic
time, pessimistic time, and most likely time in order to calculate the duration
of an activity. Optimistic time (t
0
) is the minimum amount of time within which
an activity can be completed. Pessimistic time (t
p
) is the maximum amount of
time required to complete an activity. Most likely time (t
m
) is the time that is the
best guess for the completion of an activity (neither optimistic nor pessimistic).
Expected time,
t =
6
p
t
m
4t
0
t
.
32. (b)
6
c 4b a
According to the three-point method of estimating the duration of project
activities, the project manager considers three types of estimates optimistic
time, pessimistic time, and most likely time in order to calculate the duration
of an activity. Optimistic time (t
0
) is the minimum amount of time within which
an activity can be completed. Pessimistic time (t
p
) is the maximum amount of
time required to complete an activity. Most likely time (t
m
) is the time that is the
best guess for the completion of an activity (neither optimistic nor pessimistic).
Expected time,
87
t =
6
p
t
m
4t
0
t
. In the given question, t
0
= a, t
m
= b, and t
p
= c.
Therefore, expected time, t =
6
c 4b a
.
33. (c) It can be more than the pessimistic time of that activity.
Optimistic time (t
0
) is the minimum amount of time within which an activity can
be completed. Pessimistic time (t
p
) is the maximum amount of time required to
complete an activity. Most likely time (t
m
) is the time that is the best guess for the
completion of an activity (neither optimistic nor pessimistic).
Expected time, t =
6
p
t
m
4t
0
t
.
The expected time of an activity cannot be more than the pessimistic time of that
activity. However, it can be more than the optimistic time. The expected time of
an activity is more than, less than, or equal to the most likely time of that activity.
34. (b) Resource calendar
The project manager prepares two types of calendars resource calendars and
project calendars to schedule the project. Resource calendars schedule the project
on the basis of the resources used. The focus is on scheduling and utilizing
specific resources effectively. Resource calendars deal with how a specific
resource or specific category of resources is spent over a period of time. Project
calendars emphasize the completion time of the project activities. They are
concerned with how various project resources are consumed over a period of
time. A resource pool description contains details of all the project resources and
their allocation to project activities.
The project manager can use methods like the critical path method, the program
evaluation and review technique, and the graphical evaluation and review
technique for schedule development. These methods are used to: estimate the
completion time of the project; find out if the project is behind, ahead of, or on
schedule; compare the actual resources spent with the planned resources at any
stage of the project; and study activities that are critical for project completion
and activities that can be delayed without delaying project completion.
There are three types of floats total float, free float, and independent float. Total
float is the amount of time by which the completion of an activity can be delayed
duration. Free float is the amount of time by which the completion of an activity
can be delayed beyond the earliest finish time without affecting the earliest start
of a subsequent activity. Independent float is the amount of time by which the
start of an activity can be delayed without affecting the earliest start of any
activities following immediately.
37. (d) Independent float is the difference between total float and tail slack.
Total float is the difference between the latest start time and the earliest start time
of a project activity. Slack is the difference between the latest event time and
earliest event time. Free float is the difference between total float and head slack.
Independent float is the amount of time by which the start of an activity can be
delayed without affecting the earliest start of any activities following
immediately. It is the difference between free float and tail slack.
88
38. (b) The Work Breakdown Structure
Methods like the critical path method, the program evaluation and review
technique, and the graphical evaluation and review technique are used for
schedule development. The work breakdown structure is a deliverable-oriented
grouping of project activities that organizes and defines the total scope of the
project.
39. (a) Head slack
In an event, slack is the difference between the latest event time and earliest event
time. For an event i, slack = L
i
E
i
. For an activity (i, j), the slack of event j is
called head slack, while the slack of event i is called tail slack. Head slack = L
j
E
j
, and Tail slack = L
i
E
i
.
The critical path method, the program evaluation and review technique, and the
graphical evaluation and review technique are the various methods used for
scheduling a project. Black box is a technique used to enhance creativity in
individuals. The realized yield approach is a method used for estimating the rate
of return required by the equity shareholders.
41. (b) The critical path of the project is the shortest path through the network.
Critical path method is a network analysis technique used to predict the project
duration by finding out which sequence of activities (the critical path) has the
least amount of scheduling flexibility. In this method, the project manager
identifies the critical activities of the project that constitute the critical path of the
project. The critical path of the project is the longest path through the network.
The length of the critical path gives the shortest allowable time for the completion
of the project. This helps the project manager to concentrate and prioritize critical
activities while allocating project resources.
42. (d) Critical path method
Critical path method is a network analysis technique used to predict the project
duration by finding out which sequence of activities (the critical path) has the
least amount of scheduling flexibility. In this method, the project manager
identifies the critical activities of the project that constitute the critical path of the
project. Crashing refers to decreasing the total project duration after analyzing a
number of alternatives to determine how to get the maximum duration
compression for the least cost. Fast tracking refers to compressing the project
schedule by overlapping activities that would normally be done in sequence.
Decomposition refers to the breaking down of work into hierarchy of activities
and tasks.
When the expected completion time of the project is more than the desired time,
the project manager tries to reduce the project duration using some duration
compression techniques like crashing and fast tracking. Crashing refers to
decreasing the total project duration after analyzing a number of alternatives to
determine how to get the maximum duration compression for the least cost. Fast
tracking refers to compressing the project schedule by overlapping activities that
would normally be done in a sequence. The critical path method and program
evaluation and review technique are techniques used by the project manager to
develop schedules.
89
44. (b) Crashing
Crashing refers to decreasing the total project duration after analyzing a number
of alternatives to determine how to get the maximum duration compression for
the least cost. In crashing, the project manager reduces the project duration by
allotting more resources, subcontracting some activities, using more labor, etc.
Fast tracking refers to compressing the project schedule by overlapping activities
that would normally be done in sequence. Decomposition refers to the breaking
down of work into a hierarchy of activities and tasks.
45. (d)
Crash slope is the per unit crash cost for each activity involved in a project.
It is calculated as,
.
46. (c) It does not show alternative plans in a single network diagram.
The graphical evaluation and review technique is similar to the project evaluation
and review technique. It allows multiple project activities by the way of looping
and branching project activities. The program evaluation and review technique
cannot show alternative plans in a single network diagram. This problem is
overcome in the graphical evaluation and review technique as it shows alternative
ways to continue the project.
47. (c) Activities that have a high per unit crash cost
the least cost. Following are the type of activities that are considered for crashing:
activities that are of longer duration; activities that are labor intensive; activities
that are critical; activities that have a low per unit crash cost; and activities that do
not cause any quality problems, if crashed.
48. (c) Schedule control
Schedule control studies all the factors that affect project schedules. It determines
the schedule changes and manages to complete them within the desired time.
Based on the changes, the project manager updates the project schedules.
the least cost. In this technique, the project manager attempts to reduce the project
duration by carrying out project activities in parallel. Schedule development is
concerned with determining a realistic start and finish time for project activities.
A. 7.5 days
t =
6
p
t
m
4t
0
t
90
Where,
t = expected time
t
o
= optimistic time = 5 days
t
m
= most likely time = 7 days
t
p
= pessimistic time = 12 days
t =
6
12 7 4 5
= 7.5 days.
B. 18 days
Earliest start times:
Activity A to X, E
iX
= 3 days
Activity B to X, E
jX
= 5 days
Activity C to X, E
kX
= 7 days
Duration estimates:
Activity A to X, t
iX
= 5 days
Activity B to X, t
jX
= 7 days
Activity C to X, t
kX
= 11 days
Earliest event time at X, E
X
= Maximum [(E
iX
+ t
iX
), (E
jX
+ t
jX
), (E
kX
+ t
kX
)] = [(3
+ 5), (5 + 7), (7 + 11)] = (8, 12, 18) = 18 days.
C. 2, 0, -2
Total float = (L
2
E
2
) t
12
= (20 11) 7 = 9 7 = 2.
Free float = (E
2
E
1
) t
12 = (18 11) 7 = 7 7 = 0.
Independent float= (E
2
L
1
) t
12 = (18 13) 7 = 5 7 = -2.
D. 1
Total float = (L
2
E
2
) t
12
= (18 9) 8 = 9 8 = 1.
E. 25.34
Activity Optimistic
Time (t
o
)
Most
Likely
Time (t
m
)
Pessimistic
Time (t
p
)
Expected time
6
t t 4 t
p m 0
Variance
36
t t
2
o p
A 2 8 12 7.67 2.78
B 3 5 10 5.5 1.36
C 4 7 18 8.33 5.44
D 3 9 16 9.17 4.69
E 5 8 14 8.5 2.25
91
Critical path of the project = A D E.
Expected times of completion,
A = 7.67
D = 9.17
E = 8.5
Expected time of completion of the project, = 7.67 + 9.17 + 8.5 = 25.34.
F. 16.52
Refer table above
Total variance of the project = Sum of variances of all the activities in the project
= 2.78 + 1.36 + 5.44 + 4.69 + 2.25 = 16.52.
G. 0.6554
Refer table above
z is the probability of completing the project in 27 days. It is calculated as:
z =
project the of deviation Standard
completion of date Expected - date Due
=
- x
Due date, x = 27 days
Expected date of completion, = 25.34
Total variance of the project = 16.52.
Standard deviation, = Variance = 16.52 = 4.064.
The probability of completing the project in 27 days is the probability of
completing the project in less than or equal to 27 days.
For x = 27, the corresponding value of the standard normal variate,
z =
- x
=
4.064
25.34 - 27
= 0.4085.
P(x 27) P
4.064
25.34 - 27
P(z < 0.4085)
) 4085 . 0 0 ( + ) 0 - ( z P z P
(From the standardized normal distribution table or F(z) table, the area under the
normal curve corresponding to z = 0.4085 is 0.1554.)
0.5 + 0.1554 = 0.6554
(Note: In standard normal distribution, the probability of completing the project in
the expected time ( ) will always be 0.5. As due date (27 days) is more than (25.34
days), the probability of completion will definitely be greater than 0.5.)
92
H. 0.7823
Assume z is the probability of completing the project in 30 days. It is calculated
as:
z =
project the of deviation Standard
completion of date Expected date Due
Due date, x = 30 days
Expected date of completion, = 28 days
Standard deviation, = 2.56
The probability of completing the project by 30 days is the probability of
completing the project in less than or equal to 30 days.
For x = 30, the corresponding value of the standard normal variate, z =
x
=
2.56
28 30
= 0.7813.
P(x < 30)
2.56
28 30
z P
P(z < 0.7813)
0.7813) z P(0 0) z P(
(From the standardized normal distribution table or F(z) table, the area under the
normal curve corresponding to z = 0.7813 is 0.2823.)
0.5 + 0.2823 = 0.7823
(Note: In standard normal distribution, the probability of completing the project in
expected time ( ) will always be 0.5. As due date (30 days) is more than (28 days),
the probability of completion will definitely be greater than 0.5.).
I. 1.414
Variances of critical activities of a project = 0.2, 0.6, 0.5, and 0.7.
Total variance of the project = 0.2 + 0.6 + 0.5 + 0.7 = 2.0
Standard deviation = Variance = 2 = 1.414.
J. 1.36
Variance =
36
2
o
t
p
t
Where, t
p
= pessimistic time = 10 days
t
o
= optimistic time = 3 days
Variance =
36
2
3 10
= 1.36.
93
K. 250
Given,
Normal cost = Rs. 2,500
Crash cost = Rs. 3,000
Normal time = 9 days
Crash time = 7 days
Crash slope =
=
7 9
2500 3000
= 250.
Unit 9
Project Review
Structure
1. Introduction
2. Objectives
3. Importance of Project Review
4. Types of Project Reviews
5. Project Review Stages
6. Project Status Review Meetings
7. Advantages of a Project Status Review Meeting
8. Types of Project Status Meetings
9. Summary
10. Glossary
1. Introduction
In the previous unit, we have discussed activity sequencing, estimation of duration
and scheduling. In this unit, we will discuss project review. Once a project is
organized, in terms of building the project team and drawing up the operating rules, it
is time for the project manager to design and develop an effective tool to check
whether the activities are proceeding as per the plan. This task requires a mechanism
to review the performance of various project aspects such as project status, product
design and process.
This unit will explain the importance of the project review process. We will discuss
the various types of project reviews and the different stages involved in the project
review. We shall then move on to discuss project status review meetings and the
advantages of conducting them. Finally, we would be explaining the various types of
project status meetings.
2. Objectives
By the end of this unit, the students should be able to:
understand the importance of project review.
classify the various types of project reviews.
define project review stages.
discuss project status review meetings.
identify the advantages of a project status review meeting.
recognize the types of project status meetings.
3. Importance of Project Review
Once the project enters the implementation phase, the project manager should take up
the responsibility of reviewing the status of the project in a timely and phased manner.
Project reviews conducted at various stages of project implementation play a major
role in the success of a project. The project manager conducts reviews to find out;
Project Review
95
If the project can accomplish the business goals.
Whether the rules of the organization are understood properly and implemented
If it is worthwhile to take up the project at all before entering into major contracts
Whether the project is managed effectively and the team members are sure of
completing the project, by following the guidelines.
Reviews give the project manager and the organization a chance to solve problems
before they get out of hand, or to improve the way in which the projects are being
handled. To derive the maximum benefit out of the reviews the project manager has to
take follow-up action with an open mind. Reviews ensure that the project utilizes the
available funds to gain business advantage. On the whole, a review helps the project
manager;
Keep in mind the purpose of carrying out a project
Determine the appropriateness of the project activities from time to time
Gauge the way in which the objectives are being accomplished
Verify the completion of the project
Evaluate the cost of the project
Understand the project requirements.
Check Your Progress
1. Which of the following is/are the purpose/s of a project review?
i. To determine whether the project can accomplish the business goals.
ii. To check whether the project is exceeding the budget limits set by the
management.
iii. To determine whether it is worthwhile taking up the project at all before entering
into major contracts.
iv. To see whether the project is being managed effectively and whether the team
members can complete the project by following the guidelines.
a. i, ii, iii, and iv
b. Only i and ii
d. Only i, ii, and iii
2. In which of the following ways does the review help the project manager?
i. To remember the purpose of carrying out the project.
ii. To verify the completion of the project.
iii. To evaluate the cost of the project.
iv. To understand the project requirements.
a. Only i
b. Only ii and iii
c. Only iii and iv
96
4. Types of Project Reviews
A project manager has to conduct various reviews throughout the life of a project to
ensure that it is progressing towards achieving the planned objectives. The manner in
which these reviews are conducted decides the success of current and future projects.
In general, a project manager conducts three types of reviews -- status reviews, design
reviews, and process reviews.
Status Reviews
Status review is the most common and frequently conducted review in organizations
taking up projects. These reviews are conducted at fixed intervals to review the
present position of the project. A status review is usually conducted at two levels:
cursory review and comprehensive review.
Though deciding the frequency of project reviews is largely a matter of judgment, a
weekly cursory and a monthly comprehensive review are conducted for projects of
one year duration. The frequency with which project reviews are conducted also
depends on the frequency with which problems occur. Project reviews are conducted
frequently whenever problems arise. Care should be taken to avoid conducting too
many project reviews. The project manager should take care that team members give
status reports that are substantiated by meaningful numerical figures on cost,
performance, time and scope. The project manager should also be aware of the
possibility of mis-reporting. In many cases, team members report that they are on
schedule even if they are not, in the hope that they will be back on schedule by the
next reporting period. The project manager should design a reporting system that can
detect deviations which are greater than the permissible variance limits.
It is always advantageous to have an organizational structure that focuses on correcting
problems, rather than punishing those held responsible for these problems. Therefore,
project reviews must be conducted with the aim of solving the problem rather than with
the objective of giving out punishment to person responsible for the problem. A
problem-solving project review has three steps: (i) Identification of existing problems,
(ii) Identification of factors that cause problems, and (iii) Exploring solutions that can
solve the problem. An effective problem-solving approach is one that can get to the root
cause of the problem, rather than trying to tackle the symptoms.
Design Reviews
Generally, a project is subjected to a design review, usually at the major milestones.
The primary objective of conducting a design review is to check whether the design of
the product or service being produced is of the desired performance quality. Thus a
design review is more a tool for reviewing the performance factor than the cost, time
and scope of a project.
The performance of the product determines the projects success or failure. The design
of the product plays a major role in the effective performance of the product. Many
projects fail due to improper product design. While deviations from the schedule with
regard to the cost, time and scope of a project can be corrected, a deviation in design
would result in an underperforming product that would be rejected by the client.
Therefore, the design review plays an important role in ensuring the performance
quality of the project deliverable.
A design review should cover aspects like:
Conditions of manufacturability, serviceability, tooling, economics of special
machinery and processes to ensure better integration of design with manufacturing to
ensure overall optimization.
Project Review
97
Safety of operators and maintenance personnel and precautions taken to minimize
damages.
Scope statement along with technical specifications based on which the performance
of end products can be evaluated.
Informal reviews are also done by implementing Management By Walking Around
(MBWA) where the project manager personally goes around all the departments to
make sure that the work is progressing as planned in terms of design. In order to make
sure that a design is reviewed properly, ANSI (American National Standards Institute)
has developed some design review criteria. These criteria can be used for any program
involving design.
Example: Elements of Design Review
Elements of design review as recommended by ANSI are as follows:
1. Were the inputs rightly chosen and put into the design?
2. Are assumptions required to conduct the design review complete and
reasonable?
3. Are the assumptions identified for re-verification, if needed, on completion of
detailed design activities?
4. Are the quality and quality assurance standards specified?
5. Are the codes, standards and regulations pertaining to design and its approval
identified and met?
6. Is the construction and operating experience considered, if applicable?
7. Is the design interface requirement satisfactory?
8. Was the design method relevant?
9. Is the output justified in comparison with inputs?
10. Does the parts, equipment and processes suit the application?
11. Is there compatibility between the specified materials and the design
environment in which the material will be put to use?
12. Are there sufficient maintenance features and requirements?
13. Are there enough accessibility and design provisions to carry on maintenance
and repairs?
14. Is there sufficient provision for accessibility to conduct in-service inspection
that can be needed during the plant life?
15. Has the impact of the design on the public and the plant personnel been
considered?
16. Is the acceptance criterion in the design document sufficient to verify the
satisfactory accomplishment of design requirements?
17. Are sufficient pre-operational and follow-up periodic test requirements given?
18. Are the given handling, storing, cleaning and shipping specifications adequate?
19. Are there enough identification requirements?
20. Are adequate requirements for documenting records, acceptance, storing, etc.
specified?
Adapted from James P.Lewis Mastering Project Management," MC Graw-Hill, 1998, p.258.
98
Process Reviews
The primary objective of conducting a process review is to determine whether the
processes are going on as planned and whether any improvements are possible. A
process review is conducted either once in three months or at major milestones in the
project, whichever comes first. Process reviews can be conducted once a month if the
project is of shorter duration. The two objectives of process reviews are: (i) To
preserve the performance of project processes those are going on well, and (ii) To
improve the processes those are below standard. Even if there is nothing wrong with
the processes, there may be some scope for improvement and process reviews suggest
how improvements can be made.
Process reviews are conducted by the project manager or an external facilitator. Both
of them have their own limitations. Leadership is one of the processes crucial for the
success of a project. A process review conducted by the project manager will not get
the desired feedback as the team members will not feel free to be critical about the
leadership skills of their project manager. An external facilitator can gather better
information in such situations. Sometimes, relations between the project manager and
his team may deteriorate if the team gives a negative feedback on the leadership skills
of the project manager.
Activity: Perfect Pte. is a Singapore-based white goods manufacturing company.
To develop an ultra modern future-ready washing machine, the company started a
project (codename WM-800). It produced an initial batch of washing machines and
brought in an external consultant to review the machine design. And after thorough
inspection, the consultant found that the temperature of the dryer was damaging the
clothes. The company also found that the project manager was not technically
sound and so he did not review the design properly. What do you think the project
manager should have done to conduct a design review? And what are the
parameters to be taken into consideration while conducting a design review?
Answer:
Check Your Progress
3. Expand ANSI.
a. Australian National Standards Institute
b. American National Symbols Institute
c. American National Standards Institute
d. American National Serial Institute
4. Project reviews conducted at fixed intervals to analyze the present position of the
projects are called
a. design reviews.
b. status reviews.
c. process reviews.
Project Review
99
5. Of the following reviews, pick the one that is done mostly during major
milestones of the project implementation and whose objective is to know whether
the design or service being produced is of the desired performance quality.
a. Comprehensive review
b. Status review
c. Process review
d. Design review
6. Which of the project reviews is generally conducted by an external facilitator
rather than the project manager?
a. Status reviews
b. Cursory reviews
c. Process reviews
d. Comprehensive reviews
7. Project reviews must be conducted with the aim of solving the problem rather
than punishing those who are responsible for the problem. Which of the following
is the correct sequence of steps in problem solving?
i. Exploring the solutions that can solve problems.
ii. Identifying the factors that cause problems.
iii. Identifying the existing problems.
a. i-ii-iii
b. iii-ii-i
c. ii-iii-i
d. ii-i-iii
8. The review that is done on a weekly basis as part of the status review of the
projects is called
a. comprehensive review.
b. cursory review.
c. design review.
d. process review
9. Which of the following are the two objectives of process reviews?
i. To review the financial performance of the project.
ii. To preserve the performance of project processes that are going well.
iii. To improve the processes that are below standard.
iv. To ensure the safety of operators and maintenance personnel and take precautions
to minimize damage.
a. Only i and ii
b. Only i and iv
c. Only ii and iii
d. Only iii and iv
10. Which of the following aspects is not covered by design review?
a. Conditions of manufacturability
b. Serviceability
c. Control of costs in project implementation
d. Safety of operators and maintenance and personnel
100
5. Project Review Stages
A review should always be conducted before taking any major decisions that can
affect the future of the project. Some of the important points or stages at which a
review is conducted are as follows;
In the initial stages of the project life cycle, i.e., after the project proposal has been
submitted.
At the stage when an in-depth evaluation is conducted i.e., after the primary business
case has been accepted.
During the implementation of the project, i.e., while the activities of the project are
being carried out, particularly at the following points before entering into major
contracts; when the major output of the project is to be delivered; at points where the
risk is substantially high; and at points where major problems occur.
When the project is completed.
When auditing has to be conducted.
Review after Submission of Project Proposal
A review at this point would help the project manger to know whether the proposal
is worth the resources on undertaking an initial investigation; the proposal is in
keeping with the existing business strategy; and the proposal is flexible, in case it does
not comply with the existing business strategy.
Review in the Implementation Phase
There are different types of reviewing techniques to monitor the project in the
implementation phase. Status reviews, design reviews, and process reviews are carried
out during this phase of the project.
Review at the Time of Completion of Project
A project is closed either when it accomplishes its objectives (successful project) or
when it fails to do so. Closing a project is a formal activity aimed at discharging all
the assets belonging to the project in a proper manner. The project manager conducts a
review at this stage to
Evaluate the project efficiency by comparing the delivered output with the planned
one, in terms of time, cost and performance standards.
Ensure that the benefits are well documented for use in future projects.
Document the lessons learnt as these may be helpful in the management of future
projects.
Review in the Post-implementation Stage
This kind of review is usually conducted any time between three to six months after
the completion of the project. The project manager undertakes the review to judge
whether the project was successful in meeting its goals or not. These reviews should;
Evaluate the benefits of the project and compare them with the benefits envisaged in
the initial plan
Judge the effectiveness and efficiency of the delivered output of the project when it is
put to use in real-life situations
Suggest corrective measures, if necessary
Document the lessons, as these may prove helpful in managing future projects
Be conducted keeping in mind the information requirements of the various
stakeholders, like the sponsor of the project, the functional departments, the end-users
and the clients.
Project Review
101
Post project reviews have a special significance in project management.
Example: Significance of Post Project Review
Project review is probably the most effective tool for improving project results and
project management practices. An effective and thorough review of project
performance can help the project manager find out what was right and what was
wrong about the conduct of the project. Project reviews should be target oriented
and realistic i.e., they should be conducted efficiently and lay emphasis on overall
project goals and objectives. To sum up, post project reviews should analyze the
performance of the project so as to build on the project achievements and avoid
problems in the future. Post project reviews help evaluate the performance of the
project from various perspectives:
1. Was the project a total success?
2. Was it a well defined project?
3. Did the project deliver the expected results?
4. Was the project implemented according to established project management
policies and procedures?
5. Was the progress of the project monitored and controlled properly?
6. Was the project a success from the stakeholders point of view?
7. Is the project team happy with the performance of the project?
Every project has some valuable lessons for improving future projects and
developing professional skills. Post project reviews help uncover those valuable
lessons.
Adapted from www.ittoolkit.com/pmreview_intro.htm.
Check Your Progress
11. Projects are reviewed at the post-implementation stage usually between three and
six months after the completion of the project. Which of the following stages of
project review falls under the post-implementation stage of the project?
a. When auditing is to be conducted
b. When the major output of the project is to be delivered
c. At the point where major problems occur
12. At which of the following points in the implementation stage is the project review
not taken up?
a. Before entering into major contracts.
b. At points where the risk is substantially high.
c. At points where major problems occur.
d. When there are any minor difficulties in the project implementation.
13. Which of the following are the stages at which project review is to be conducted?
i. During the initial stages, after the project proposal has been submitted.
ii. At the stage when in-depth evaluation is conducted.
iii. During the implementation of the project.
iv. When auditing has to be conducted.
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a. Only i and ii
b. Only iii and iv
c. i, ii, and iii
Meetings are an effective and essential means of conducting project reviews in an
organization. These meetings are aimed at reviewing the project status and have a
specific agenda. At these meetings, decisions are made, different aspects of the project
are discussed and the work is planned and scheduled. Project managers usually use a
top-down approach for conducting a project status review meeting. The sequence of
events at a review meeting is generally as follows;
1) The project leader presents the changes in the project scope that may have an
impact on its future
2) The client presents the changes in the project that may have an impact on its
future
3) The project manager presents the status of the project, with a note on the impact
of changes that were considered or approved earlier
4) Activity managers present the progress since the last status meeting
5) Activity managers of future activities present the changes having an impact on the
project status since the last meeting
6) The project manager checks the status of the problems that remained unresolved
at the previous meetings
7) Members present in the meeting explore new problem areas and assign
responsibility for solving these problems.
8) Closing comments are made by the project leader, the client or the project
manager
9) The project manager closes the meeting after announcing the venue, date and time
of the next review meeting.
The following aspects have to be decided upon before holding a review meeting --
frequency of meetings, preparing agenda, meeting coordinator, and recording and
distributing minutes.
Frequency of Meetings
If the activity manager submits his report to the project manager on a weekly basis,
and the project manager in turn submits his report to senior management on a
biweekly basis, project status review meetings may be conducted once in two weeks.
But there is no hard and fast rule about the frequency of meeting. The frequency is
usually based on the length and duration of the project. Meetings must not be held too
frequently as this leads to waste of time. At the same time if the review meetings are
infrequent, the project manager may lose control over the project. The project
manager must therefore exercise his judgment while deciding the frequency of
meetings.
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Preparing Agenda
The agenda lists the issues that are to be discussed at the meeting. It helps the project
manager to ensure that every one participates in the discussion. The agenda should not
have many topics for discussion. If the agenda provides background information for
each topic that is listed, participants can come better prepared for the meeting.
Depending on the importance of a topic, the agenda specifies a time limit for
discussing the topic.
Meeting Coordinator
The meeting coordinator fixes the place and time for the meeting and arranges for the
required equipment. While deciding the time and the arrangements for the meeting,
the coordinator must consider the following;
Is the room big enough to accommodate all the participants? The room should neither
be too small nor too large.
The convenience of the place.
Are the seating arrangements comfortable? Can additional seats be provided if
required?
Does the room have proper light and ventilation?
Are the visual aids working properly?
Is additional stationery available?
Are name plates required?
Handling of messages.
Once these aspects have been taken care of, the preparation for the meeting are over.
Let us now see how a review meeting should be conducted.
Before starting a review meeting it is the responsibility of the project manager to
respect the protocol. The following measures/precautions have to be taken to avoid the
problems arising out of breach of protocol.
Participants must be given enough notice and the agenda given to them must contain
background information about the topics that are to be discussed
The heads of the relevant departments must be informed about the requirement of
expert subordinates
New comers must be introduced to the other members before the meeting starts
Participants must be listed in alphabetical order
Significant contributions made by persons inside and outside the group must be
acknowledged
Participants must be informed well in advance if the meeting is being postponed or
being canceled.
Once the meeting gets underway, it is the responsibility of the project manager to
encourage discussion, seek the opinions of all the participants and before concluding
the meeting, to summarize what was discussed at the meeting. The project manager
must ensure;
That all the participants have a clear understanding of the objectives of the meeting.
That a time limit for the entire meeting has been set in the agenda and that this time
limit is made known before the meeting begins.
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The meeting will be a success if all the participants agree upon the objectives from the
same point of view. The leadership skills of the project manager and cooperation
among the participants determine the success of the review meetings. The project
manager and the participants should;
Get acquainted with other participants before the meeting starts
Allow other participants to come out with their ideas and recommendations
Carefully listen to the views of other participants
Welcome new ideas that support the objectives of the meeting
Help in arriving at a consensus
Be flexible enough.
Even if all efforts are made to make sure the meeting goes on smoothly, a number of
problems may arise. Participants inability to reach a consensus on the objectives of
the meeting is a major problem. Another key problem is the difficulty participants
face in communicating effectively with one another, due to differences in age, rank,
status etc. Sometimes participants tend to spend too much time trying to solve a single
problem. If this happens, the project manager should intervene in the discussion and
make sure that things go according to schedule. When participants fail to arrive at a
decision, the project manager must help them sort out their differences and encourage
them to reach a decision before the meeting concludes. While closing the meeting, the
project manager should present a summary of the discussions and thank all those who
made significant contributions to the meeting. A follow up should be done to make
sure the decisions taken at the meeting are implemented.
Recording and Distributing Minutes
The minutes of a meeting form an important part of the project documentation. They
provide proof that certain problems were discussed and certain decisions were arrived at.
Therefore, recording and distributing the minutes is as important as preparing the agenda.
Check Your Progress
14. Which of the following will be the correct sequence of a typical project status
review meeting?
i. The project leader outlines the changes in the project that may have an impact on
its future.
ii. Activity managers present a report of the progress since the last status meeting.
iii. The project manager checks the status of the problems that remained unsolved at
the previous meetings.
iv. Members present at the meeting explore new problem areas and assign
a. i-ii-iii-iv
b. ii-i-iii-iv
c. ii-i-iv-iii
d. i-iv-iii-ii
15. Based on which of the following factors is the frequency of holding the project
review meetings decided?
a. Length and duration of the project
b. Budget allotted for the project
c. Availability of venue for holding the meetings
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16. Which of the following are specified by the agenda of the meeting?
a. Duration of the meeting.
b. Time limit for discussing each of the topics.
c. The scope of discussion of the topics.
17. Who among the following decides on the time of the meeting and makes the
arrangements for it like fixing the place and arranging the required equipment?
a. Project manager
b. Meeting coordinator
c. Project member
d. External facilitator
18. Which of the following aspects have to be decided upon before a review meeting
is held?
i. Quorum for the meeting
ii. Frequency of the meeting
iii. Location of the meeting
iv. Recording and distributing minutes
a. Only i and iii
b. Only i, ii and iv
c. Only ii and iv
d. i, ii, iii and iv
19. Which of the following involves the recording of the proceedings of the project
status review meetings and forms an important part of the project documentation?
a. Preparing agenda
b. Recording and distributing minutes
c. Status reviews
d. Design reviews
20. Reviewing the __________ is the purpose of holding the project review meeting.
a. project budget
b. project status
c. project design
d. project duration
21. The _________ lists the issues that are to be discussed at the meeting.
a. minutes
b. agenda
c. duration of the meeting
d. time
22. Which of the following aspects need not be considered by the meeting
coordinator when deciding on the time and arrangements for the meeting?
a. The convenience of the place.
b. Whether the seating arrangements are comfortable.
c. Whether the visual aids are working properly.
d. The proximity of the meeting place to the project site.
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7. Advantages of a Project Status Review Meeting
Apart from allowing participants to share information and make decisions, a project
status review meeting also gives the project manager a chance to make the team
more cohesive; keep the team informed about projects progress; identify potential
problems; make sure the team has a clear idea of where the project is going; and
ensure that the entire team is willing to put in their efforts to meet the project
objectives.
Activity: Ganesh Ahuja joined a software development firm as assistant project
manager. He is assigned to work under the senior project manager Shreenivas Raju,
on a telecommunication software project. The project was half-way through when
Raju called for a review meeting. And unexpectedly Raju was sent to New Jersey
to handle another project (on which he was the project manager). So, the
responsibility of conducting the review meeting was handed over to Ahuja, who
had no previous experience in conducting review meetings. Think yourself as a
senior project manager in the firm and advice Ahuja on how to conduct a review
meeting. Explain to him the advantages of conducting review meetings.
Answer:
8. Types of Project Status Meetings
Project status meetings keep the participants informed about the projects progress.
These meetings are usually attended by the representatives of senior management, the
project manager, the client and the key members of the project team. These are the
people who should be kept informed of the project progress. In the case of projects
that are geographically dispersed, or projects in which different activities are being
taken up in two different locations, it may not be possible for the project manager to
bring all the parties involved under one roof to hold the traditional project review
meeting. In such situations modern communication technology can be used to
conduct meetings. Such meetings could either be long distance status meetings, which
allow two-way communication or meetings conducted through a visibility web-site
which allows only one-way communication.
Long Distance Status Meetings
These meetings enable two-way communication between the parties involved through
audio conferencing or video conferencing. These meetings need a high amount of
formality to ensure that all the topics in agenda are addressed. To make sure that all
the topics in the agenda are discussed at these meetings and to keep track of all the
parties involved, a structure called Open Job Report is prepared.
Visibility Websites
A visibility website allows one-way communication between the project manager and
the parties involved. This is the best way to keep people informed about the project
developments. This information is available across the globe through a Uniform
Resource Locator (URL). The most significant aspect of visibility website is its ability
to link team members spread across different geographical locations.
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Check Your Progress
23. Which of the following allows a one-way communication between the project
manager and parties who are geographically dispersed?
a. Long distance status meetings
b. Project review
c. Visibility website
24. __________ is prepared to ensure that all the topics on the agenda are discussed
and to keep track of all the parties involved.
a. Open Job Report
b. Visibility web site
c. Agenda
d. Process review
25. Which of the following enable/s two-way communication between the parties
involved in the project through audio and video conferencing?
a. Visibility website
b. Long distance status meetings
c. Project status review meetings
9. Summary
Once the project enters the implementation phase, the project manager should review
the status of the project in a timely and phased manner. Project reviews conducted at
various stages of project implementation play a major role in the success of a project.
Reviews are conducted to find out if the project can accomplish the business goals;
whether the rules of the organization are understood properly and implemented; if it is
worthwhile to take up the project at all before entering into major contracts; and
whether the project is managed effectively, and the team members are sure of
completing the project by following the guidelines.
A project manager has to conduct various reviews throughout the life of a project to
ensure that it is progressing towards achieving the planned objectives. Generally, a
project manager conducts three types of reviews status reviews, design reviews, and
process reviews.
A review should always be conducted before taking any major decisions that can
affect the future of the project. Reviews can be conducted during the various stages of
the project life cycle such as initial stage, implementation stage, and closing stage.
Meetings are an effective and essential means of conducting project reviews in an
organization. Project status review meetings are aimed at reviewing the project status
and have a specific agenda. At these meetings, decisions are made, different aspects of
the project are discussed, and the work is planned and scheduled.
Project status meetings keep the participants informed about the projects progress.
These meetings are usually attended by the representatives of senior management, the
project manager, the client and the key members of the project team.
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Project status meetings could either be long distance status meetings, which allow
two-way communication or meetings conducted through a visibility web-site which
allows only one-way communication.
10. Glossary
Agenda: Lists the issues that are to be discussed at the meeting and process reviews
are used to determine whether the processes are going as planned.
Comprehensive reviews: These are conducted monthly basis as part of the status
reviews. Status reviews and process reviews are not done at any fixed milestones, but
are conducted frequently to know the status and process of the project.
Cursory reviews: These are conducted as a part of the status review on a weekly
basis.
Design review: The review conducted at the major milestones of project
implementation to ensure the performance quality of the project deliverable.
Long distance status meetings: Enable/s two-way communication between the
parties involved in the project through audio and video conferencing.
Open job report: A structure prepared to ensure that all the topics on the agenda are
discussed at these meetings and to keep track of all the parties involved.
Visibility websites: One-way tools that help the project manager communicate with
parties situated at distant places.
1. As the project enters the implementation phase, the project manager should
review the status of the project in a timely and phased manner. Explain the
importance of conducting a project review.
2. A project manager has to conduct various reviews throughout the life of a project
to ensure that it is progressing towards achieving the planned objectives. What
are the different types of project reviews conducted by a project manager?
3. A project review should be conducted before taking any major decisions that can
affect the future of the project. What are the different stages in the project life
cycle at which a project manager can conduct project reviews?
4. Meetings are an effective and essential means of conducting project reviews in an
organization. What are these meetings? Describe the advantages of conducting these
meetings. What are the various ways in which these meetings can be conducted?
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1. (c) Only i, iii, and iv
The purpose of the project review is to know whether the project can accomplish
the business goals, whether the rules of the organization have been understood
and will be implemented properly, whether it is worthwhile taking up the project
at all before entering into major contracts, whether the project is being managed
effectively, and whether the team members are sure of completing the project by
following the guidelines laid out. It is not one of the purposes of the project
review to determine whether the project is exceeding the budget limits set by the
manager. But the results of the review will help the management to evaluate the
cost of the project.
The project review helps the manager in keeping in mind the purpose of carrying
out the project, determining the appropriateness of the project activities from time
to time, gauging the way in which the objectives are being accomplished,
verifying the completion of the project, evaluating the cost of the project, and
understanding the project requirements.
3. (c) American National Standards Institute
The design review criteria developed by the American National Standards
Institute help in the design review of the projects.
4. (b) status reviews.
Status reviews are conducted at fixed intervals to review the present position of
the project. Generally, a cursory review is done every week and a comprehensive
one every month to review the status of the project. But the frequency with which
the reviews are conducted may vary depending on the frequency with which
problems occur. Design reviews are conducted to check whether the design of the
product or service being produced is of expected quality and the process reviews
are conducted to determine whether the processes are going as planned and
whether any improvements are possible.
5. (d)Design review
Design review refers to the review conducted at the major milestones of project
implementation to ensure the performance quality of the project deliverable.
Design review is the tool to review the performance factor of the project.
Comprehensive review is done on a monthly basis as part of the status reviews.
Status reviews and process reviews are not done at any fixed milestones, but are
conducted frequently to know the status and process of the project.
6. (c) Process reviews
Process reviews are sometimes conducted by external facilitators rather than the
project manager himself/herself. This is because the team members may not feel
free to be critical about the leadership skills of their project manager, leadership
being one of the processes crucial for the success of the project. Cursory reviews
and comprehensive reviews, which are part of status reviews, are generally
conducted by the manager himself/herself.
7. (b) iii-ii-i
The steps in the problem-solving process are: Identifying the existing problems,
identifying the factors that cause problems, and exploring solutions that can solve
the problems.
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8. (b) cursory review.
Cursory reviews are done as a part of the status review on a weekly basis.
Comprehensive reviews, also a part of the status reviews, are done on a monthly
basis. Design reviews are conducted to check whether the design of the product or
service being produced is of the expected quality and process reviews are
conducted to determine whether the processes are going as planned and whether
any improvements are possible.
The main objective of conducting a project review is to determine whether the
processes are going on as planned and whether any improvements are possible.
The two objectives of process reviews are: To preserve the performance of
project processes that are going well and to improve the processes that are below
standard. Reviewing the financial performance of the project and the safety of the
operators and maintenance personnel are not the objectives of process reviews.
10. (c) Control of costs in project implementation
The design review covers only the performance aspects of the project
implementation like manufacturability, serviceability, tooling, economics of
special machinery, safety of operators and maintenance personnel, precautions
taken to minimize damages, etc. It doesnt cover the cost, time, and scope of the
project.
11. (a) When auditing is to be conducted
The projects are reviewed at the post-implementation stage three to six months
after the completion of the project and during the conduct of audit of the project.
The other two options: when the major output of the project is to be delivered and
at the point where major problems occur do not fall under the post-
implementation stage of the project.
12. (d) When there are any minor difficulties in the project implementation.
The project review is conducted at the implementation stage of the projects at the
following points: Before entering into major contracts, when the major output of
the project is to be delivered, when the risk is substantially high, and when major
problems occur.
The important points or stages at which a review is conducted are as follows: In
the initial stages of the project life cycle, at the stage when an in-depth evaluation
is conducted, during the implementation of the project, when the project is
completed, and when auditing has to be conducted.
14. (a) i-ii-iii-iv
The sequence of events at a review meeting are: The project leader presents the
changes in the project that may have an impact on its future, the client presents
the changes in the project that may have an impact on its future, the project
manager presents the status of the project accompanied by a note on the impact of
changes considered earlier, activity managers present a report of the progress
since the last status meeting, activity managers of future activities outline the
changes that have had an impact on the project status since the last meeting, the
project manager checks the status of the problems that remained unresolved at the
previous meetings, members present at the meeting explore new problem areas
and assign responsibility for solving these problems, the project leader, the client,
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111
or the project manager makes closing comments and the project manager closes
the meeting after announcing the venue, date, and time of the next review
meeting. The activity manager presents the progress since the last status meeting
to the members present at the meeting exploring new problem areas and assigning
15. (a) Length and duration of the project
The frequency of holding meetings is decided based on the length and duration of
the project. This is because meetings held more often than necessary lead to
wastage of time. The budget allotted and the availability of venue for holding the
meetings are not factors which determine the frequency of holding project review
meetings.
16. (b) Time limit for discussing each of the topics.
The agenda of the meeting specifies the time limit for discussing each of the
topics, depending upon the importance of the topics. The duration of the meeting
and the scope of discussion of the topics at the meetings are not specified by the
agenda of the meeting.
17. (b) Meeting coordinator
The meeting coordinator fixes the place and time for the meeting and arranges for
the required equipment. The project manager and project member do not decide
upon the time and arrangements of the meeting. The external facilitator is used in
the process reviews of the project.
18. (c) ii and iv
The aspects that are to be decided upon before a review meeting is held are:
Frequency of meetings, preparing the agenda, meeting the coordinator, and
recording and distributing minutes. It is not necessary to decide upon the quorum
for the meeting and the location before holding the review meeting.
19. (b) Recording and distributing minutes
Recording and distributing minutes forms an important part of project
documentation and provides evidence regarding the problems which were
discussed and the decisions arrived at in the review meeting.
20. (b) project status
Organizing meetings is an effective way of conducting project reviews in the
organization. The meetings will have a specific agenda of reviewing the status of
the implementation of the projects. Reviewing the project budget, project design,
and project duration are not the purposes for which a project review meeting is
held.
21. (b) agenda
The agenda of the meeting lists out various issues that are to be discussed at the
meeting. The minutes of the meeting are prepared after the meeting has been
conducted.
22. (d) The proximity of the meeting place to the project site.
The coordinator must consider the following while deciding on the place and time
of the meeting: Whether the room is big enough to accommodate all the
participants of the meeting, the convenience of the place, whether the seating
arrangements are comfortable, whether the room in which the meeting is to be
held has proper light and ventilation, whether the visual aids are working
properly, whether additional stationery and name plates are required, and how
messages are to be handled in the meeting.
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23. (c) Visibility website
The visibility website is a tool which enables a one-way communication between
the project manager and the parties involved.
24. (a) Open Job Report
Open job report is the structure prepared to ensure that all the topics on the
agenda are discussed at these meetings and to keep track of all the parties
involved. Visibility websites are one-way tools that help the project manager
communicate with parties situated at distant places. The agenda lists the issues
that are to be discussed at the meeting and process reviews are used to determine
whether the processes are going as planned.
25. (b) Long distance status meetings
Long distance status meetings enable two-way communication between the
parties situated at distant places through audio and video conferencing. The
visibility website only allows one way communication between the project
manager and the parties involved. Project status review meetings are held if the
participants have geographical proximity.
Unit 10
Project Control
Structure
1. Introduction
2. Objectives
3. The Fundamentals of Project Control
4. The Objectives of Control
5. Reasons for Measuring Duration and Cost Deviations
6. Control as a Function of Management
7. Control Vs. Risk
8. Balancing the Control System
9. Control of Change and Scope Creep
10. Progress Reporting System
11. Types of Project Status Reports
12. Graphical Reporting Tools
14. Managing Risk
15. Managing Quality
16. Summary
17. Glossary
1. Introduction
In the previous unit, we have discussed about project review. In this unit, we will
discuss about project control. Project control is the process of collecting information
related to the performance of the project system, comparing it with the desired level of
performance and taking corrective action to decrease the gap between the actual and
the desired performance levels. The basic purpose of project control is to control and
manage change. Project control is not a separate phase in itself but it goes hand in
hand with the project implementation phase.
As the project progresses, the project manager gathers all the information pertaining to
project status from its team members and the clients. The information gathered has to
contain the progress made, percentage of work completed and predictions indicating
the possible date of completion. This is the right period for getting inputs on changes
in activity dependencies and to decide on the inclusion or exclusion of activities from
the plan. The information gathered can be analyzed to find out variances, to examine
the total performance of the project and to prepare monthly sales reports. The
significant areas to look out for variances are scope of the project, project schedule
and resource utilization.
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An effective project management system is one which puts in place a well organized
control system at the time of project planning. Once the project enters the execution
phase, it is the responsibility of the project manager to check whether the actual output
matches with scheduled/desired level of output. The parameters to be used are
performance, time and cost. A project control system helps in fixing problems in time
and in putting the system back in shape. The idea behind implementing a project
control system is A stitch in time saves nine. A project control system is a
corrective, evaluating tool to minimize the risk and cost of project deviations that may
lead to project failure.
This unit will deal with the fundamentals of project control. We will discuss the
objectives of control, control as a function of management, and the difference between
control and risk. We will also discuss the reasons for measuring duration and cost
deviations, and understand the ways to balance the control system, and control change
and scope creep. We shall then move on to discuss progress reporting system and
describe the various types of project status reports. We will also discuss about the
graphical reporting tools and project status review meetings. Finally, we would be
discussing the different ways to manage risk and quality.
2. Objectives
explain the fundamentals of project control.
define the objectives of control.
discuss the reasons for measuring duration and cost deviations.
recognize control as a function of management.
differentiate between control and risk.
identify ways to balance the control system.
determine ways to control change and scope creep.
define progress reporting system.
recognize the various types of project status reports.
list the graphical reporting tools.
discuss project status review meetings.
find out different ways to manage risk and manage quality.
3. The Fundamentals of Project Control
Project controls are tools developed to diagnose the system for deviations from the
actual plan and reset them back with the actual plans/schedule. Project controls are
required to check whether the project is progressing in accordance with the plans and
standards set during the planning phase. In fact, the project controls are measures
taken by the project manager in order to minimize the gap between the planned output
and the delivered output.
Answering the following questions will help us in designing an effective control
system:
Who sets the standards?
How realistic are the set standards?
How clear are the standards?
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Do these standards achieve the projects goals?
What are the outputs and behaviour that need to be monitored?
Is monitoring of people required?
What kind of sensors are to be used?
Where should the sensors be placed?
How frequently should the monitoring be done?
What should be the tolerable gap between the actual and the planned output before
taking the corrective measures?
What are the corrective measures available to take corrective action if needed?
How ethical are these corrective measures?
What rewards and penalties can be used to get the desired results?
What kinds of actions are to be taken and by whom?
An effective control system is one that appears sensible and acceptable to those who
use it and those who are controlled by it.
Characteristics of an Effective Control System
For a control system to be effective and efficient, it should fulfill the following
requirements:
Comprehensiveness: The control system should give a detailed overview of the work
to be performed. It has to estimate the time, labor, and costs required to finish the
project.
Communicability: The system should communicate the scope of the project.
Authenticity: The system should reflect budgetary discipline and authentic expense
tracking by accounting tangible progress and cost expenditure in time.
Timeliness: The control system should be able to frequently re-analyze the cost and
time required for the completion of the remaining work. This is done by comparing
the delivered output with the actual/scheduled output in terms of performance, cost
and time thereby rendering the system cost effective.
Simplicity: The system should be simple to operate.
Flexibility: The system should be open to extensions and alterations and it should also
be easy to maintain.
Morally sound: The system should conform to all the ethical standards.
Check Your Progress
1. Which of the following characteristics of an effective project control system
refers to budgetary discipline and expense tracking by accounting tangible
progress and cost expenditure in time?
a. Comprehensiveness
b. Simplicity
c. Authenticity
d. Moral soundness
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2. It is the duty of the project manager to ensure that the actual output matches the
desired output. Which of the following parameters should be used to ensure that
this is monitored properly?
i. Performance
ii. Time
iii. Price
iv. Cost
a. Only i
3. Which of the following options involves the process of collecting information
related to the performance of a project, comparing the performance with the
desired levels of performance, and taking corrective action if there is any gap
between the actual and desired levels?
b. Project review
c. Project control
d. Project risk management
e. None of the above
4. Project controls are required to check whether the project is progressing in
accordance with the standards set during the planning phase. Which of the
following is a characteristic of an effective project control system?
i. Comprehensiveness
ii. Authenticity
iii. Timeliness
iv. Moral soundness
a. Only i
b. Only i, iii and iv
c. i, ii, iii, and iv
5. Which of the following characteristics of project control means that the system is
open to extensions and alterations and is easy to operate?
a. Comprehensiveness
b. Flexibility
c. Simplicity
d. Moral soundness
4. The Objectives of Control
The primary objective of control is regulation. The purpose is to monitor the delivered
output by comparing it with the actual/scheduled output suggested in the planning
phase. The regulatory function of control helps in translating the objectives into
performance standards that are represented by program activities and events; and
formulating budgets in order to compare the delivered output with the
actual/scheduled output.
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The secondary objective of control is conservation of resources. The project manager
is entrusted the responsibility of protecting the physical, human and financial
resources of the organization. The process of guarding each of these three assets is
different. Resource control involves evaluating the utilization factor of resources.
Human resource control tries to determine whether the individuals are capable of the
efforts required to finish the task on time. It is hardly possible to dedicate the
resources totally to a specific project. When the human resources are shared between
the projects, some projects may not be able to achieve its objectives due to
mismanagement or misallocation of their personnel.
Physical asset control is the process of controlling the use of physical assets. It
includes the preventive or corrective maintenance of the assets. A project manager has
to schedule the maintenance/ replacement plan in a way as to minimize interruption to
the work in progress and without overlooking the quality aspect. Controlling the
inventory is also a key aspect that involves receiving, inspecting, storing and
recording to ensure genuine payment to vendors. This also involves proper material
handling techniques.
Human resource control is the process of controlling and maintaining the growth and
development of the human capital of the organization. Unique projects enable people
gain rich experience within a short period of time. Conserving human resource is
therefore a significant aspect of the control system.
Financial resource control is a combination of regulatory and conservatory functions.
The conservatory function of control on capital investments requires the meeting of
certain conditions before investments are made. The same conditions also regulate
capital flows for a higher return on investment. The regulatory and conservatory
techniques of financial resource control consist of a control on current assets and
project budgets along with capital investments. These controls are implemented
through a series of analysis and audits by the controller or the project manager.
The tertiary objective of project control is to facilitate decision-making. Effective
decision-making by the management requires the following reports:
A report comprising the plan, schedule and budget made during the planning phase.
Data consisting of the comparison between the resources spent in order to achieve the
delivered output and the scheduled output. This report should also include an
estimation of the remaining work.
An estimate of the resources required for the completion of the project.
These reports that are submitted to the project managers and team members are useful
in the following manner:
They provide feedback to the management, planners and team members.
They identify the deviations from the scheduled plan.
They implement a contingency plan at an early stage in order to protect the project
from higher losses due to cost, performance and time overruns.
Need to Control Performance, Time, and Cost
Talking of control always brings three parameters into the discussion: the
performance, the cost and the time of a project. These three aspects are of utmost
importance to any project manager because he is answerable to the client. This makes
the project manager to check whether the project is progressing as per the expectations
and if it is operating within the time frame and budget. The need to control the
performance, cost and time arises from this.
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Controlling Performance
It is necessary to control performance because technical problems may spring up any
moment; resources may become scarce; complicated technical snags may develop;
quality problems may arise; the client may request for changes in the system
specifications; inter functional complications may arise; and technological
breakthroughs can also affect the project.
Controlling Costs
Some of the reasons that necessitate cost control are more resources are required to
solve the technical problems; cost of the project increases proportionately with the
scope of the project; low estimations were given initially; poor reporting structures;
inappropriate budgeting; failure to put a corrective measure in place in time; and
change in the prices of inputs.
Controlling Time
Some of the reasons that necessitate time control are solving a technical snag may
require more time than estimated; time estimations that were done initially were very
optimistic; tasks were inappropriately sequenced; shortage of material, personnel or
equipment when required; incomplete preliminary tasks that were necessary to
complete a series of activities; and changing government regulations.
Check Your Progress
6. The project manager is entrusted with the responsibility of protecting the
physical, human, and financial resources of the organization. ___________ is the
objective of project control which deals with the protection of these resources.
a. Conserving the resources
b. Regulation
c. Facilitating decision making
d. None the above
7. Which of the following options reflect the primary, secondary, and tertiary
objectives of a control system in an order?
a. Facilitating decision making, conserving resources, and regulation
b. Conserving resources, facilitating decision making, and regulation
c. Regulation, conserving resources, and facilitating decision making
5. Reasons for Measuring Duration and Cost Deviations
Before going into the reasons behind measuring duration and cost deviations, it is
necessary to talk about variances and kinds of variances. Variances are deviations
from the actual plan. Based on the parameters of time and cost, variances can be
classified into Positive variances and Negative variances.
A positive variance is one in which the delivered output is ahead of the planned
schedule or the cost incurred is less than the planned cost. Though positive variances
are good news for the project managers, they can be as threatening as negative
variances. Positive variances are capable of advancing the project completion date and
allocating lesser resources than estimated. However, these variances can also occur as
a result of missing an activity that was supposed to be completed during the reporting
period. It needs to be examined thoroughly before reporting a positive variance.
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A negative variance is one in which the delivered output is behind schedule or the cost
incurred is more than the planned cost. The project manager would want a detailed
report on the schedule accomplished and the costs incurred, along with the reasons for
the delay.
It is important to measure duration and cost deviations because they play a significant
role in the project management life cycle. Though all the parameters of project
management have their own levels of significance, time and cost share a special place.
Identifying Deviations from the Curve Early
When the project manager plots the actual performance or cost curve against the
planned performance or cost curve, he may observe some deviation between the
curves. This deviation between the curves cautions the project manager about cost and
performance overruns. This enables the project manager to initiate timely corrective
measures to minimize the deviations.
Dampen Oscillation
A constant, continuous and identical pattern should be displayed by curves
representing the actual and the planned performance over time. Projects with high
fluctuations over time result in many bottlenecks in the project life cycle like running
behind schedule, overspending during one phase and going out of control in the next
phase. Measuring deviations would help the project manager in taking timely
corrective measures that would nip problems in the bud.
Facilitate Early Corrective Action
A schedule or a cost problem is better reported to the project manager at an early stage
of its development. The project manager has more opportunities for a corrective action
plan when the problem is detected early.
Estimating Weekly Schedule Variance
Weekly reports on the work in progress have to be made, to give the project manager
enough time to take corrective measures before the situation gets out of control.
Determining Weekly Effort (Person Hrs/Day) Variance
The variance between the planned/scheduled effort and the delivered effort has a
direct impact on the planned cumulative cost and schedule. A lower delivered effort
than the scheduled effort indicates that the potential has not been optimized i.e., a
person failing to enhance his/her effort in the following phases of the project.
However, if the delivered effort is more than the scheduled effort, where progress is
not in proportion with the effort put in, may result in a cost over run. It is very
important to detect the out of control situations early. The longer one takes to detect a
problem, the harder it will be to put the project back on track.
Example: Reasons for Cost Overruns
During the proposal submission phase
1. Lack of understanding of the clients requirements.
2. Unrealistic evaluation of internal strengths.
3. Misjudging time requirements for project completion.
During the planning phase
1. Neglecting importance of planning
2. Incorrect work breakdown structure
Contd
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Contd
3. Distortion of Information.
4. Using inappropriate reviewing techniques.
5. Inability to find and focus on the key parameters of the cost
6. Inability to analyze risk
During the negotiation phase
1. Demanding a faster settlement.
2. Settling for a higher cost
During the contractual phase
1. Conflicting clauses in the contract.
2. Different teams for projects and proposals
During the design phase
1. Entertaining change requests from the client without the top managements
approval.
2. Difficulty in the communicating with the client.
3. Difficulty in conducting meetings on design review.
During the production phase
1. Higher inventory costs
2. Inappropriate specifications of the deliverables
3. Lack of compatibility between the production and engineering functions.
Source: www.projectnet.com.
Check Your Progress
8. Which of the following options refers to the project manager taking timely
corrective action to nip problems in the bud?
a. Facilitating early corrective action
b. Estimating weekly schedule variance
c. Identifying deviations from the curve early
d. Dampening oscillation
9. Among the following options, what is the type of variance in which the delivered
output is behind the project schedule or the cost incurred is more than the
scheduled cost?
a. Coefficient of variation
b. Positive variance
c. Negative variance
10. ___________ is the deviation from the actual project plan.
a. Range
b. Variance
c. Coefficient of variation
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6. Control as a Function of Management
Project control is generally implemented through people. Any form of control has a
significant impact on human behavior. Because of this, it becomes necessary to study
project control with special reference to people and their behavior.
The Governance Model in an Organization
The purpose of establishing governance and control across the organizational
hierarchy is to minimize the gap between the delivered schedule, budget and output of
the project and the planned schedule, budget and output. Though the fundamental
purpose of control remains constant - to minimize the deviation between the actual
and planned output- the management function of control involves developing and
implementing control systems to observe peoples response to various controls.
The various techniques for enhancing creativity and problem-solving through team
work such as Total Quality Management (TQM) and Employee Involvement (EI) give
the team a sense of direction and motivation to achieve a goal. All these techniques
signify control. Control is an inherent part of every organization. Control helps in
achieving and preserving the ethical goal directed behavior. It is the project managers
responsibility to implement controls that instigate only those behaviors that are
desirable. It is presumed that the control system motivates individuals and also affects
the levels of motivation.
Individuals may respond to the goal directedness of control systems in the following
manner through active and passive participation and goal oriented behavior; through
passive involvement to minimize loss; and through active but negative involvement
and resistance.
Types of Control Processes
The process of controlling a project is a highly complex task. The complexity is more
than fixing the problem after waiting for something to go wrong. Control starts from
identifying the points in the project to exert control, knowing what should be
controlled and how to measure it, what should be the tolerable limit of deviation and
how to identify and correct these deviations as they happen. Project control is used to
check the four key parameters time, cost, scope and performance. There are three
basic control mechanisms cybernetic control, go/no-go control, and post control.
Cybernetic Control
Cybernetic controls, also known as steering controls, are very common control
systems. Automatic operation is its chief characteristic. A cybernetic control is like a
steering in an automobile that enables the controller to keep the project on track.
Cybernetic controls are generally used to monitor and control tasks that are carried out
more or less continuously, for example, software projects. The designing of cybernetic
controls requires identifying mechanical tasks, based on the Work Breakdown
Structure (WBS).
The operation begins with an input that gets processed into an output. The sensing unit
that monitors the output of the process (that we wish to control) sends the input to the
comparison unit which then compares it with the standards that are already set. The
comparison unit after measuring the variation between the input and the standard set,
sends the output to the decision maker to decide on the requirement of a corrective
action depending on the size of variation. If the variation is large enough to
implement a corrective measure, the decision maker acts on the processing unit or the
input to get it in close congruence with the set standards.
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A cybernetic control system that minimizes the variation from the set standards is
known as a negative feedback loop. The control mechanism in a cybernetic control
system acts in a direction that is opposite to the one in which the variation moves
away from the standard. Also the speed of action of a control is directly proportionate
to the size of variation from the standard.
Cybernetic controls can be classified into three types, depending on the sophistication
of the standards set. A first order control system is a goal-seeking device. It is a rigid
system that seldom allows altering the set standards. The standards once set can be
altered only by an external intervention. For example, once a standard temperature is
set in a thermostat, the air-conditioning systems operate to maintain it. A second order
control system can alter the standards that are set only in accordance with
predetermined rules and regulations. A third order control system is a flexible goal
seeking device. These systems are flexible enough to alter their standards from time to
time, based on the evaluation of the past performances. These systems can deal with
contingencies better than the rest.
Information Requirements of a Cybernetic Control System
Every output needs an input that has to be processed. If output here is an effective
cybernetic control system, the inputs required by the project manager would be
information. The information that is required for developing cybernetic controls is as
follows:
Defining the characteristics of the output that are to be controlled.
Setting the standards for the defined characteristics.
Acquiring the sensors that measure the characteristics at a particular level of precision.
Transforming the measurements into signals that are to be compared with the set
standards.
Detecting the difference between the output and the standard set. If the variation is
large enough, the decision maker should act on the processing unit in such a way that
it tries to bring the output in close congruence with the set standards.
A cybernetic control system is most effective in keeping track of a system and in
notifying the project manager automatically when the output starts deviating from the
set standards.
Activity: George Erix, the COO of a project management firm, wants to revise the
firms control mechanisms for a new project erecting a manufacturing facility at
a new steel plant. Freddy Fernandez, a senior project manager, is asked to develop
control mechanisms right from scratch. Identify and describe the control
mechanisms that Fernandez can incorporate in the project. What type of
information do these mechanisms require?
Answer:
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Check Your Progress
11. From the following options, identify the type of control whose chief characteristic
is automatic operation.
a. Go/No-go control
b. Post control
c. Cybernetic control
12. In the negative feedback loop cybernetic control system, the speed of action of
control is ________ proportionate to the size of variation from the standard.
a. inversely
b. directly
c. conversely
13. Cybernetic controls can be classified into various types depending upon the
sophistication of the standards set. Which of the following control system is a
flexible goal-seeking device?
a. First order controls
b. Second order controls
c. Third order controls
d. Fourth order controls
14. Individuals can respond to the goal directedness of control systems in various
ways. Which among the following is/are the ways through which individuals
respond to goal directedness of the control system?
i. Through active and passive participation and goal-oriented behaviour.
ii. Through passive involvement to minimize loss.
iii. Through active but negative involvement and resistance.
a. Only i
b. Only ii and iii
c. i, ii, and iii
d. Only i and ii
15. The setting up of the cybernetic controls requires various types of information. Of
the following, which type of information is not needed for setting up the
cybernetic controls?
a. Setting the standards for the defined characteristics.
b. Defining the characteristics of the output that is to be controlled.
c. Milestones achieved in project implementation.
d. Transforming the measurements into signals that are to be compared with the set
standards.
16. A cybernetic control system that minimizes the variation from the set standards is
known as a __________.
a. negative feedback loop
b. go/no-go controls
c. post controls
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Go/No-Go Controls
As cost and time overruns may require the organization to pay penalties to the
customer, Go/No-go controls are instituted to check whether the output meets the
preset cost and time standards. These control systems are flexible and apply to all the
aspects of project management. The project plan, budget and schedule are the control
documents that contain preset milestones that act as verification points.
Controls are usually done at the level of detail as mentioned in the project plan,
budget and schedule. The periodicities with which Go/no-go controls are operated are
regular and preset. Preset intervals are decided upon with the help of calendars or the
operating cycles. Because project milestones do not happen as planned in the
calendar, it is advantageous to link these controls to the actual plans and the
happening of real events. But a judicious use of these controls is advisable. While
some parameters of output have to meet a particular standard range, others may or
may not meet the standards precisely.
The major difference between the cybernetic and the Go/No -go control system is that
a cybernetic system functions automatically and continuously, while a go/no-go
system functions only when it is put into application by the controller, and is periodic.
Information Requirements for Go/No-Go Controls
Setting up an effective Go/no-go control system requires the following documents:
Project proposal: This document specifies the expected business value (i.e., return on
investment) along with the cost and time estimates of the project. It describes what is
to be done, whos going to do it, when is it going to be done and how. It gives a
detailed map of the project. The project proposal describes the project background,
states the objective of the project, and specifies the approach, the time and the cost
requirements of the project.
Project plan: This document gives the ends and means to a particular action or
objective. It describes the ways in which a project can be executed. It is a decision
making tool that enables the project manager choose the best alternative from
different approaches, schedules and resource requirements. A project plan is an
effective tool in the hands of the project manager. An effective project plan reduces
uncertainty and enhances clarity and efficiency of the delivered output.
Project specifications: These are the set of rules and regulations under which the
objectives of the project are met. This document lays down standards that are to be
met by the output of all the processes contained in the project lifecycle.
Project schedule: This document specifies a time frame for each activity.
Project budgets: Cost of the project being a key parameter in the project management,
it needs to be monitored very carefully. Capital is a very scarce and valuable resource
in project management that needs to be monitored closely. This document gives the
estimation of the cost required to finish the project.
Milestones: These are the key parameters that highlight the control activity.
Milestones, which are in the form of output, are delivered by the project. If the project
is able to meet the milestones on time and budget and at a desired quality level, the
project manager can be sure that the project is proceeding smoothly.
Post Controls
These are the control systems that are applied after the completion of the project. These
are also called post project controls or reviews. As George Santayana said Those who
cannot remember the past are condemned to repeat it. Thus, while cybernetic and
go/no-go controls help a firm to accomplish the goals of current projects, post control
tries to enhance the firms chances of meeting future project goals, on the basis of
lessons learnt in the past projects. A post control report has the following sections:
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The Objectives of the Project
The post control report explains the objectives of the project. It also includes the effect of
change requisitions and their approvals on the project scope. Though the actual output of
the project depends partially on uncontrollable external factors such as strikes, vendor
delays, climatic conditions etc., the assumptions made while planning the budget and
schedule should also be mentioned. Enough care has to be taken while giving assumptions
so that they do not seem to be excuses to cover failures in the later projects.
Milestones, Checkpoints, and Budgets
This part of the post control report compares the actual project performance with the
plans and points out deviations. This section includes the different status reports
prepared during the project life cycle.
The Final Project Result Report
In this final project result report no distinction is made between positive or negative
deviations while reporting the deviation of actual performance from the planned
performance. The report is focused on the How aspect of the deviation rather than
the What aspect. This part of the post control report describes the techniques that
were used to plan and direct the project, review the communication networks and
monitoring and control systems used during the project life cycle and examines the
interactions between different work groups.
Recommendations for Performance and Process Improvement
This final section of the post control report contains recommendations for future
projects. Though most of the reasons for deviation are one time events, some of the
reasons are likely to recur and these are the areas that need attention. The
predictability of such events can be improved by psroviding a slot for them in the
project plan. Organizational systems and management techniques that proved
effective in the current project can be used for future projects. Thus post control has a
significant impact on the way future projects are handled. The control mechanisms are
aimed at minimizing the amount of risk involved in managing projects. However, risk
cannot be eliminated totally.
Check Your Progress
17. Which type of project control mechanisms deal with the How aspect of the
deviation rather than the What aspect?
a. Cybernetic controls
b. Go/No-go controls
c. Post controls
18. The setting up of the Go/No-go controls requires various documents. Of the
following, identify the document which is not necessary for setting up the
Go/No-go controls.
a. Project schedule
b. Project plan
c. Project definition statement
d. Project proposal
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19. The control systems that are applied after the completion of the project are called
a. cybernetic controls.
b. go/no-go controls.
c. post controls.
d. negative feedback loop.
20. Post control systems are applied after the completion of the project. From the
options given, identify the sections present in the post control report.
i. Objectives of the project
ii. Milestones, checkpoints, and budgets
iii. The final project result report
iv. Recommendations for performance and process improvement
21. The document which specifies the time frame for each activity in the project is
called
a. project proposal.
b. project plan.
c. project schedule.
d. project budgets.
22. The set of rules and regulations under which the objectives of the project are met
is called
a. project proposal.
b. project plan.
c. project budgets.
d. project specifications.
23. Out of the following control mechanisms, identify the ones applied periodically.
a. Cybernetic controls
b. Go/No-go controls
c. Post controls
7. Control vs. Risk
Once the project is in the implementation phase, the project manager would like to
make sure that the project is moving ahead according to the plan. A number of reports
are developed that show how closely the project is following the plan. This makes it
easier for the firm to identify and correct deviations. The project plan being a system
may go out of balance any time and hence as a precautionary measure we require a
corrective plan that can bring the system back to equilibrium. Control systems are
designed in such a way that they enable early detection of problems and a faster
implementation of corrective measures.
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High Control Low Risk
Putting in more controls can reduce the risk of the project. But there is a balance
between the amount of control that is achieved by seeking reports and enhancing their
frequency and the protection bought against the out-of-balance situations that affect
the risk unfavorably.
Low Control High Risk
The project is unlikely to move ahead according to the plan, without proper control
measures in place. Timely detection of problem situations in a project and the design
and implementation of a control plan is critical to a projects success. Without control
plans, a project runs the risk of being completely derailed whenever problems occur.
In studying the relationship between control and risk it becomes necessary to know
the tools that enable us to strike a balance between control and risk.
8. Balancing the Control System
The greater the control exercised over a project, the less likelihood there is of project
getting into trouble. However, enhancing the frequency of carrying out the project
controls leads to wastage of time in reporting. In order to respond to the controls
exerted, the team members would have to spend time in preparing reports and
answering queries - thereby minimizing the time spent on project work. Controls do
not come without a cost. Exercising greater control pushes up the cost of the project
and leads to micromanaging events. The project manager has to decide as to what
extent the project has to be controlled. Excessive control induces rigidity and tends to
block creativity. The project manager should encourage creativity. The cost of control
should be measured against its effect on the team members. Figure 10.1 gives the total
cost of control and risk. It depicts the relationship between risk and control.
Conceptually, the balance point reduces the overall cost liability for choosing a
specific degree of control.
Figure 10.1: Total Cost of Control and Risk
A balanced control system has the following characteristics:
The fact that investment in control and returns are inversely proportional to each other
is to be kept in mind before designing a balanced control system. A linear increment
in the degree of control results in an exponential hike in the cost.
A balanced control system acknowledges that exerting control beyond a point would
dampen creativity.
A balanced control system focuses on correcting errors, rather than punishments.
A balanced control system exercises only the minimum control that is required to
achieve the project goals.
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On the whole, a balanced control system is one that is cost effective and well
equipped to seek the end results. For example treating everyone equally appeals to a
sense of equity, but treating everyone individually would achieve better results.
Causes of Imbalance
It is important to know the factors that cause imbalances in a control system. such
imbalances could be due to the following reasons:
Focusing on easy to measure factors, while ignoring intangible factors that are
difficult to measure.
Laying greater emphasis on short-term results rather than on long-range objectives.
Ignoring the organizational goals and structural changes brought about by time and
the circumstances in which the firm operates.
Exercising too much control.
When organizations adopt management by objectives employees may ignore
activities that are not considered for measurement.
Implementing a balanced control system is difficult. An important principle that is
often overlooked is the need to relate the controls directly to the project goals. Also
controls should be related to particular performance outputs. The process of relating
controls to the project goals starts by describing the desired outputs as precisely as
possible. Then the potential reasons for deviations are examined, after which proper
controls are developed for these reasons starting with the one that can cause the
highest intensity of deviation.
Striking a balance between the long-term and short-term controls is a difficult task
because project managers are often more concerned with achieving the short-term
objectives rather than long-term goals.
Check Your Progress
24. Which of the following options represents the correct relationships between risk
and control while balancing risk and control in the control process?
i. Low Control-High Risk
ii. Low Control-Low Risk
iii. High Control-Low Risk
iv. High Control-High Risk
a. Only i and iii
b. Only ii and iii
c. Only iii and iv
d. i, ii, iii and iv
25. Various factors cause imbalances in the control system. Which of the following is
not a cause for such imbalances?
a. Focusing on the easy to measure factors while ignoring the intangible factors that
are difficult to measure.
b. Laying too much emphasis on long-range objectives rather than short-term
results.
c. Exercising too much control.
d. Ignoring the organizational changes and structural changes brought about by the
time and the circumstances in which the firm operates.
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26. Exercising greater control pushes up the cost of the project. ______________
reduces the overall cost liability for choosing a specific degree of control.
a. Balance point
b. Balance control system
c. Post controls
9. Control of Change and Scope Creep
Controlling the scope of a project involves attempts to include changes in the project
scope when they occur and manage these changes simultaneously. In situations where
these scope changes are inevitable, the project manager has to find out their impact on
the project plan and seek the approval for the same from the client. Also the changes
have to be communicated to the team members and the stakeholders, after they are
approved by the client. There are many factors that have the potential to make a good
application obsolete, such as changes in technology, changes in the competitive
environment, or the reactions of customers. The three basic causes that can lead to
changes in the project are;
Uncertainty regarding the technology that is to be used in the project
An increase in the level of sophistication of customers, leading to scope creep
Modification of rules and regulations under which a process has to be carried out to
convert the input into a desired output.
Any change can hamper progress, especially if it is introduced in the implementation
phase. But changes cannot be avoided, as they are usually caused by factors that are
beyond the control of the project manager. An effective project management system
must have an effective change management method. Most changes are a result of
efforts made by the client and the team members to improve the product.
Incorporating changes when the project has already reached an advanced stage is
difficult and expensive.
The absence of a proper control system to qualify a change for an implementation
would result in a continuous piling up of all the small changes, which will have a
negative impact on the cost and schedule of a project. Practices like Total Quality
Management (TQM) and Employee Involvement (EI) have proved helpful in
conducting a detailed study on the outputs and processes of control systems. This
detailed study is conducted by a team that represents the interests of all the
stakeholders such as the clients, the management, the project team and the
community.
A formal change control system that can minimize the risk associated with a change,
is usually a part of the configuration management system that integrates and
coordinates changes across the project development life cycle. The tasks of this
system are;
Examining the changes that are requested by the stakeholders of the project
Determining the impact of these changes on the cost, schedule and performance of the
project
Exploring alternate changes that could yield the same or better output
Accepting or rejecting the changes that are proposed
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Communicating the changes to all the parties involved
Incorporating the changes properly as per the plan
Developing monthly reports detailing all the changes and their impact on the project.
The following guidelines are useful in designing an effective change control system:
All project agreements should include a detailed report on how requests for a change
in the plan, budget, schedule or the output of a project should be introduced and
processed.
A change order that describes every change in the project should be prepared. This
must include a description of the changes that are agreed upon, along with
corresponding changes in the plan, budget, schedule and output.
An approval letter must be obtained, both from the clients agent and senior
managements representative, on the changes to be implemented. The project
manager should be consulted before the change order is finalized. However, the
approval of the project manager is not mandatory.
Once the change order is approved, a master plan of the project should be made
reflecting the changes and the change order is now a part of the master plan.
An effective change management process contains two documents:
Requisition for change in a project and
A project impact statement
Requisition for change in a project: It is important to document every change
requested by the client. This can be done in the form of a simple memo or in the
format prescribed by the project team. This will help the team to evaluate the impact
of the change on the project and to determine whether the change can be incorporated.
Project impact statement: Once a requisition for a change is made, a project impact
statement is prepared. This statement identifies various alternative actions along with
the pros and cons of each. The client then chooses the best alternative. The following
are the possible responses to a requisition for a change:
Accommodating the change within the allocated resources and time schedule of the
project.
Accommodating the change with an extension in the delivery schedule of the project.
Accommodating the change with additional resources and/or extension in delivery
schedule.
Implementing the change in a phased manner by the way of prioritizing the output
needed.
Controlling Scope Creep
The most important reason for deviations from the budget is scope creep. One factor
that causes scope creep is the absence of a detailed definition of scope. Repeated
attempts by the project team and the client to improve the product/service is another.
It is important to design an effective control mechanism to handle scope creep. The
project manager must ensure that no expenditure is incurred until the scope change is
approved. With changes being introduced during the implementation of the project,
there is bound to be a discrepancy between the actual output and the planned one. An
effective reporting system should be in place that periodically submits reports on the
progress of the project and gives details about all the changes and their impact on the
original project objectives and schedules, to all the parties involved in the project.
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Activity: Go Stop Inc. (GSI) is a Munich-based automobile braking systems
manufacturing company. It is an OEM (Original Equipment Manufacturer) for
more than 75 models of cars and bikes across Europe. The company bagged an
order from a motorbike manufacturing firm for its ventilated disc braking systems.
After the design was approved and the project was set to start, the project
organization received a requisition for change in the size of the disc brakes. What
should the project organization do to control the changes and ultimately the scope
of the project?
Answer:
Check Your Progress
27. A change management process requires two documents. ___________ identifies
the various alternative actions along with the pros and cons of each alternative.
a. Project impact statement
b. Requisition for change in a project
c. Project proposal
d. Project plan
28. Which of the following options describes all changes in the project?
a. Change order
b. Scope creep
c. Current period reports
10. Progress Reporting System
Once the project enters the implementation phase, the project manager has to be kept
informed about how the project is progressing. This can be done through an effective
reporting system. To design an effective reporting system, one must first decide the
following:
i) What information is to be reported? And how is it to be reported?
ii) How frequently are the reports to be submitted?
iii) What level of detail is to be reported?
Information to be Reported
To design a progress reporting system one must first determine various information
requirements of people involved in the project across the organizational structure.
This involves deciding what kind of information is required and by whom, and at
which hierarchy level, along with the timing and duration of the reporting.
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Determining a specific day of the week and a period of time: The updated information
has to be submitted by the project team on a particular day of the week and for a
specified duration of time as scheduled. It is the responsibility of the project
administrator to see that all the updated information is made available in time.
Reporting the actual work done during the period: There is sometimes a lot of
difference between what was planned and what is actually accomplished. Activity
managers usually report that they have achieved what was planned, even if they are
behind schedule, hoping to catch up by the next reporting time. It is the responsibility
of the project manager to check the accuracy of information provided in the report.
Recording the historical information and re-estimating the work that is to be
completed: Reporting all the finished work till the deadline along with the analysis of
deviations that occurred. A proper re-estimating is done on the work to be completed
in terms of cost and duration.
The start and finish dates have to be reported: The actual start and finish dates of the
tasks that are started or finished during the time of reporting.
Recording the number of days spent and the number of days required for the
completion of the task: The first parameter to be reported is the number of days spent
on doing the task. The other aspect to be reported is the number of days required for
completing the remainder of the task.
Recording the number of hours spent per day to finish the task: The man hours
already spent on a task and also an estimate of the man hours required to accomplish
the remainder of the task.
Frequency of Reporting Progress
Progress reports are usually submitted once in a week. However, this varies from
project to project. As the complexity of the project changes the frequency of reporting
also changes.
Level of Detail to be Reported
It is very difficult to decide the exact level of detail that is to be included in a project
status report. The information needs of the person controlling the project vary
depending on his or her position in the management hierarchy. The following are the
information requirements for different people across the organizational hierarchy:
The activity manager requires a detailed report, because he is the person directly
responsible for getting the work done. As he has to manage the resources required for
completing the project, he would like to know the what, why and how of all the
resources and activities under his control.
The project manager requires the status information of all the tasks that are in
progress during the reporting period. Reports submitted to the project manager contain
information related to scheduling. They are infact documents for adjusting the
schedules and for preparing the overall project status. The level of detail of this report
is very high and the report is generally meant for reviews internal to the project teams.
Senior management usually prefers to get information in the form of graphs and
pictorial representations. As they have a very limited time for reviewing project
reports, a report submitted to them is best limited to a single page with the milestones
of the project highlighted. In case the project is out of balance, it is advisable to attach
a get-well plan narrating the problem involved, alternative solutions, the actions
recommended and some estimate of when the situation will be rectified.
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Characteristics of an Effective Progress Reporting System
The information gathered for a progress reporting system must have the following
characteristics:
Information must be complete, accurate and timely.
It should not add over head time to the planned time of completion.
It must be acceptable to senior management and the project team.
It should indicate the potential problems to the controller, in order to take timely and
proper action.
It should be understood easily and clearly by the people who need it.
It is difficult to arrive at a generic reporting structure for all projects because each and
every project is unique and the information requirements of different projects vary.
Therefore, it is advisable to use project management software packages to develop
customized reports that meet the needs of different types of projects.
Check Your Progress
29. The project should be comprehensive to provide proper information that meets
the requirements of the people who use it. Which of the following options
represent this feature of the progress reporting system?
a. Frequency of the reporting progress
b. Information to be reported
c. Level of detail to be reported
30. A good reporting system is needed for the project manager to be kept informed
about the progress of the project. Which of the following are the characteristics of
an effective progress reporting system?
a. Information should be complete, accurate, and timely.
b. It must be acceptable to the senior management of the firm.
c. It should be understood easily and clearly by the people who need it.
d. All of the above
11. Types of Project Status Reports
Depending on the degree of detail and the frequency of reporting, project status
reports can be classified into five categories current period reports, cumulative
reports, exception reports, spotlight reports, and variance reports.
Current Period Reports
These reports describe the project activities that have recently been completed. They
indicate the progress of only those tasks that have been scheduled for a specific
period. These reports can also focus on the deviations between the planned and the
actual completion dates. The reasons for these deviations should be explained and a
plan to correct the deviations from schedule should be recommended in the report.
Cumulative Reports
These reports present the history of the project, from its inception to the ending of the
current reporting period. Because these reports indicate trends in project progress,
they are considered to be more informative than current period reports.
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Exception Reports
These reports show variances from the plan. Since senior managers do not have much
time to spare, the information in these reports is presented in a way that is easy to read
and interpret. Such reports have a one page executive summary that highlights the
main points of the status of the project and its deviations from the plan. Senior
managers who wish to learn about the reasons for these deviations can read the
detailed report.
Spotlight Reports
These reports are alterations to be used along with all the reports discussed above. A
green color sticker is placed on the top right hand corner of the first page of the
project status report, to indicate to senior management that the project is progressing
smoothly. A yellow sticker is placed on the top right hand corner of the first page of
the project status report, to indicate that though there have been some problems in the
execution of the project, a plan is in place to deal with these problems. An additional
sheet attached to the report, describes the problems in a detailed manner along with
the measures that have been taken to correct these problems and gives an estimate of
the time needed to complete this rectification. A red sticker is placed on the top right
hand corner of the first page of the project status report, to indicate that there is a
serious problem in the project for which no corrective measures have been developed.
The conditions in the red sticker reports are beyond the control of the project manager.
Variance Reports
These reports show how the delivered output/activity deviates from the plan. The
report is divided into three columns, having the planned number, the delivered number
and the variance (between the two) as the column heading. A variance report can have
a numeric or a graphic format. In a graphic representation, the variance need not be
represented because it is just the difference between the two curves at a particular
point in time. Variance reports follow a format that is consistent across all the
activities and tasks within a project, to make the senior management feel more
comfortable while using it.
Activity: Gautam Gupta is a senior project manager at a software consulting firm.
The firm bagged a project to develop an information system package for an
upcoming retail chain in India. Gupta is made the project leader for this new
project. The top management asked Gupta to design a separate progress reporting
system for the project so that the senior authorities could monitor the project
closely. What are the factors that Gupta should consider to develop a progress
reporting system? What are the different types of project status reports he can
consider?
Answer:
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Check Your Progress
31. A ___________ is a type of report which shows how the delivered output/activity
deviates from the project plan.
a. variance report
b. spotlight report
c. exception report
d. cumulative report
32. The project reports are classified into various categories depending upon the
degree of detail and frequency of reporting. Identify the kind of report that
describes the project activities that have recently been completed.
a. Cumulative reports
b. Current period reports
c. Exception reports
33. Which of the following are the alterations that are used to attract the attention of
the senior management to the status of the project?
a. Variance reports
b. Spotlight reports
c. Exception reports
12. Graphical Reporting Tools
In addition to the reporting tools mentioned above that use numerical and theoretical
data, the following are the types of reporting techniques that use graphs as their
reporting tools. Graphical reporting tools are of three types Gantt charts, milestone
trend charts, and cost schedule control. Given the time constraints of the senior
management, the project manager has to use reporting tools that effectively convey
the meaning of a 15-page document in a single graphical representation.
Gantt Charts
Gantt charts depict the activities of a project in an easy-to-grasp manner. A Gantt
chart can be used for different applications in project management, starting from
planning, resource scheduling and status reporting. A Gantt chart represents the
schedule of a project in a two dimensional manner. Activities are plotted on the Y-axis
and time on the X-axis. The inability to show dependency relationships is a
shortcoming of a Gantt chart.
Milestone Trend Charts
Milestones are key events/activities in the project life cycle that need to be tracked.
These key events/activities represent the existence of certain conditions in the project.
Milestones are planned in a fashion similar to activity planning. These charts plot the
gap between the scheduled and the estimated dates of a milestone of a particular
period. Each reporting period shows an extra slippage since the last reporting period.
Project managers should take corrective action if such a slippage occurs four times
continuously, irrespective of the size of slippage. Sometimes the milestone trend
charts show drastic change between two successive reporting periods. Such radical
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change patterns may be a result of unrealistic time estimates at the planning stage or
due to some data error occurring while preparing the trend chart. Hence a project
manager has to conduct further enquiry to find out the reasons for such changes.
Cost Schedule Control
This tool uses rupee value of work performed to measure project performance.
Manhours/day can also be used to measure project performance if the project budget
is not being managed by the project manager. The measures Manhours/day and the
Rupee value of work are helpful for determining the plan and cost variances in the
current period and cumulative variances till date. The planned work is compared to
the actual work performed. These parameters are required to give the total project
history and it is not sufficient to have either the planned work or the actual work
accomplished. These parameters are primarily used to monitor a projects health,
which must be restored by the project manager as required.
A cost schedule control measures the budgeted cost of work scheduled, the budgeted
cost of work performed, and the actual cost of work performed. Schedule variance and
cost variance are the two-variance values resulting from the above measurements.
A cost schedule control tool can be used not only to measure the health of a project
and report its history but also to predict the future status of the project. Measuring the
budgeted cost of work scheduled, budgeted cost of work performed and the actual cost
of work performed results in knowing the two variance values that are schedule and
cost variances. Apart from measuring and reporting history, cost schedule control can
also be used to predict the future status of the project.
Inspite of designing and implementing various tools for reporting the progress of the
project there are some unanswered queries and doubts that can be solved only by
conducting project status review meetings that add a personal touch to the mechanical
processes involved.
Check Your Progress
34. Graphical tools are used to report the progress of the project along with the
numerical and theoretical data. Which of the following types of graphical
representations represents the schedule of the project in a two dimensional
manner?
a. Milestone trend charts
b. Gantt charts
c. Cost schedule control
35. __________ is a type of graphical reporting tool that not only measures the
current status of the project but also the future status of the project.
a. Gantt charts
b. Milestone trend charts
36. From the following options, identify the graphical reporting tool that tracks the
key events in the project life cycle.
a. Gantt charts
b. Milestone trend charts
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Project status review meetings are used to review the status of projects. They are not
general discussions or meetings trying to solve a generic problem, but focus on a
single project with specifically timed agendas. Various kinds of reviews are conducted
throughout the project life cycle. For a project to be called a successful one, the timing
of reviews is important. A project undergoes the following reviews during its life-
cycle status review (reviews the status of cost, performance, schedule and scope),
design review (reviews the design of the product or service to ensure that it meets
client requirements), and process review (reviews the processes and checks for the
possibility of any improvements).
Status Review
The most frequently conducted review is the status review. A status review can be
comprehensive or cursory. Generally, a cursory review is conducted on a weekly basis
while a comprehensive review is conducted on a monthly basis. Generally, for a project
of one-year duration, a weekly cursory review and a monthly comprehensive review will
suffice. When the project runs into difficulties, the frequency of reviews increases until
the problem is solved. To avoid micromanagement, the frequency of status reviews
should be limited. A status review should, ideally solve problems, not punish people. It
is always advantageous to know the kinds of problems existing in a system, the factors
causing these problems and the corrective measures required to solve them.
Design Review
A design review ensures that the product or service being developed matches
customer requirements. Generally, such reviews are conducted when a milestone has
been reached. If a product is poorly designed, it will not meet customer expectations.
Therefore, the design review focuses on the performance component rather than on
cost, time and scope of the project.
The project manager has to keep in mind some guidelines while conducting design
reviews. It is necessary to include the conditions for manufacturing and servicing in
the design review. Ensuring optimization by integrating design with manufacturing
specifics like tooling and economics of process and specialty machines, is also the
responsibility of a design review. A design review also considers the specifications of
the working conditions such as storage of inventory, ease of accessing the materials
and tools, safety in operating and maintaining and damage protection.
Process Review
The process review is focused on reviewing the how aspect of an activity. This
review tries to find out how an activity can be carried out in a better manner. Process
reviews typically take place at the milestones or once every two or three months. This
type of review tries to improve those activities that are not being carried out well.
It is important to discuss the outcome of the different types of reviews with all the
parties involved in the project.
The activity manager reports the status of the project on a weekly basis to the project
manager, who in turn reports to senior management on a biweekly basis. Thus it
becomes appropriate to conduct project status review meetings once in every two weeks.
Though the duration of the status review meeting depends on the size of the project, it is
usually limited to one hour. The list of people attending the review meeting varies across
the project life cycle, depending on the need of the person and the situation. Though
status review meetings have a flexible format as influenced by the need of the project,
the top-down approach is commonly used. The minutes of the meeting are circulated,
revised for errors and follow ups and filed in the project notebook.
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Till now we have seen all the aspects of project control that are highly vulnerable to
change at any stage in a project life cycle. We have examined all the dimensions of
control, starting from the types of controls to be exercised, their impact and the
measures to be taken under various situations. We have also described the reasons
behind using controls to keep the project in equilibrium. Now we are in a position to
discuss the two most important aspects of project control, without which the purpose
of control is not achieved. They are Risk Management and Quality Management.
Example: Format of Top Down Approach used in Review Meetings
Participants in the
Review Meeting
Specific Task Common Task
Project champions and
customers
Reporting the changes that
have a bearing on the
future of the project.
Closing comments of the
meeting
Project manager
Describing the health of
the project along with the
impact of problems,
changes and corrective
measures.
Identifying new problems and
assigning the responsibility to
solve the same
Activity manager of the
present activity
Reporting the status of the
tasks scheduled for work
between the previous and
the current review
meeting.
solve the same
Activity manager of
future activities
Reporting alterations since
previous meeting that
have a potential bearing an
impact on the project
status.
solve the same
Project manager
Reporting the status of
problems since the
previous meeting.
Meeting is adjourned after
announcing the venue and
timing of the next
meeting.
Giving closing comments of
the meeting and/or identifying
new problems and assigning
the responsibility to solve the
same
Check Your Progress
37. Identify the type of review which deals with the How aspect of the project
activities.
a. Process review
b. Status review
c. Design review
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38. Which of the following types of project review assesses the design of the product
or service to ensure that it meets the requirements of the clients?
a. Design review
b. Status review
c. Process review
39. Which of the following project review meetings are conducted to measure the
position of cost, performance, schedule, and scope of the project?
a. Process review
b. Design review
c. Status review
14. Managing Risk
Since control and risk are indirectly related to each other, it is important to examine their
impact on each other. The higher the level of control, the lower the risk of project
failure. Risk can be defined as the probability of not meeting a pre-defined project goal.
While considering risk, the consequences associated with failure should also be
considered. Risk consists of three fundamental components -- an event, the probability
that the event happens, and the impact of probability on happening of event.
Risk arises because of the lack of knowledge of future events. Opportunities can be
considered as favorable future events, while risks can be regarded as the
unfavorable future events. Effective project management is one that is able to
recognize the traps and allow the development of safeguards to overcome these traps.
With the required number of safeguards, risk is minimized. Since risk is an activity
that is based on the future, there are no tools that can totally prevent risk. The project
manager can only attempt to minimize risk, using proper judgment.
Risk management as defined by the Project Management Institute Body of Knowledge
(PMBOK) is a formal process by which risk factors are systematically identified,
assessed and provided for. Though risk is minimized to a certain extent by exerting
control, there is also a need for a proper risk management system. Effective risk
control can be achieved by combining both control and risk management systems. In
order to control risk throughout the projects life cycle, a risk management strategy is
necessary. Risk management involves identifying, quantifying, responding to and
controlling the risk.
15. Managing Quality
Quality as defined by BS4778 is the totality of features and characteristics of a
product or service which bear on its ability to satisfy a stated or implied need.
Developing and managing a control system to test the quality of the final product or
service is high priority in project management. Developing control systems, reporting
systems, and risk management systems would be futile if no proper quality control
system is in place.
The main elements of a quality system are the policy behind maintaining quality and
description and procedures for maintaining quality, preferably in the same order. The
basic objective of a quality control system is to ensure a continuous meeting of
customer needs or system objectives.
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For acquiring new businesses in new markets it is necessary to have a quality control
system. Having a quality control system also helps in protecting the firm from product
and legal claims (for faulty products) .
The PMBOK also refers to quality control as the technical aspect of quality
management. The project team members play an active role in project management to
make sure that every project process delivers a quality output. The output at the end of
each stage in the project must meet the overall quality standards. This ensures that the
desired quality is achieved. The following are the characteristics of an effective
quality control system:
Capability in identifying what to control.
Setting standards in order to provide the basis for taking decisions on corrective
measures.
Developing quality measurement tools.
Comparing the delivered output with the quality standards that have been set.
Incorporating measures that can put the processes and outputs back to standard if it
fails to meet the quality standards.
Monitoring and calibrating the devices used to measure quality.
Detailed documentation of the process.
Check Your Progress
40. Which of the following are the fundamental components of risk?
i. An event
ii. The probability of the event happening
iii. The outcome of the event
a. Only i
b. Only i and ii
c. i, ii and iii
d. Only ii and iii
41. Which of the following are the characteristics of an effective quality control
system?
i. Capability in identifying what to control
ii. Developing quality measurement tools
iii. Detailed documentation of the process
iv. Monitoring and calibrating the devices used to measure quality
a. Only ii
b. Only i and iv
d. Only iii and iv
42. The probability of not meeting a pre-defined project goal is called __________.
a. quality
b. risk
c. control
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16. Summary
Project controls are tools developed to diagnose the system for deviations from the
actual plan and reset them back with the actual plans/schedule.
Project controls are required to check whether the project is progressing in accordance
with the plans and standards set during the planning phase.
For a control system to be effective and efficient, it should have the following
characteristics comprehensiveness, communicability, authenticity, timeliness,
simplicity, flexibility, and morally sound.
The primary objective of control is regulation, while the secondary objective of
control is conservation of resources.
It is important to measure duration and cost deviations because they play a significant
role in the project management life cycle. Though all the parameters of project
management have their own levels of significance, time and cost share a special place.
Project control is generally implemented through people. Any form of control has a
significant impact on human behavior. Because of this, it becomes necessary to study
project control with special reference to people and their behavior.
The process of controlling a project is a highly complex task. Project control is used to
check the four key parameters time, cost, scope and performance.
There are three basic control mechanisms cybernetic control, go/no-go control, and
post control.
The project plan may go out of balance any time and hence as a precautionary
measure, we require a corrective plan that can bring the system back to equilibrium.
Control systems are designed in such a way that they enable early detection of
problems and a faster implementation of corrective measures.
The greater the control exercised over a project, the less likelihood there is of project
getting into trouble. The project manager has to decide as to what extent the project
has to be controlled as controls are costly. The balance point reduces the overall cost
liability for choosing a specific degree of control.
Controlling the scope of a project involves attempts to include changes in the project
scope when they occur and manage these changes simultaneously.
Once the project enters the implementation phase, the project manager has to be kept
informed about how the project is progressing. This can be done through an effective
reporting system.
Depending on the degree of detail and the frequency of reporting, project status
reports can be classified into five categories -- current period reports, cumulative
reports, exception reports, spotlight reports, and variance reports.
Gantt charts, milestone trend charts, and cost schedule control are the various
techniques that use graphs as their reporting tools.
Project status review meetings are used to review the status of projects. They focus on
a single project with specifically timed agendas.
Various kinds of reviews are conducted throughout the project life cycle. A project
undergoes the following reviews during its life-cycle status review, design review,
and process review.
Control and risk are indirectly related to each other. The higher the level of control,
the lower the risk of project failure.
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Quality can be defined as the totality of features and characteristics of a product or
service which bear on its ability to satisfy a stated or implied need. Developing and
managing a control system to test the quality of the final product or service is high
priority in project management.
17. Glossary
Cybernetic Controls (or steering controls): These are used to monitor and control
tasks that are carried out more or less continuously, for example, software projects.
Progress Reporting System: A mechanism that keeps the project organization
updated on the performance of the vendor, i.e., the way in which he is achieving the
objectives of the contract.
Project Control: The process of collecting information related to the performance of
the project system, comparing it with the desired level of performance and taking
corrective action to decrease the gap between the actual and the desired performance
levels.
Project Plan: A formal, approved document used to manage and control project
execution.
Project Proposal: An initial document that converts an idea or policy into details of a
an estimate of the resources and time required.
Project Status Report: A report mentioning the status of achievements and
deviations from the resources that are spent and the plans that are scheduled.
Quality: The totality of features and characteristics of a product or service, which
influence its ability to satisfy a stated or implied need.
Risk Management: A process by which risk factors are systematically identified,
assessed, and provided for.
1. Project control is not a separate phase in itself but it goes hand in hand with the
project implementation phase. Discuss the fundamental purpose of project
controls. Explain the characteristics of an effective control system.
2. Measurement of duration and cost deviations is very important as they play a vital
role in the project management life cycle. What are the reasons for measuring
duration and cost deviations.
3. Any form of control has a significant impact on human behavior. Explain the
objectives of controls, and the role played by controls as a function of
management. What are the control mechanisms? What do you think is the
relationship between control and risk?
4. The project plan being a system may go out of balance any time and hence as a
precautionary measure we require a corrective plan that can bring the system back
to equilibrium. How does the project manager balance a control system? What are
the factors that cause an imbalance in a control system?
5. Controlling the scope of a project involves attempts to include changes in the
project scope when they occur and manage these changes simultaneously. What
are the various ways in which the project manager can control the change and the
scope creep?
6. Once the project enters the implementation phase, the project manager has to be
kept informed about how the project is progressing. What are the factors to be
kept inmind while designing an effective reporting system? Explain the
characteristics of an effective progress reporting system.
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143
7. Project status reports can be classified into various categories depending on the
degree of detail and the frequency of reporting. What are the various types of
project status reports?
8. The project manager has to use various reporting tools to convey the details
regarding the project status. What are the different graphical reporting tools that
can be used by a project manager?
9. Project status review meetings are used to review the status of projects. Various
kinds of reviews are conducted throughout the project life cycle. Discuss the
different types of reviews conducted by the project manager during the life cycle
of a project.
10. Control and risk are indirectly related to each other. Also, a proper control system
should be in place. How can the project manager manage the risk involved and the
quality of a project? Explain the characteristics of an effective quality control system.
1. (c) Authenticity
Authenticity refers to budgetary discipline and expense tracking by accounting
tangible progress and cost expenditure in time. Comprehensiveness refers to the
detailed overview of the work performed. Simplicity and being morally sound
refer to the system being simple to operate and conforming to all the ethical
standards, respectively.
2. (b) Only i, ii, and iv
It is the responsibility of the project manager to ensure that the actual
performance matches the desired level of output. The parameters to be used for
this are performance, time, and cost.
3. (b) Project control
Project control is one of the most important parts in project implementation. It is
used to monitor the activities of the project and to take corrective action if there is
any deviation from the desired level of performance. The main purpose of project
control is to control and manage change in a project.
4. (c) i, ii, iii, and iv
The following are the characteristics of an effective project control system
comprehensiveness, communicability, authenticity, timeliness, simplicity,
flexibility, and moral soundness.
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5. (b) Flexibility
Flexibility refers to the system being open to extensions and alternations and
being easy to maintain. Comprehensiveness refers to the detailed overview of the
work performed. Simplicity and being morally sound refer to the system being
simple to operate and conforming to all the ethical standards.
6. (a) Conserving the resources
Conserving the resources is the secondary objective of project control. This
entails the protection of the physical, human, and financial resources of the
organization. Regulation and facilitation of decision-making are the primary and
territory functions respectively of project control.
7. (c) Regulation, conserving resources, and facilitating decision making
The primary objective of control is regulation, the secondary objective is
conserving resources, and the tertiary objective is facilitating decision making.
8. (d) Dampening oscillation
Measuring the deviations helps the project manager in taking corrective actions.
This will reduce the oscillation of the curves representing the actual and planned
performance over time. The other options given are not correct as they refer to the
possibility of taking corrective action. Facilitating early corrective action through
weekly schedule variance will facilitate the project manager to take action at an
early stage of the project.
9. (c) Negative variance
Negative variance refers to the case in which the delivered output is behind
schedule or the cost incurred is more than the scheduled cost. Positive variance is
the opposite of negative variance where the delivered output is ahead of the
planned schedule or the cost incurred is less than the planned cost.
10. (b) Variance
Variance is the deviation from the actual project plan. Based on the parameters of
time and cost, the variances may either be positive variances (when the resulting
output exceeds the expectations) and negative variances (when the resulting
output falls below the expectations).
11. (c) Cybernetic control
Cybernetic controls are used to monitor and control tasks that are carried out
more or less continuously. They are designed by identifying mechanical tasks
based on the work breakdown structure. Go/No-go and post controls are not
carried out automatically.
12. (b) directly
The cybernetic control system that minimizes the variation from the set of
standards is known as a negative feedback loop. The speed of action in a negative
feedback loop is directly proportional to the size of the variation from the
standard in that loop.
13. (c) Third order controls
Cybernetic controls can be classified into three types: The first order control
system, which is a goal-seeking device; the second order control system, which
can alter the standards that are set only in accordance with predetermined rules
and regulations; and the third order control system which is a flexible goal-
seeking device.
Project Control
145
14. (c) i, ii, and iii
Individuals respond to the goal directedness of control systems in all the three
ways given i.e. through active and passive participation and goal oriented
behaviour, through passive involvement to minimize loss, and through active but
negative involvement and resistance.
15. (c) Milestones achieved in the project implementation.
The information required for developing the cybernetic controls is as follows:
defining the characteristics of the output that are to be controlled, setting the
standards for the defined characteristics, acquiring the sensors that measure the
characteristics at a particular level of precision, transforming the measurements
into signals that are to be compared with the set standards, and detecting the
difference between the output and the standard set. The information regarding
milestones achieved in the project implementation is required in the setting up of
Go/No-go controls.
16. (a) Negative feedback loop
The cybernetic control system that minimizes variation from the set standards is
known as a negative feedback loop. Go/No-go and post controls are different
types of controls as compared to the cybernetic controls.
17. (c) Post controls
Post controls deal with the How aspect of deviation rather than the Why
aspect. Post control systems are applied after the completion of the project. Post
control has a significant role to play in the way future projects are handled.
18. (c) Project definition statement
The documents needed for setting up the Go/No-go control mechanism are
project proposal, project plan, project specifications, project schedule, project
budgets, and milestones. The project definition statement provides more detailed
information about the project and is not used in setting up the Go/No-go controls.
19. (c) post controls
Post controls are the control mechanisms that are applied after the completion of
the project. The cybernetic and Go/No-go controls are applied at the time of
project implementation itself. The negative feedback loop is a part of the
cybernetic controls.
The post control report has the following sections: objectives of the project,
milestones, checkpoints, and budgets, final project report, and recommendations
for performance and process improvement.
21. (c) project schedule.
The project schedule is one of the important documents for setting up a Go/No-go
control mechanism. The document specifies the time frame for each activity in
the project.
22. (d) project specifications.
Project specifications are the set of rules and regulations under which the
objectives of the project are met. The other given options in the question are
wrong because the project proposal specifies the expected business value along
with the cost and time estimates of the project. The project plan gives the ends
and means of a particular action or objective. Project budgets are the documents
with estimation of the costs required to complete the project.
146
23. (b) Go/No-go controls
The Go/No-go control system functions only when it is put into application by the
controller. It is applied periodically. Cybernetic control functions continuously
and automatically. Post controls are applied only after the completion of the
project.
24. (a) Only i and iii
In the control process, the project manager has to strike a balance between risk
and control. The available options in the control process are high risk with low
control and high control with low risk as risk and control have an inverse
relationship with each other.
25. (b) Laying too much emphasis on long-range objectives rather than short-
term results.
Laying too much emphasis on the short-term results rather than the long-term
objectives is one of the causes for imbalances in the control system. The other
options given in the question are the causes for imbalance in the control system.
26. (a) Balance point
As greater control is exercised on the project, the likelihood of the project getting
into trouble goes down. However, exercising greater control increases the cost of
the project. The balance point reduces the overall cost liability for choosing a
specific degree of control by achieving a balance between the risk and control
associated with the project.
27. (a) Project impact statement
The two documents in the change management process are: requisition for change
in a project and project impact statement. The requisition for change documents
all changes requested by the client. The project impact statement identifies the
various pros and cons of the various identified alternatives. The project proposal
and the project plan describe the expected business value along with the cost and
time estimates of the project and the ends and means for particular action or
objective.
28. (a) Change order
A change order depicts all the changes in the project. Current period reports
describe the activities that have recently been completed. Scope creep refers to
the changes in the projects scope which cannot be controlled. Scope creep occurs
when the scope of a project is not properly defined and controlled.
29. (c) Level of detail to be reported
The information needs of the people controlling the project vary depending upon
the people who use it. The information provided in the report should be detailed
enough to suit the information needs of people who use it.
30. (d) All of the above
The characteristics of an effective progress reporting system are: Information
should be complete, accurate, and timely; it should not add overhead time to the
planned time of completion; it must be acceptable to the senior management and
the project team; it should indicate potential problems to the controller; and it
should be understood easily and clearly by the people who need it.
Project Control
147
31. (a) variance report
Variance reports show how the delivered output deviates from the plan. The
report consists of three columns, viz., planned number, delivered number, and the
variance. Spotlight reports are the reports which are used along with other reports.
Exception reports show variances from the plan. Cumulative reports present the
history of the project from its inception to the end of the current reporting period.
32. (b) Current period reports
Current period reports depict the project activities that have recently been
completed. They indicate the progress of the tasks that have been scheduled for a
specific period. Cumulative reports present the progress of the project from its
inception to the current reporting period. Exception reports show the variances
from the plan.
33. (b) Spotlight reports
Spotlight reports are the alterations that are used with other types of project status
reports. Stickers of various colours like green, yellow, and red are used to indicate
the status of the project. Exception reports show the variances from the plan and
variance reports show how the delivered output/activity deviates from the plan.
34. (b) Gantt charts
Gantt charts depict the activities of the project in an easily understandable
manner. They represent the schedule of a project in a two-dimensional manner.
Activities of the project are depicted on the Y-axis, and time is represented on the
X-axis. Milestone trend charts track the key activities that need to be tracked.
Cost schedule uses the rupee value of the work performed to measure project
performance.
35. (c) Cost schedule control
Cost schedule control can be used to predict the future status of the project apart
from measuring and reporting the history of the project. Gantt charts and
milestone trend charts are not used to predict the future of the project.
36. (b) Milestone trend charts
Milestone trend charts track the milestones or key events/activities in the project
life cycle. Gantt charts depict the activities of the project in a way which is easy
to grasp. Cost schedule control uses the rupee value of the work performed.
37. (a) Process review
The process review tries to find out how an activity can be carried out better.
38. (a) Design review
Design review assesses the design of the product to ensure that it meets the
requirements of the client. Status review assesses the status of the cost,
performance, schedule, and scope of the project. Process review assesses the
process of the project.
39. (c) Status review
Status reviews are conducted on a periodic basis to review the position of the
project. They may be cursory or comprehensive reviews. Design and process
reviews are meant to review the design and process of the project.
40. (b) Only i and ii
The three fundamental components of risk are: an event, the probability of the
event happening, and the impact of the probability on the happening of the event.
148
The characteristics of an effective quality control system are: being capable of
identifying what to control, setting standards in order to provide the basis for
taking decisions on corrective measures, developing quality measurement tools,
comparing the delivered output with the quality standards that have been set,
incorporating measures that can put the processes and outputs back to standard if
they fail to meet the quality standards, monitoring and calibrating the devices
used to measure quality, and including detailed documentation of the process.
42. (b) risk
The probability of not meeting a pre-defined project goal is called risk. Quality is
the essential or distinctive characteristic of any value which is under measure.
Control refers to ensuring that all project activities are going as per the plan and
the steps that need to be taken to mitigate any deviations from the plan.
Course Components
Block
III
PROJECT IMPLEMENTATION AND
CLOSING
UNIT 11
Project Cost Management 1-19
UNIT 12
Project Risk Management 20-47
UNIT 13
Project Quality Management 48-76
UNIT 14
Project Auditing 77-101
UNIT 15
Project Closing 102-118
Expert Committee
Hyderabad Hyderabad


Hyderabad


Prof. Vivek Gupta
Hyderabad

Hyderabad

Ms. Smita Singh
IU, Sikkim

Mr. Ch Syamala Devi
IU, Meghalaya

Hyderabad

IU, Mizoram
Aizawal

IU, Dehradun

Mr. Manoj Kumar De
IU, Tripura
Agartala






Block III
Project Implementation and Closing
The third block of the course on Project & Operations Management deals with
project implementation and project closing. This block contains five units. The
first unit in this block explains project cost management. The second unit
focuses on project risk management. The third unit examines project quality
management. The fourth and fifth units of the block discuss project auditing
and project closing, respectively.
The first unit, Project Cost Management, discusses the process of managing
costs, and planning the resources. The unit also deals with the concepts of cost
estimating, cost budgeting, and cost control. Finally, the unit discusses cost
overruns and their implications.
The second unit, Project Risk Management, deals with the definition of risk,
and examines the concept of tolerance for risk. The unit also defines risk
management, and explains decision making under the conditions of certainty,
risk, and uncertainty. The unit provides an idea about the risk management
methodology, and the concept of insurance for projects.
The third unit, Project Quality Management, defines quality and discusses the
international quality standards. The unit deals with the cost of quality, and
explains the various project quality management concepts. It also explains the
different project quality control tools. The unit examines the concepts of
process capability, acceptance sampling, quality circles, and just-in-time
management, and total quality management.
The fourth unit, Project Auditing, explains project evaluation and its purpose.
The unit discusses project auditing, and the construction and use of audit
report. The unit also provides an idea about the responsibilities of the auditor,
and discusses the project audit life cycle. It also deals with the essentials of an
audit, and the concept of performance measurement.
The fifth unit, Project Closing, provides an idea about closing a project. The
unit explains the various ways in which a project can be closed. The unit also
deals with the reasons for terminating an unsuccessful project. It discusses the
process of closing a project.
Unit 11
Project Cost Management
Structure
1. Introduction
2. Objectives
3. Process of Cost Management
4. Resource Planning
5. Cost Estimating
6. Cost Budgeting
7. Cost Control
8. Cost Overruns and their Implications
9. Summary
10. Glossary
1. Introduction
In the last unit of the previous block, we have discussed about project control. In this
unit, we will discuss project cost management. Project cost management includes all
the processes that are required to ensure that the project is completed within the
approved budget. After each phase of the project is completed, cost management
estimates the resources (people, equipment and materials) that were already spent and
the budget needed for all subsequent project phases.
As the project progresses, the project manager notes the differences between the
planned and the actual costs. He then measures the impact of these differences on the
overall project budget. Changes are made to the budget, if necessary, using cost
control procedures, with the permission of the client and other stakeholders.
Estimating the cost of a project is difficult as it is affected by different factors like
inflation, the exchange rate, demand and supply conditions, seasonal effects, etc.
Other than these external factors, internal factors like mismanagement of various
resources, failure to complete activities within the specified time, mishandling of
equipment and employee absenteeism increase project costs.
Cost management is an important concern for the project manager, as costs directly
affect the profits of the firm. However, merely reducing costs should not be the
objective of the project manager. If costs are minimized by reducing the number of
reviews and inspections, the project output is likely to be of poor quality.
If a project incurs higher costs than originally envisaged, the project client loses
confidence in the firm and the firm earns a bad reputation. Thus, the process of cost
management requires proper planning and implementation at every stage of the
project, if the project is to be a success.
This unit will discuss the process of managing costs, and resource planning. We will
discuss the concepts of cost estimating, cost budgeting, and cost control. Finally, we
would be discussing cost overruns and their implications.
2
2. Objectives
explain the process of cost management.
define resource planning.
discuss the concepts of cost estimating, cost budgeting, and cost control.
define cost overruns, and identify their implications.
3. Process of Cost Management
The process of cost management involves four steps resource planning, cost
estimating, cost budgeting and cost control. Resource planning identifies the resources
required and the quantities required of each of these, for the completion of the project.
Cost estimating is calculating the approximate costs of all project activities, while cost
budgeting is the assigning of costs to each project activity. Cost control involves
taking necessary steps to keep project costs within permissible limits.
4. Resource Planning
Resource planning is the process of identifying what project resources are required
and in what quantities. Resources normally include money, manpower, machinery and
materials. For instance, the construction of a cement plant requires skilled workmen,
some initial investment, machines like concrete mixers and various construction
materials. The project manager should have a thorough knowledge of all the project
activities in order to allocate the resources properly.
Resource planning is done after considering the Project Scope Statement, the Work
Breakdown Structure of the Project, Historical Information, Description of the
Resource Pool, and Organizational Policies.
Project Scope Statement: The scope statement allows all project stakeholders to gain
an understanding of the project. It explains why the project has been taken up and
what the main objectives of the project are. Both these aspects have to be considered
during resource planning.
Work Breakdown Structure (WBS): The WBS is a deliverable-oriented grouping of
project elements. Each descending level of WBS represents an increasingly detailed
description of a project component (the component may be a product or service). As it
describes all the project activities, it gives the project manager an idea of the resources
that will be required.
Historical Information: The project manager studies similar projects that were
successfully implemented earlier. This gives him an idea of the resources he will
require to execute the current project.
Description of Resource Pool: Here, the project manager specifies what project
resources he will require and in what quantities. For example, the skill levels of the
workmen, and the kind of machinery and materials to be used, are listed. The resource
pool description is specific to each project. It also varies from one phase of the project
to another. For example, in the planning phase of an engineering design project, only
senior engineers are required. While the project is being executed, junior engineers
can also be used for activities like inspection, quality testing, etc.
Organizational Policies: The project manager has to abide by the organizational
policies while developing resources plans. Policies regarding the purchase of supplies
and staffing should be considered. For instance, if a firm has a long-term contract with
a specific supplier for the procurement of raw materials, the project manager must go
to the same supplier.
3
While allocating resources for various project activities, the project manager identifies
the alternative ways of completing each activity and makes use of the opinions of
experts in various fields.
Identification of Alternatives
There may be several ways of completing a particular project activity. The resources
required vary with each method. The project manager uses techniques like
brainstorming and focused group interviews to identify different methods of
completing different activities. For example, the project manager may hold
discussions with his team members to identify the suppliers in the market from whom
they can procure the required raw materials.
Expert Opinions
The project manager consults experts like consultants and researchers, to determine
what inputs he will require to implement the project. The ideas given by these experts
help the project manager to come up with better resource plans. Sometimes, the
project manager may get contradictory views about resource allocation. When this
happens, the project manager should choose a suitable approach after a careful
analysis of his own constraints.
The Resource Planning process thus specifies the project resources required to
execute a project. The resource plan shows the type of resources required and the
quantities in which these are required. These resources are obtained either through
staff acquisition or by procurement.
Check Your Progress
1. Which of the following options depicts the correct sequence of steps in the
process of cost management?
i. Cost budgeting
ii. Cost estimating
iii. Cost control
iv. Resource planning
a. Option i followed by ii followed by iii and iv
b. Option iv followed by ii followed by i and iii
c. Option iii followed by ii followed by i and iv
d. Option ii followed by iii followed by i and iv
2. _____________ includes all the processes that are essential to ensure that the
project is completed within the approved budgets.
a. Resource planning
b. Project cost management
c. Cost budgeting
d. Cost control
3. Which of the following options provides an understanding of the project and is
part of the resource planning of a project?
a. Project scope statement
b. Work breakdown structure
c. Organizational policies
4
4. _______________ is considered as the deliverable-oriented grouping of project
elements.
a. Project scope statement
b. Organizational policies
5. Which of the following steps in the process of cost management involves taking
necessary steps to keep the project costs within the permissible limits?
a. Cost budgeting
b. Cost estimating
c. Cost control
d. Resource planning
6. The step in cost management that involves identifying the project resources
required and in specific quantities is ___________.
a. cost estimating
b. cost budgeting
c. resource planning
d. cost control
5. Cost Estimating
After the resource requirements are identified, the project manager develops an
estimate of the costs of the resources required to execute the project. This includes
identifying and evaluating various cost alternatives. The project manager considers the
WBS, resource rates, activity duration estimates, historical information and the chart
of accounts in estimating the costs.
The WBS is used to ensure that cost estimates are made for all the identified activities.
The resource rates show the cost of each unit of resource such as labor cost per hour,
the cost of one litre of lubricant oil, etc. The project manager considers the activity
duration estimates for all the project activities to know by what time the resources
should be made ready.
The project manager also considers historical information in estimating the cost of the
project. He studies project files, and commercial cost estimating databases of past
projects. A good overall understanding of similar projects undertaken in the past
proves helpful. The chart of accounts is a numbering system used to monitor project
costs by category (labor, supplies, materials, etc.) It is a coding structure that the firm
uses to report financial information in its ledger. Some of the techniques used by the
project manager to estimate costs are -- analogous estimating, bottom-up estimating,
parametric modeling, and computerized tools.
Analogous Estimating
In analogous estimating, the project manager considers similar projects to estimate the
costs of the project. Based on the actual costs incurred in that project, the project
manager prepares the cost estimates by considering the parameters like time value of
money, inflation rate, etc. Though this type of estimating is easy and economical, but
it is less accurate than the other methods.
5
Normally, this technique can be used only in consultation with an expert. The
difficulty in using this approach lies in finding a similar project and determining its
actual costs. This technique is also called the top-down estimating.
Bottom-up Estimating
In bottom-up estimating, the cost of each element of the project is calculated
separately and all these costs are added up to estimate the total project cost. The
smaller the work elements of the project, the greater the accuracy of the estimate.
Parametric Modeling
In parametric modeling, cost estimates are made using mathematical models. For
instance, if, according to the estimates of the project manager, the cost of constructing
a building is Rs. 20,000 per square yard, a sum of Rs. 20 million is required for
constructing a 1000 square yard building. Even if the estimates made with these
models are not exact, they give the project manager a rough idea about the costs that
are likely to be incurred.
Parametric modeling provides reliable estimates when the model is developed on the
basis of accurate historical information; all project parameters are quantifiable; and
the model is scalable (can be applied to all projects irrespective of their size).
Computerized Tools
The project manager can use computerized project management software packages
like Project 2000 to estimate the project costs. These software packages compute
various costs once the relevant data is provided. The project manager prepares the cost
estimates, supporting details and the cost management plan of the project on the basis
of techniques discussed above. The cost estimates for all the project resources are
expressed in terms of rupees dollors, etc.
The project manager provides supporting details for the project cost estimates. He
describes the work estimated (based on the WBS), the basis of estimation, specifies
the assumptions made in the estimation and calculates the range of possible estimates.
The project manager also prepares a cost management plan that describes how cost
variances can be managed. This plan is highly detailed and prepared in such a way as
to meet the requirements of the project stakeholders. A good cost management plan
lets the stakeholders know how the project manager is going to estimate project costs.
Example: Hotel Corporation of India
Hotel Corporation of India (HCI) was set up in July 1971 as a wholly-owned
subsidiary of Air India, with the objective of running hotels, motels and flight
kitchens as well as other activities to assist AIs business. The different projects of
HCI and their time and cost overruns are given below:
Project
Time
Overrun
(in months)
Cost Overrun
(% increase
over estimate)
Centaur Hotel Bombay Airport (CHBA) 7 -
Centaur Hotel Juhu Beach (CHJB) 85 132.05
Centaur Hotel Delhi Airport (CHDA) 10 35.45
Centaur Lake View Hotel Srinagar (CHLV) 37 85.92
Chefair Flight Catering Bombay (CFCB) 73 71.00
Chefair Flight Catering Delhi (CFCD) 37 65.20
Source: Report of the Comptroller and Auditor General of India-Union Government No. 1
(Commercial) 1995.
Contd...
6
Contd...
These cost and time overruns were due to price escalations, change in project
scope, budget omissions, under estimation etc. In several cases, HCIs resources
had been mismanaged. Given below are a few examples of mismanagement of
resources:
HCI had begun the construction of the CHJB in 1980, without getting the plans
approved by the Bombay Metropolitan Regional Development Authority
(BMRDA) and the Municipal Corporation of Greater Bombay. Later, the
authorities made changes in the plans and HCI had to alter its construction
plans. It finally got final clearance in June 1982.
However, the implementation of the project was delayed due to revisions in
drawings, designs, etc. To make these revisions, the consultants demanded a
higher fee. HCI has also faced similar problems with its contractors and
architects during the construction of CHLV. The contractors who had
completed the structural work of the hotel asked for more money and even a
huge amount of material belonging to HCI was stolen.
The CHLV had imported laundry equipment in December 1983 at a cost of Rs
7.2 million. After May 1985, due to poor occupancy, low voltage power
supply and the absence of trained staff, the equipment was used only to a
limited extent. While on the one hand the laundry equipment was not fully
utilized, on the other hand, between April 1984 and November 1986, the
laundry services were entrusted to a private firm at Srinagar, involving an
expenditure of Rs 0.37 million. During the period 1984-85 to 1987-88 the
revenue earned by the hotel from laundry services was a mere Rs 0.63 million.
The interest charges alone for these four years, on the investment (at 18% per
annum) amounted to Rs 5.2 million.
HCI had begun the construction of CHDA on land belonging to the
International Airport Authority of India, without getting the building plans
approved by the Municipal Corporation of Delhi (MCD). Following this, the
MCD imposed a penalty of Rs 3.12 million on HCI. This was reduced later to
a token penalty of Rs 0.31 million, after extensive deliberations, and at the
instance of the Ministry of Tourism and Civil Aviation.
HCI entered into a contract with the Delhi Electricity Supply Undertaking
(DESU) for supply of 4161 kW of electricity, effective from September 1982.
This was expected to meet the electricity requirements of laundry equipment
and a discotheque. However, as the laundry and the discotheque were not
constructed, the actual usage of power was turned out to be much less than
4161 KW. In February 1984, HCI asked DESU to reduce the contracted
demand to 2100 kW. However, DESU did not agree to this, as the agreement
between HCI and DESU lay down that the demand level could not be altered.
In September 1986, HCI procured 23 cold storage units at a total cost of Rs 3.6
million and installed them at CFCB. The units were not operated during the
first year. Only five cold storage units were in use, two had been given on hire
to ITDC, three were kept as standby, and the remaining were kept idle. Thus,
the investment of Rs 2.81 million in the 13 cold storage units that were not put
in operation lying unused.
7
Activity: Today, leading English daily in northern India has 16 editions to cater to
readers all over North India. Recently, the management of the Today Group
decided to start a new edition in South India to increase its circulation and sales.
The chairman of the Today Group, Babu Ramji appointed Subhash Chakravarthy
as the project manager and asked him to estimate the costs of the project. What are
the alternative techniques available to Chakravarthy to estimate the costs of the
project? What are the requirements that Chakravarthy needed for cost estimating?
Answer:
Check Your Progress
7. In which method of cost estimating, the cost of each element of the project
calculated separately and then added up to estimate the total project cost?
a. Analogous estimating
b. Bottom-up estimating
c. Parametric modeling
8. Under which of the following methods does the project manager estimate the
costs by considering similar projects?
a. Analogous estimating
9. In parametric modeling, which of the following conditions need to be fulfilled in
order to give reliable estimates?
a. The project parameters should be quantifiable
b. The model should be developed on the basis of accurate historical information
c. The model should be scalable
d. All of the above
10. Which of the following techniques for estimating costs is also called the top-
down estimating technique?
a. Parametric estimating
c. Analogous estimating
8
6. Cost Budgeting
In the process of cost budgeting, the project manager allocates the costs to individual
work items, based on the cost estimates made. The cost allocated for each individual
work becomes the cost baseline for that work. These cost baselines are used to
measure the cost performance of the project. The Work Breakdown Structure and the
cost estimates made (in the cost estimating process) help the project manager to
determine the amount of resources to be allocated for each project work element. The
project schedule helps him to assign costs to the time period during which the costs
will be incurred. The project manager can also use techniques like Analogous
Estimating, Bottom-up Estimating, Parametric Modeling, and Computerized Tools
(discussed earlier) in cost budgeting.
Preparation of Cost Baseline
The cost baseline, an output of cost budgeting, is a time-phased budget that
periodically measures and monitors the cost performance of the project. It also
describes how costs are going to be incurred over a period of time. It is usually
displayed in the form of an S-curve. For large and complex projects, multiple cost
baselines are prepared for various aspects of the project. The project manager should
ensure that costs are being incurred as per the cost baseline.
7. Cost Control
The project manager uses cost control to manage the factors that bring about changes
in the cost baseline in such a way as to make sure that the changes are beneficial. Cost
control also helps him to determine whether the cost baseline has changed and to
manage the changes whenever they occur.
The project manager tries to determine how cost variances are likely to occur. Some
of the steps that the project manager can take to control project costs are:
Defining the project scope precisely and clearly
Using a relevant and reliable database
Designing an organization structure that is appropriate for the current project
Monitoring and controlling deviations from the project plan
Periodically evaluating and monitoring cost performances
Checking whether the changes are recorded in the cost baseline
Selecting vendors and project consultants carefully
Cost Change Control System
The cost change control system describes the procedures that bring about changes in
the cost baseline. The system includes the paper work, the tracking systems, and the
approval levels necessary for authorizing changes. The system must be integrated with
the overall change control system, if it is to be effective.
Performance Measurement
Techniques like variance analysis, trend analysis, and earned value analysis help the
project manager to understand the cost performance. Variance analysis compares the
actual project results to the planned results. The cost variations are measured at every
stage of the project and the causes of these variances are determined. Trend analysis
examines the project results over a period of time to find out if the cost performance is
improving or not.
9
Earned value analysis is a technique that measures the project performance by
integrating the scope, cost and schedule measures of the project. According to this
analysis, three values are important. These are: Budgeted Cost Work Schedule, Actual
Cost Work Performed (ACWP) and Earned Value (also called Budgeted Cost of Work
Performed, (BCWP)).
The Budgeted Cost Work Schedule is the approved cost estimate planned for a project
activity for a given period. The Actual Cost Work Performed is the total costs (both
direct and indirect) incurred while implementing an activity in a given period. The
Earned Value is a percentage of the total budget equal to the percentage of work
completed.
These three values along with certain measures like Cost Variance (BCWP-ACWP),
the Schedule Variance (BCWP-BCWS) and the Cost Performance Index
(BCWP/ACWP) help the project manager to determine whether the work is
progressing according to the schedule and whether it is within the budget. The
cumulative Cost Performance Index for the entire project (total of BCWPs of all
project activities divided by total of all ACWPs) forecasts the project cost at
completion.
The project manager prepares revised cost estimates, budget updates, and Estimates
At Completion (EAC) and decides what corrective actions should be taken. The
project manager prepares revised cost estimates by making modifications to the
current cost information. These revised cost estimates should be communicated to all
project stakeholders.
In budget updates, changes are made to the approved cost baseline. The EAC is a
forecast of the total project costs on the basis of the project performance. Here, the
completion times are estimated as actual work completed plus a new estimate for
remaining work. The project manager also documents all the lessons he has learnt in
controlling project costs.
Check Your Progress
11. ___________ is the process by which the project manager allocates costs to
individual work items, based on the cost estimates made.
a. Cost budgeting
b. Cost baseline
d. Analogous estimating
12. The analysis which determines whether the cost performance is improving or not
by examining the project results over a period of time is called
________________.
a. variance analysis
b. trend analysis
c. earned value analysis
13. The full form of ACWP is _____________.
a. Actual Cost Work Performed
b. Actual Cost Work Paid
c. Actual Cost Week Paid
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14. Procedures that bring about changes in the cost baseline are called
______________.
a. cost control
b. cost change control system
c. cost budgeting
d. All of the above
15. The full form of EAC is ______________.
a. Estimates At Confirmation
b. Estimates At Completion
c. Estimates At Control
d. Estimates At Costs
16. What is the time-phased budget that periodically measures and monitors the cost
performance of the project?
a. Cost baseline
b. Cost budgeting
d. Analogous estimating
17. The full form of BCWP is
a. Budgeted Cost Work Paid
b. Budgeted Cost Work Performed
c. Budgeted Cost Week Paid
18. Cost performance index is represented by ________________.
a.
ACWP
BCWP
b.
BCWS
BCWP
c.
BCWS
ACWP
d. BCWP ACWP
19. The project manager decides the corrective actions to be taken after the
preparation of which of the following?
a. Revised cost estimates
b. Budget updates
c. Estimates at completion
d. All of the above
20. What is the technique that measures project performance by integrating the scope,
cost, and schedule of the project?
a. Variance analysis
b. Earned value analysis
c. Trend analysis
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21. Cost variance is represented by _________
a. BCWP BCWS
b. BCWP ACWP
c. BCWS ACWP
d. ACWP BCWS
8. Cost Overruns and their Implications
The extra costs incurred over the estimated costs are called cost overruns. If the actual
costs incurred are less than the estimated costs, they are called cost underruns. In
practice, this does not happen often as the human tendency is to plan the costs at
minimum level and they continue to be raised as the project progresses.
Factors that Cause Cost Overruns
The important factors that cause cost overruns are described below.
Cost Escalations
The cost of a project usually increases due to the time gap between the planning and
implementation of the project. The project manager prepares a cost overruns analysis
sheet to determine the reasons for cost overruns.
Cost escalations occur for many reasons. Some of these are:
An increase in the unit price of materials, machinery, labor costs and overheads
Change in scope of the project
Increase in statutory taxes and duties like sales tax, customs tax, and excise duty
The impact of the adverse exchange rate variations on import of machinery and
equipment
An increase in the cost of capital when the project is not completed in the estimated
time
The project manager must arrange for forward contracts with importers of machinery
and equipment to take care of cost overruns due to unfavorable foreign exchange
fluctuations. The project manager should prepare contingency plans to effectively deal
with when the cost overruns occur.
Time Overruns
Poor planning and failure to meet time schedules result in time overruns. The project
manager prepares a time overruns analysis sheet to understand where delays have
occurred and the reasons for delays. Time overruns occur due to:
A change in the scope of the project
Ineffective project time management (which itself is the result of improper planning
and scheduling)
Delays in starting and executing some of the project activities
Delays in subsequent projects as a result of a delay in one project
Use of outdated technology
Bureaucratic/ political interference, and poor administration
To complete the project on schedule, the project manager must prepare realistic time
schedules, select capable vendors, carryout periodical monitoring of project activities,
and take quick decisions.
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Scope Changes
Scope changes during the implementation of the project, that were not envisaged
during the planning stage increase project costs. Inadequate attention to detail at the
time of project formulation is the main cause of these scope changes.
Scope changes include the introduction of new features to the project product, design
modifications, increased plant capacity and extra construction works, updated
technical versions, and newly framed statutory requirements of the government may
necessitate changes in scope.
Proper assessment of the project requirements and understanding the statutory
conditions help the project manager to avoid changes in the scope of the project.
Budget under Estimation/Omission
If the budget prepared is not exact, extra costs are incurred when the project is
actually implemented. This happens when the costs are estimated on the basis of an
incorrect project scope statement, or when adequate technical information is not
available. Sometimes certain project elements might be ignored while the budget is
being prepared. All these factors finally result in an increase in the project costs. By
preparing a detailed, exhaustive checklist of all project activities, the project manager
can reduce overruns.
Rectifications and Replacements
The project managers lack of experience, wrong choice of technology, defective
designs and flaws in the equipment purchased result in project cost overruns, as
drawings have to be revised, or the machinery has to be repaired. By undertaking
frequent inspections, setting up equipment carefully, ensuring that the equipment is
not damaged during transportation, and standardizing some of the processes, the
project manager can reduce these cost overruns.
Unforeseen Contingencies
Unexpected factors like natural calamities, lockouts, labor unrest, fires or accidents
cause project cost overruns. The costs arising out of these contingencies cannot be
controlled. However, the project manager can take some preventive measures to
reduce their impact.
Other Related Factors
An ineffective organization structure, outdated systems, poor decision making, and the
interference of stakeholders are other factors that push up the costs. The project
manager should be aware of all these aspects in order to be able to minimize the cost
overruns that are likely to occur in the execution of a project. An evaluation of all the
project activities, consultation with outside experts, and a critical view of all related
factors can minimize cost overruns.
Example: Overruns in Government Projects
According to the Ministry of Planning and Program Implementation, the cost
escalations of various mega projects across the country put the government back by
over Rs 1,000 billion. A review of 110 major projects, each costing Rs 1 billion or
more, estimated that the time over run was up to five years, and cost escalation was
40 to 75 per cent. The ministry made a point that the cost overruns were
exceptionally high in the following projects: the two nuclear power plants in
Rajasthan, the modernization of the Rourkela and Durgapur steel plants, the
Kandla-Bhatinda pipeline, the Dulhasti and the Koyalkaro hydroelectric projects,
and the Kehalgaon thermal power projects.
Contd
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Contd
The 19 mega railway projects alone incurred cost overruns of Rs 35 billion. For the
Jammu-Udhampur railway line project, the cost escalation was over Rs 1.3 billion
and for the Jagighopa-Guwahati, Talchar-Sambalpur, Guna-Etawah and Madras-
Trichy lines, and the MRTS line from Madras Beach to Luz, the cost overruns
were Rs 1.08 billion, Rs 1.17 billion, Rs 1 billion, Rs 1 billion, and Rs 1.08 billion
respectively. The review ascribed these cost overruns to factors such as delays in
getting clearance from the regulatory agencies for land acquisition and
procurement of material, scope changes while the project is being executed,
management problems such as personnel, labor, and contract disputes, etc.
The ninth Five-year plan focused on cutting cost and time overruns. It was decided
to scrap those projects where less than 10 per cent of the approved outlay had been
spent. The action plan suggested that only a limited number of new projects should
be considered for approval during the 9th plan. The ministry has also initiated
actions to wind up or privatize the most delayed projects. According to Dr Y K
Alagh, the minister of Planning and Program Implementation, the existing
memoranda of understanding between the ministries and the project authority only
related to the target of the working of the project in terms of production, profit or
loss. But now the project implementation guidelines should also be a part of the
MoU. This means the project authority has to meet the approved project
guidelines.
Besides modifying the MoU between the ministries and the project authorities, the
other proposal is to lay down more detailed contract management procedures so
that corruption can be minimized. Dr. Alagh states from the current fiscal year, the
implementation of his ministrys action plan will push up the economic growth rate
in key infrastructure sectors.
Adapted from the article "Projects delays cost Rs 1000 bn; govt plan to force pace," from
www.rediff.com, dated 9 July 1997.
Activity: The Govardhan Group of Industries located near Ahmedabad, Gujarat
wanted to lay a railway line inside the company premises (500 acres) to speed up
the movement of materials and machinery among the various departments. The
management estimated that the project required a capital of Rs. 85 lakh. But the
firm did not take up the project due to lack of funds. After two years, the
management took up the project. But the firm failed to complete the project within
the budget. Discuss why the company failed. Also, list some of the factors that lead
to cost overruns.
Answer:
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Check Your Progress
22. Which of the following options are the reasons for the escalation of costs that
cannot be controlled but whose impact can be reduced by taking some preventive
measures?
a. Scope changes
b. Unforeseen contingencies
c. Budget underestimation/omission
d. Use of outdated technology
23. What among the following options are the reasons for time overruns?
i. Change in the scope of the project
ii. Use of outdated technology
iii. Political interference
iv. Delay in starting and executing some of the project activities
a. Only i and ii
b. Only ii and iii
24. Budget underestimation and budget omission are the causes of ____________.
a. time overruns
b. rectification costs
c. estimation errors
d. cost escalations
25. The extra costs incurred over the estimated costs are called _______________.
a. cost escalations
b. rectification costs
c. cost overruns
d. estimation errors
26. From the following options, identify which is/are responsible for project cost
overruns?
a. Cost escalations
b. Scope changes
c. Rectification costs
d. All of the above
27. Which of the following options is the reason for scope changes in the project that
occur at the time of implementation of the project?
a. Use of outdated technology
b. Bureaucratic and political interference
c. Updated technical versions
d. Poor administration
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9. Summary
Project cost management includes all the processes that are required to ensure that the
project is completed within the approved budget. After each phase of the project is
completed, cost management estimates the resources (people, equipment and
materials) that were already spent and the budget needed for all subsequent project
phases.
The process of cost management involves four steps -- resource planning, cost
estimating, cost budgeting, and cost control.
Resource planning is the process of identifying what project resources are required
and in what quantities. Resources normally include money, manpower, machinery
and materials.
After the resource requirements are identified, the project manager develops an
estimate of the costs of the resources required to execute the project. This includes
identifying and evaluating various cost alternatives.
In the process of cost budgeting, the project manager allocates the costs to individual
work items, based on the cost estimates made. The cost allocated for each individual
work becomes the cost baseline for that work.
The project manager uses cost control to manage the factors that bring about changes
in the cost baseline in such a way as to make sure that the changes are beneficial. Cost
control also helps him/her to determine whether the cost baseline has changed and to
manage the changes whenever they occur.
The extra costs incurred over the estimated costs are called cost overruns. If the actual
costs incurred are less than the estimated costs, they are called cost underruns.
The important factors that cause cost overruns are cost escalations, time overruns,
scope changes, budget under estimation/omission, rectifications and replacements,
unforeseen contingencies, and other related factors.
10. Glossary
Actual Cost of Work Performance (ACWP): Total costs incurred (direct and
indirect) in accomplishing work during a given time period.
Bottom-up Estimating: In this technique, the cost of each element of the project is
calculated separately and all these costs are added up to estimate the total project cost.
Budget Cost of Work Scheduled (BCWS): The sum of the approved cost estimates
(including any overhead allocation) for activities scheduled to be performed during a
given period.
Budgeted Cost of Work Performance (BCWP): The sum of the approved cost
estimates (including any overhead allocation) for activities completed during a given
period.
Cost Budgeting: A process of allocating the costs to individual work items, based on
the cost estimates made.
Cost Estimating: Identifying and evaluating various cost alternatives.
Cost Overruns: Extra costs incurred over the estimated costs.
Cost Underruns: Actual costs incurred are less than the estimated costs.
Resource Planning: The process of identifying the nature and quantity of physical
resources required to perform the project activities.
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1. The process of cost management requires proper planning and implementation at
every stage of the project, if the project is to be a success. What are the steps
involved in the process of cost management?
2. The first step in the process of cost management involves identification of the
resources and their quantities. Explain the process of resource planning in cost
management. What the various aspects, which need to be considered while
planning for resources?
3. After the resource requirements are identified, the project manager develops an
estimate of the costs of the resources. Describe the process of cost estimating.
4. Based on the cost estimates made, the project manager allocates the costs to
individual work items. Explain the process of cost budgeting. How can the project
manager control the costs?
5. Sometimes, the actual costs incurred may be more or less than the estimated
costs. What factors lead to such variations? Explain the implications of such
variations.
1. (b) Option iv followed by ii followed by i and iii
The four steps involved in the process of cost management are in sequence,
resource planning, cost estimating, cost budgeting, and cost control.
2. (b) Project cost management
Project cost management includes all the processes that are required to complete
the project within the approved budget. The other options given in the question
resource planning, cost budgeting, cost control are the steps involved in the
process of cost management.
3. (a) Project scope statement
The project scope statement allows all project stakeholders to gain an
understanding of the project. The work breakdown structure is the deliverable-
oriented grouping of the project elements. Organizational policies refer to the
definite course of action taken by the organization. The project manager has to
abide by these organizational policies while developing resource plans. The policies
regarding purchase of supplies and staffing should be considered properly.
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4. (c) Work breakdown structure
The work breakdown structure refers to the deliverable-oriented grouping of the
project elements. Each descending level of WBS represents an increasingly
detailed description of the project component. The project scope statement allows
all project stakeholders to gain an understanding of the project. Organizational
policies refer to the definite course of action taken by the organization. The
project manager has to abide by these organizational policies while developing
resource plans. The policies regarding purchase of supplies and staffing should be
considered.
5. (c) Cost control
Cost control refers to taking the necessary steps to keep the project costs within
the permissible limits. Cost budgeting involves assigning costs to each project
activity. Cost estimating refers to calculating the approximate costs of all project
activities and resource planning means planning for and gathering resources to
complete the project.
6. (c) resource planning
Resource planning is the primary step in the process of cost management and
involves identifying what project resources are required and in what quantities.
Cost estimating is the estimation of costs of the resources required to execute the
project. Cost budgeting is the process of allocating costs to individual work items.
Cost control is the process of controlling the costs of the project.
7. (b) Bottom-up estimating
In bottom-up estimating, the cost of each element of the project is calculated and
then added up to estimate the total cost of the project. In the case of analogous
estimating, the project manager considers similar projects to estimate the cost of
the project. In parametric modeling, cost estimates are made using mathematical
models.
8. (a) Analogous estimating
In the case of analogous estimating, the project manager estimates the cost of the
project by considering similar projects. He/she prepares the cost estimates by
considering parameters like time value of money, inflation, etc.
The following conditions need to be fulfilled if parametric modeling is to give
reliable estimates: The model should be developed on the basis of accurate
historical information, all the project parameters should be quantifiable, and the
model should be scalable.
10. (c) Analogous estimating
The analogous estimating technique refers to estimating the cost of the project by
comparing the costs of other similar projects. As this involves arriving at the costs
of the project from the top, it is also called top-down estimating. Parametric
modeling involves estimating the cost of the project using mathematical models.
In bottom-up estimating, the cost of each element of the project is calculated
separately and then added to arrive at the project cost.
11. (a) Cost budgeting
Cost budgeting is the process by which the project manager allocates costs to
individual work items based on the cost estimates made.
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12. (b) trend analysis
Trend analysis examines the project results over a period of time to know whether
the cost performance is improving or not. Variance analysis compares the actual
project results with the planned results. Earned value analysis measures the
project performance by integrating the scope, cost, and schedule measures of the
project.
13. (a) Actual Cost Work Performed
Actual cost work performed is one of the important values in earned value
analysis. Earned value analysis is the technique that measures project
performance by integrating the scope, cost, and schedule measures of the project.
14. (b) cost change control system
The cost change control system describes the procedures that bring about changes
in the cost baseline. The cost change control system includes the paper work,
tracking systems, and approval levels necessary for authorizing changes. Cost
budgeting refers to the allocation of costs to individual work items. Cost control
refers to the overall necessary steps to keep the project costs within the
permissible limits.
15. (b) Estimates At Completion
Before deciding what corrective action is to be taken, the project manager
prepares revised cost estimates, budget updates, and estimates at completion
(EAC).
16. (a) Cost baseline
Cost baseline is a time-phased budget that periodically measures and monitors the
cost performance of the project. It refers to the allocation of costs to individual
work items. Parametric modeling involves estimating the cost of the project using
mathematical models. In the case of analogous estimating, the project manager
considers similar projects to estimate the costs of the project.
17. (b) Budgeted Cost Work Performed
Budgeted cost work performed is an important part of earned value analysis.
Earned value analysis is the technique that measures project performance by
integrating the scope, cost, and schedule measures of the project.
18. (a)
ACWP
BCWP
Cost performance index is one of the measures of performance measurement. It is
represented by budgeted cost of work performed divided by actual cost of work
performed.
The project manager prepares the revised cost estimates, budget updates and
estimates at completion and then decides on the corrective actions that need to be
taken.
20. (b) Earned value analysis
Earned value analysis is a technique that measures the performance of the project
by integrating the scope, cost, and schedule measures of the project. The three
values that are important for the measurement of project performance are:
budgeted cost work schedule, actual cost work performed, and earned value.
19
21. (b) BCWP-ACWP
The three values in the performance measurement are: cost variance, schedule
variance, and cost performance index. Cost variance is represented by BCWP-
ACWP, which means budgeted cost of work performed less actual cost work
performed.
22. (b) Unforeseen contingencies
Factors like natural calamities, lockouts, labor unrest, and fire accidents are
examples of unforeseen contingencies. The costs arising out of these
contingencies cannot be controlled. However, the project manager can take some
preventive measures to reduce their impact.
The main reasons for the occurrence of time overruns are: A change in the scope
of the project, ineffective project time management, delays in starting and
executing some of the project activities, delays in subsequent projects as a result
of a delay in one project, use of outdated technology, bureaucratic/political
interference, and poor administration.
24. (c) estimation errors
Estimation errors are one of the reasons for project cost overruns. Budget
underestimation and budget omission are the causes of estimation errors. Time
overruns are the results of unrealistic time scheduling and unforeseen
contingencies. Rectification costs are the result of flaws in the equipment used
and of the wrong choice of technology. Cost escalations are the result of increases
in the prices, taxes and duties, and exchange rate fluctuations.
25. (c) cost overruns
The extra costs that are incurred over the estimated costs are called cost overruns.
If the actual costs incurred are less than the estimated costs they are called cost
underruns. Cost escalations are the reasons for the increase in costs that, in turn,
cause cost overruns. Rectification costs are the costs that are incurred to rectify
the errors made by making wrong choices. Estimation errors are the errors that
result from underestimation of the budget.
The following are the reasons for project overruns: cost escalations, time
overruns, scope overruns, estimation errors, rectification costs, unforeseen
contingencies, and some other miscellaneous reasons like ineffective organization
structure and political interference.
27. (c) Updated technical versions
The main reasons for the changes in the scope of the project are: introduction of
new features to the project product, design modifications, increased plant capacity
and extra construction, updated technical versions, and newly framed statutory
requirements of the government. The other options given in the question are the
reasons for time overruns in the project.
Unit 12
Project Risk Management
Structure
1. Introduction
2. Objectives
3. Definition of Risk
4. Tolerance for Risk
5. Definition of Risk Management
6. Certainty, Risk, and Uncertainty
7. Risk Management Methodology
8. Insurance for Projects
9. Summary
10. Glossary
1. Introduction
In the previous unit, we have discussed project cost management. In this unit, we will
discuss project risk management. The element of risk is inherent in every activity of a
project. The project manager should carefully handle the risks that the project is likely
to be exposed to. For projects whose duration is less than one year, we can assume
that the operating environment is known and stable. But in the case of big projects of
longer duration, it is necessary to conduct a risk analysis. Projects are exposed to
various types of risks like technical risks, economic risks, social risks, production
risks, financial risks and human risks.
Since all risks cannot be eliminated or avoided, it is the job of the project manager to
ensure that risks do not have adverse consequences. Every project manager follows a
specialized risk management methodology that normally consists of four processes:
risk identification, risk quantification, risk response and risk control. To relieve
themselves of risk, individuals and firms insure the projects they undertake. While
insurance cannot prevent risk, it can mitigate the risk by providing financial
compensation.
This unit will discuss the definition of risk and examines the concept of tolerance for
risk. We will discuss risk management, and decision making under the conditions of
certainty, risk, and uncertainty. Finally, we would be discussing the risk management
methodology, and the concept of insurance for projects.
2. Objectives
define risk and risk management.
explain the concept of tolerance for risk.
explain decision making under the conditions of certainty, risk, and uncertainty.
discuss the risk management methodology.
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3. Definition of Risk
Risk is defined as the possibility of an outcome being different from the expected
outcome. It refers to the possibility of adverse results flowing from the uncertainty
involved in carrying out the activities. When a project or a project activity is expected
to be possible, the chance of its occurrence varies from zero and one. Every activity of
the project is always exposed to a certain degree of risk. Damage to machinery,
dramatic changes in technology, loss of human life and stagnation of financial flows
are some of the areas of risk that a project manager should pay attention to.
Conceptually, project risk is a function of uncertainty and damage.
Therefore, Risk = f (uncertainty, damage)
Both uncertainty and the potential for damage for every project activity should be
carefully examined when conducting a risk analysis. Sometimes, risk also refers to the
cumulative effect of all the adverse, unfavorable action.
Risk also arises because of hazards, which can be defined as a source of danger. The
project manager must provide some safeguards to reduce or eliminate hazards. So risk
can also be referred to as a function of hazard and safeguard.
Therefore, Risk = f (hazard, safeguard)
Types of Risks (H2)
Risks are of several types. Broadly, they can be categorized into technical risks, social
risks, economic risks, political risks, production risks, marketing risks, financial risks
and human risks.
Technical Risks
Technical risks refer to the failure to meet a particular performance requirement.
Failure of the feasibility of a design and changes in technology are some of the
sources of technical risk. For example, some software modules run well when tested
individually on a limited scale, but they fail when they are integrated and tested on a
large scale. The project is also under technical risk if the technology being used
becomes outdated by the time the project delivers the final product or service. So it is
the responsibility of the project manager to continuously update the technical aspects
of the project.
Social Risks
Social risks refer to risks arising from changes in the needs and changing preferences
of target customers. Lack of necessary natural resources, labor unrest, agitations and
social movements against the project also constitute social risks.
Economic Risks
Economic risks refer to an increase in the rate of inflation, changes in the economic
policies of governments, and distribution of income. Since the project manager does
not have any control over these risks, he should carefully assess such risks and should
ensure that the project is not going to suffer because of these risks.
Political Risks
Nationalization or privatization of a particular industry, political instability, trade
restriction are some examples of political risks. The project manager should ensure
that the project does not go against the political interests of the country.
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Production Risks
Production risks refer to the shortage of necessary raw materials, sudden breakdown
of key machinery, and exponential rise in installation and maintenance costs. As these
risks can be controlled to some extent, the project manager should try to reduce the
effect of these risks on the project.
Marketing Risks
Marketing risks refer to failure of the developed product or service in the market due
to changes in market demand, errors in forecasting of demand, or difficulties in
distribution. The project manager should change the market strategy to deal with these
risks and generate more revenues.
Financial Risks
Financial risks refer to bad debts, change in the interest rates, wrong choice of
investments and mistakes in the accounting procedures. Consistent financial
performance assessment of the project will give the project manager a clear picture of
financial condition of the project.
Human Risks
Human risks refer to the sudden demise of a key employee, limited availability of
competent employees, inter-group politics etc. A clear, and result encouraging HR
policy coupled with employee group insurance schemes generally solves most
problems caused by such risks.
Check Your Progress
1. What is the possibility of an outcome being different from the expected outcome
called?
a. Uncertainty
b. Risk
c. Technical risks
d. Political risks
2. ___________ refer to the possibility of failure of the product or service in the
market due to factors like change in demand, errors in forecasting of demand, and
difficulties in distribution.
a. Financial risks
b. Marketing risks
c. Political risks
d. Economic risks
3. Identify the risks that arise from the needs and changing preferences of target
customers.
a. Technical risks
b. Economic risks
c. Social risks
d. Human risks
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4. Identify the type of the risk that arises due to raw material shortage, breakdown of
important machinery, and a steep rise in the installation and maintenance costs.
a. Marketing risks
b. Political risks
c. Social risks
d. Production risks
5. Risk = f ( ______, ______ )
i. Uncertainty, damage
ii. Certainty, safeguard
iii. Hazard, safeguard
iv. Damage, certainty
a. Only i
b. Only i and iii
c. Only ii and iii
4. Tolerance for Risk
There are no tools or techniques for avoiding risk completely. The project manager
must use his judgment to identify an appropriate tool for dealing with a risk. Even
though no tool can nullify a risk completely, it can lessen the adverse impact of the
risk. Project managers deal with risks in different ways, depending on their level of
tolerance for risks.
Project managers can be classified as risk averters, risk neutrals and risk seekers on
the basis of their attitude toward risk. The tolerance curve for each type of manager is
derived by comparing his risk preference with the utility (the amount of satisfaction
the project manager derives from a payoff). The utility can also be referred as the
tolerance for risk.
A risk averter is a person who always wishes to avoid risk. When more money is at
stake, the risk averters utility increases, but at a decreasing rate. A risk seeker is a
person who wishes to accept more and more risks. For such a person, the utility
increases at an increasing rate as the amount of money at stake increases. A risk
neutral persons attitude falls midway between the risk averters and the risk seekers
attitude. His utility increases in proportion to an increase in the amount of money at
stake.
5. Definition of Risk Management
The PMBOK defines risk management as the formal process by which risk factors
are systematically identified, assessed, and provided for. Risk management is not a
separate project activity, rather, it is an aspect of project implementation. A project
manager must use several tools to manage risks in technical areas, to understand the
causes of risks, and to identify the corrective actions.
A project manager should take a proactive rather than reactive approach to project
management. Take the case of a project for developing new technology for a
particular activity. According to the schedule, the project must be completed in six
months. But the technical team feels that the development of new technology requires
eight months. If the project manager is proactive, he might develop a contingency plan
24
for completing the activity within six months, either by increasing the size of the team
or by outsourcing some aspects of the development of technology. If the project
manager is reactive, he will not take any action until the problem actually occurs.
Proper risk management clearly reduces the likelihood of a risk occurring.
Check Your Progress
6. The formal process by which risk factors are systematically identified, assessed,
and tackled is known as _________________.
a. political risks
b. risk management
c. financial risks
d. economic risks
7. In the case of which of the following types of project manager does the utility
increase in proportion to an increase in the amount at stake?
i. Risk neutral
ii. Risk averter
iii. Risk seeker
a. i, ii and iii
b. Only i and iii
c. Only i
d. Only ii
8. A person who wishes to avoid risks completely is called a ___________.
a. risk neutral
b. risk seeker
c. risk averter
6. Certainty, Risk, and Uncertainty
To execute a project successfully, a project manager must be capable of taking good
decisions. Project managers take decisions under three conditions: certainty, risk and
uncertainty. Decision-making is easy under conditions of certainty, but it is extremely
difficult under conditions of uncertainty. As the situation progresses from certainty to
risk to uncertainty, the expected potential damage to the project increases.
Decision Making Under Certainty
Decision making under certainty implies that the project manager is fully aware of all
the states of nature available and the expected payoffs for each state of nature. The
term state of nature refer to a future event that is not under the control of the
decision maker. By constructing a payoff matrix for all the states of nature, the project
manager can select the best possible strategy.
To construct a payoff matrix, the project manager identifies all the states of nature and
formulates the strategies to be taken for each state of nature. All the possible outcomes
for each action, under each state of nature, are recorded to complete the payoff matrix.
Under conditions of certainty, the project manager exactly knows which state of
nature is going to occur. The project manager selects the best course of action on the
basis of the state of nature that will exist.
25
The following example explains the decision-making process under conditions of
certainty. For example, Midwest Laboratories wants to develop a new drug with an
investment of Rs. 5 lakh. The existing states of nature of market demand are;
N1: strong market demand
N2: average market demand, and
N3: weak market demand
The company has three strategies for developing the drug, S1, S2, and S3. Table 12.1
shows the payoff matrix for the given states of nature and the three strategies
formulated.
Table 12.1: Payoff Matrix (Profit in Lakhs of Rupees)
Strategy States of Nature
N1 N2 N3
S1 2 1.5 0.5
S2 3 1.6 0.8
S3 2.5 1.4 0.8
If the project manager knows that a particular state of nature is going to exist, he can
choose the appropriate strategy. For example, if the project manager knows N2 is the
expected state of nature, he can adopt strategy S2 as it provides higher returns than
other strategies.
Decision Making under Risk
The PMBOK defines risk as the totality effect of outcomes (i.e. states of nature) that
can be described within established confidence limits (i.e. probability distributions).
Under conditions of risk, the project manager is able to assign some probability of
occurrence to each state of nature. Based on this information, the project manager
calculates the expected value for each strategy and selects the strategy that earns
higher returns.
The expected value of a strategy is calculated as the sum of the product of the
probability of a state of nature and the respective payoff value of a strategy. Assume
the probabilities of a particular state of nature are 0.25, 0.25 and 0.5. Table 12.2
represents the payoff matrix under conditions of risk.
Table 12.2: Payoff Matrix (Profit in Lakhs of Rupees)
Strategy
States of Nature
Exp.Value
N1 N2 N3
S1 2 1.5 0.5 1.125
S2 3 1.6 0.8 1.35
S3 4 3 0.1 1.8
P (N1)=0.25, P(N2)=0.25 and P(N3)=0.5
Considering the above payoff matrix, the project manager chooses strategy S3 as it
has high expected value.
26
Decision Making under Uncertainty
Under conditions of uncertainty, the project manager does not know the probability of
occurrence of each state of nature. So the project manager uses four types of criteria to
select a strategy. They are: maximax criterion (Hurwicz criterion), maximin criterion
(Wald criterion), minimax regret criterion, and criterion of realism.
Maximax Criterion
This criterion is also called Hurwicz criterion. Under this criterion, the project
manager chooses the strategy that is likely to earn him the highest returns. From Table
12.2, the project manager would choose strategy S3, as it gives higher returns than
other strategies.
Maximin Criterion
This criterion is also called Wald criterion. Under this criterion, the project manager
identifies the minimum payoff values for each strategy and adopts the strategy that has
the highest payoff value. In Table 12.2, the minimum payoffs are 0.5, 0.8 and 0.1.
Using the maximin criterion, the project manager selects strategy S
2
.
Minimax regret criterion
In this criterion, the project manager attempts to minimize the maximum regret value
(maximum opportunity loss). The regret value is obtained by subtracting all the payoff
values in each state of nature from the largest payoff value of that state of nature.
Table 12.3 is the regret table for the values given in Table 12.2. The maximum regrets
for each strategy are 2, 1.4 and 0.7. So, the project manager chooses strategy S3 as it
minimizes the maximum opportunity loss.
Table 12.3: Regret Table
Strategy
Status of Nature
Max. Regret
N1 N2 N3
S1 2 1.5 0.3 2
S2 1 1.4 0 1.4
S3 0 0 0.7 0.7
Criterion of realism
This criterion is also called the Laplace criterion. According to this criterion, each
state of nature has the same probability of occurrence. So, the project manager
considers the average value of all the payoffs for each strategy and selects the strategy
that has the highest average payoff value. For Table 12.2, the average payoffs are
1.33, 1.8 and 2.36. So, the project manager chooses strategy S3.
Decision tree analysis
The project manager can use decision tree analysis when a decision involves a series
of several interrelated decisions. The project manager computes the Expected
Monetary Value (EMV) of all strategies and chooses the strategy with highest EMV.
Assume that the project manager has four alternative strategies, S1, S2, S3 and S4.
The resultant values for each strategy at different probability levels are R1, R2, and
R3. Assume that the probability of occurrence of these results is 0.5, 0.2 and 0.3. The
payoff matrix for this problem is given in Table 12.4.
27
Table 12.4: Payoff Matrix
R1 R2 R3
S1 14 9 10
S2 11 10 8
S3 9 10 10
S4 8 10 11
The project manager finally selects strategy S1 as it has the highest expected value.
Activity: The management of Asian Abrasives plans to launch a new product. The
project manager in charge of launching the new product, identified three states of
nature for the product: a low demand, a moderate demand, and a high demand. The
project manager prepared three types of strategies, S1, S2, and S3, to improve the
product's sales. A payoff matrix prepared by him is given below. The matrix
provides payoff values for each of these three states of nature against each strategy.
To choose a strategy for implementation, he wanted to use the minimax regret
criterion. What is the minimax criterion? Explain which type of strategy is
preferred using this criterion?
Strategy
States of Nature
N1 N2 N3
S1
S2
S3
50
40
60
30
35
40
80
85
65
Answer:
Check Your Progress
9. Which of the following criteria is also called the Wald criterion under conditions
of uncertainty?
a. Criterion of realism
b. Minimax regret criterion
c. Maximin criterion
d. Maximax criterion
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10. From the given payoff matrix, which strategy should the project manager choose
under conditions of certainty?
Payoff matrix (Profit in millions of rupees)
Strategy
States of nature
N1 N2 N3
S1 2 1 0.8
S2 3.5 2.5 1.5
S3 4.5 3 1
N1: Strong market demand
N2: Average market demand, and
N3: Weak market demand
a. S1
b. S2
c. S3
d. Data insufficient
11. Which of the following criteria is also called the Hurwicz criterion under
conditions of uncertainty?
b. Minimax regret criterion
12. Under conditions of uncertainty, the project manager uses various types of criteria
to select a strategy. Which of the following is/are the criteria to select the
strategy?
i. Minimax regret criterion
ii. Maximin criterion
iii. Maximax criterion
iv. Criterion of unrealism
a. Only i and ii
b. i, ii, iii and iv
c. Only iv
d. i, ii, and iii
13. Which of the following types of analysis is used when a decision involves a series
of several interrelated decisions?
b. Decision tree analysis
c. Maximax criteria
d. Minimax regret criterion
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14. Which of the following criteria is also called the Laplace criterion under
conditions of uncertainty?
a. Minimax regret criterion
b. Criterion of realism
15. In the case of decision-making under _________ conditions, the project manager
is fully aware of all the states of nature available and the expected payoffs for
each state of nature.
a. risk
b. certainty
c. uncertainty
Exercises
a. From the given payoff matrix, which strategy should be chosen by the project
manager under conditions of risk, assuming the probabilities of a particular state
of nature are: 0.2, 0.2, and 0.4?
Payoff Matrix
(Profit in millions of rupees)
Strategy
States of nature
N1 N2 N3
S1 3 2.5 1
S2 4 2 1
S3 5 4 0.5
b. Using the decision tree analysis, select the best strategy with the highest expected
monetary value. The project manager has four alternatives strategies to choose
from S1, S2, S3, and S4. The resultant values for each strategy at different
probability levels are 0.4, 0.25, and 0.36.
R1 R2 R3
S1 13 7 8
S2 10 9 7
S3 8 7 8
S4 7 8 9
7. Risk Management Methodology
The successful completion of a project depends on the ability of the project manager
to deal with different types of risks. It is important for a project manager to develop a
risk management strategy at the beginning of the project. The risk management
strategy should be incorporated into the process of project implementation. The steps
involved in the process of risk management are risk identification, risk
quantification, risk response, and risk control. Each of these steps is discussed below.
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Risk Identification
Risk identification involves the scanning of project activities, the identification of
potential risks and documentation of risk. The task of the project manager is to
perceive that there is a possibility of risk exposure and identifying the causes of the
risks. The project manager should carefully discover all the risks that the project is
likely to be exposed to. The project manager should study the nature of all the project
activities, the manner in which they are carried out, and where they are carried out.
Once all the risks have been identified, the project manager should carefully document
all the characteristics of each risk associated with the project. Even though some risks
may have meager impact on the project, the project manager should study the
cumulative effect of these small risks. The process of risk identification is a
continuous process and should be carried out at regular intervals.
The project manager should address both the internal and external risks of the project.
Since internal risks normally arise because of negligence or mismanagement, the
project manager should deal with such risks in a proactive manner. Certain internal
risks are part of the activity of a project. For example, poor quality raw material is
regarded as an internal risk. The project manager can take some preventive steps or
controlling techniques to deal with such risks. External risks are beyond the control of
the project manager. The project manager should ensure that the project will not be
seriously affected by the external risks. If necessary, he should find some alternative
ways of completing the project.
Risk identification can be done either through a cause-and-effect analysis or an effect-
and-cause analysis. In a cause-and-effect analysis, the project manager lists all the
causes of risk and compares each risk with its possible effect. Measures are then taken
to reduce the effect of each risk. In effect-and-cause analysis, the project manager
identifies the outcomes to be avoided and initiates action to remove the causes of
those risks.
To identify the potential risks, a project manager should -- analyze the project
outcome; critically view all the processes involved in a project; estimate the costs and
schedules for various activities of a project; identify the required human resources;
understand the market conditions; and study the records and databases of old and
successfully implemented projects.
The project manager should use tools and techniques like checklists and flowcharts
and conduct interviews to identify the risks involved in the project. Checklists provide
the technology required and necessary human resources to conduct a project. A
flowchart depicts how the various elements of a system are related to one another.
Interviews with various promoters and stakeholders will also help the project manager
identify the risks that are likely to arise during the life of the project. The project
manager should ensure that the process of risk identification uncovers the sources of
risk, potential risk events, and risk symptoms.
Sources of Risk
Sources of risk are the areas of possible risk events, which are likely to affect the
outcome of the project. Team turnover, unreliable investment, new technologies and
stockholder actions are some of the sources of risks. The project manager should
broadly categorize all the sources of risks, describe all the sources of risk with the
probability of a risk to occur, range of possible outcomes, and frequency of
occurrence of risk.
31
Potential Risk Events
Such events occur unexpectedly, but the amount of loss they are likely to cause for the
project is very high. The departure of a key project team member, natural disasters,
governments ban on a particular product or service that is related to the ongoing
project are some examples for potential risk events. A potential risk cannot adversely
affect all types of the projects. For example, a storm is a potential risk event for a
construction project, but not for a biological lab project. Since the potential risk events
are specific to the application area, project managers should carefully assess the
sources of potential risks for specific projects.
Risk Symptoms
These are also called triggers. These events are not actual risk events, but they reveal
the increasing chances of risk. For example, unusual sound from some equipment is
an indication of the possible breakdown of that equipment. Similarly, the employees
personal problems can indicate a likely delay in the schedule. The project manager
should carefully handle the risks once he has identified the risk symptoms.
After the risks have been identified, the project manager should initiate activities that
will reduce the adverse effects of the risk. Sometimes the process of identification of
risk also identifies the need to do another activity in other areas. For example, the
process of identification of risk can reveal that the work breakdown structure may not
be sufficient to identify all the possible risks.
Risk Quantification
The quantification of risks involves an assessment of the range of risks associated
with a possible project outcome. Sometimes, a single risk event can cause multiple
effects. For example, delay in obtaining a critical component leads to cost overruns,
schedule delays, and low quality outcome.
A small problem in a rocket may lead to the failure to launch a satellite on a specific
path. As some of the risks cannot be quantified, reliability of a product or service
should also be studied by the project manager. For example, a small defect in an
airplane might result in the death of several people.
The changing business environment and the schedule delays that have already
occurred create risks and force the project manager to consider an alternative risk
strategy. The quantification of risk also changes from one firm to other firm based on
their past experiences, nature of project and assumptions made. One firm perceives
incurring of 20 percent more overheads than expected as high risk while another firm
perceives it as low risk. So financial soundness of an organization should also be
considered before taking any decision.
Decision trees and calculation of EMV (Expected Monetary Value) are useful for
quantifying risk. Project managers also use some Operations Research techniques like
simulation, PERT and CPM, and probability distributions to quantify risk. These
techniques help project managers determine whether risk requires attention or can be
ignored.
Risk Response
This refers to the steps to be taken by the project manager to respond to the risks
identified and quantified. Quick response to a particular risk is likely to reduce its
impact on a project. The following data must be gathered before developing a risk
response policy:
List of identified risks
Probability of occurrence of each risk
32
Review of the potential responses that have been identified during risk identification
stage
List of project stakeholders who play a role in developing proper risk response
Definition of the acceptable level of risk.
If any of this information is missing, the response will not be developed effectively.
Activity: Ruvila Lubricants produces and distributes various industrial lubricants.
The management of the company wanted to launch a new industrial lubricant
Lupil. Bipin Chandra, the company CEO, asked Andrew Stephen, the project
manager, to identify the risks involved in the project. What is risk identification?
What are the things to be uncovered in the process of risk identification? What
kind of data should Stephen collect to determine the risk response used for the
risks?
Answer:
Criteria for Selection of an Effective Response
The criteria for selection of an appropriate response is very important. The project
manager should ensure that the selected risk response has the following
characteristics:
Appropriate: The response should be appropriate for the risk, given the size and
criticality of the risk. The project manager should not spend lot of time and effort in
developing inappropriate responses to minor risks.
Affordable: The cost of responses must be estimated; responses should be cost-
effective. The amount of time, effort and money spent on addressing the risk should
not exceed the agreed budget.
Actionable: An Action Window that defines the time within which responses need to
be completed should be developed. While some of the risks require immediate action,
others can be addressed later.
Achievable: The project manager should ensure that the developed responses are
technically feasible, and can be achieved by the project team.
Agreed: The consensus and commitment of the projects stakeholders is essential
before developing the responses.
Accepted: Each response should be preliminarily tested before accepting it.
It is important to determine the appropriate response before implementing it. The
project manager should select an appropriate model to implement the strategy;
otherwise the implementation of one response may nullify the effect of another
response. For example, the project has removed some unproductive team members to
avoid production risks. Since the response developed by the project manager may
affect morale of the other employees, he has to face human risks.
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Example: Approaches to Effective Risk Management
Successful organizations use some of the following approaches to manage risk
effectively:
Making the organizational culture risk friendly.
Prioritizing the risk along with cost, time and scope management.
Decision making and resource allocation are based on the results of risk analysis.
Using highest quality data and other resources for risk analysis.
Encouraging professionals to see risk management as a career path.
Making risk analysis functions independent of the organization
Benchmarking the risk management processes throughout the organization.
Use of continuous improvement systems.
Encouraging professional interchanges through conferences and journals.
Abstract from the paper of David T. Hulett, Key Characteristics of a Mature Risk Management
Process, presented at the Fourth European Project Management Conference, PMI Europe
2001, London, UK.
Types of Risk Responses
A project manager can consider four types of responses to risks -- risk avoidance, risk
transfer, risk mitigation, and risk acceptance.
Risk Avoidance
The project manager considers this technique as a first option as this attempts to avoid
the risk by eliminating the cause of the risk. For example, the project manager might
feel that the use of low quality cement caused the failure of the prototype models
developed. In this situation, the project manager can replace cement with Plaster of
Paris. Of course, it is not possible to eliminate or avoid most types of risks and their
causes, and so this kind of response is not often used.
The risk avoidance technique can be implemented in two ways; directly or indirectly.
The direct approach is used when the risk arises from lack of knowledge; and the
indirect approach is used when the risk arises from a particular source. In the direct
approach, uncertainty is eliminated by obtaining more information, improving
communication, and undertaking research or prototype development. In the indirect
approach, the source or cause of the risk is removed.
Risk Transfer
This risk response method attempts to transfer the liability for risk to a third party. But
the scope of this technique is limited as only financial risk can be transferred. The
project manager makes use of the insurance mechanism, to transfer the risk to the
insurer. But this mechanism only protects against the financial risks of the project. It
is also important to remember that risk transfer not only shifts the liability, but also
changes ownership of the risk. This means risk transfer does not remove the risk, but
simply makes another party responsible.
Some other financial instruments used for risk transferring are performance bonds,
warranties and guarantees. The project manager should realize that transfer of risk is
limited to recovery of financial losses and does not in any way help put the project
back on schedule. The project manager also considers techniques like self-insurance
or captive insurance as an alternative mechanism for insurance. These techniques are
discussed later.
34
Risk Mitigation
Very few risks can be effectively addressed by avoidance or transfer responses. The
project manager can also take preventive measures to reduce the loss caused by the
risk. This is called risk mitigation. The purpose of risk mitigation is to reduce the
intensity of the risk to a point where it can be accepted.
Risk mitigation techniques can be implemented in two ways: by eliminating the causes
of the risk, or reducing the impact of the risk. By eliminating the causes of the risk, this
approach reduces the probability of the occurrence of the risk. If the probability of the
risk cannot be reduced, the technique aims at reducing the impact of the risk.
To reduce the likelihood of losses, the project manager can use best quality
equipment, maintain the equipment and use sophisticated production processes. As the
treatment of risk differs for each risk, the risk mitigation methodology also varies with
the nature of the risk. This is the most widely used method as the majority of the risks
can be targeted through this technique.
Risk Acceptance
Sometimes the project manager is forced to accept the consequences of certain risks.
This is because the risks are the residual risks and cannot be eliminated by using
avoidance, transfer or mitigation techniques. In such a situation, the project manager
prepares a contingency plan to face the risks.
In the case of relatively low level risks, the project manager accepts them. For example,
the manager of a showroom accepts the risk of his showroom glass windows being
broken. Similarly, risks that reduce profits but do not produce any adverse effects are
also accepted. The project manager creates a separate reserve to face these risks.
Risk Control
When changes in the course of the project are observed, the project manager repeats
the cycle of identifying, quantifying and responding to risks. The process of risk
control includes identifying the additional risks and their sources, management by
wandering around and developing more risk response developments. The process of
risk control results in corrective action and revision of the risk management plan.
Corrective Actions
To take corrective action, the project manager prepares contingency plans and does
workarounds. Contingency plans are the alternative ways of doing the work when the
risk is faced. Workarounds are the informal checking up of the project activities.
These corrective actions help in reducing the severity of the risk.
Updates to Risk Management Plan
Evaluation of the risk event and identification of the causes for failing to respond to a
particular risk are aspects to be considered by the project manager when revising or
updating the earlier risk management plan.
Activity: Build India Ltd. manufactures industrial inverters and generators. In
2001, the company got several orders to manufacture industrial inverters and
generators from various companies. The company incurred huge losses due to its
poor risk management record. Therefore, the company management asked Ravi
Prabhakar, the project manager, to prepare effective risk responses to deal with the
risks that may arise. What are the various types of risk responses? Discuss the
criteria for selecting an appropriate risk response.
Contd
35
Contd
Answer:
Check Your Progress
16. Which of the following options involves the assessment of the range of risks
associated with a possible project outcome?
a. Risk response
b. Risk quantification
c. Risk transfer
d. Risk mitigation
17. Which of the following responses to risks involves taking preventive measures to
reduce the loss caused by the risk?
a. Risk avoidance
b. Risk transfer
c. Risk acceptance
d. Risk mitigation
18. Which of the data need not be collected by the project manager before developing
a risk response policy?
a. List of identified risks
b. Probability of occurrence of each risk
c. Analysis of the project outcome
d. Review of the potential responses that have been identified during the risk
identification stage
19. The successful implementation of a project depends on the ability of the project
manager to deal with different types of risks. Which of the following is/are the
steps in risk management?
i. Risk identification
ii. Risk quantification
iii. Risk response
iv. Risk control
a. Only i
b. Only ii and iv
d. Only iii and iv
36
20. Which of the following are the events which reveal the increasing chances of
risk?
a. Sources of risk
b. Risk symptoms
c. Potential risk events
d. Risk quantification
21. From the options given, identify the ways by which the risk mitigation techniques
can be implemented.
i. By accepting the consequences of risk
ii. By eliminating the causes of risk
iii. By transferring the liability of risk to a third party
iv. By reducing the impact of risk
a. i and iv
b. ii and iv
c. iii and iv
d. ii and iii
22. For identifying the potential risks, the project manager need not perform which of
the following activities?
a. Analyzing the project outcome
b. Understanding the market conditions
c. Estimating the probability of occurrence of each risk
d. Identifying the required human resources
23. The concept of insurance is a kind of ___________ response.
a. risk avoidance
b. risk mitigation
c. risk transfer
d. risk control
24. __________ refer to the informal checking up of project activities.
a. Contingency plans
b. Corrective actions
c. Workarounds
25. Which of the following types of responses to risk involves shifting the risk to a
third party?
a. Risk avoidance
b. Risk acceptance
c. Risk transfer
d. Risk mitigation
37
8. Insurance for Projects
The concept of insurance is a kind of risk transfer response. Diversification of risk is
an important aspect of insurance that spreads the risks over a large group of projects.
The project manager enters into an insurance or risk pool to transfer the risk over a
wide area and over a period of time.
Basically, risks are of two types: speculative risks and pure risks. The mechanism of
insurance is applicable only for pure risks. The term pure risk refers to those
situations that involve the likelihood of incurring losses. Speculative risk describes a
situation where there is the possibility of making profits. Risks caused by changes in
technology, political upheaval etc. are speculative risks; and damage caused by fire,
earthquake or human risks such as burglary, theft negligence etc are pure risks.
The purpose of insurance is to safeguard the business against a set of pure risks that
affect the solvency of the project. The project manager should acquaint himself with
all the aspects of insurance coverage and he should identify all the risks that can be
covered and the risks that cannot be covered by insurance coverage. At the same time,
the project manager is responsible for reducing the severity of the risks. Some of the
techniques followed by project managers to secure the project against certain types of
risks are discussed below.
Self Insurance
Assuming a financial risk oneself instead of paying the premium to another company is
called self- insurance. Organizations that are financially very strong usually opt for self-
insurance. Such organizations are aware of the occurrence of risks, instead of transferring
these risks to other parties, they create separate reserves to deal with such risks.
Self insurance is normally done when an organization feels that the risks are not very
severe and in the case where insurance is not applicable. By making self-insurance, a
firm can save costs like agent commission, and administration costs of the insurance
company.
Captive Company
Big organizations create a separate entity to provide insurance to its corporate firm
and to its affiliates. The created entity works like an insurance company and is called
a captive company. There are two types of captives: pure captives and group captives.
In a pure captive, a single company provides insurance coverage to its affiliates; and
in group captives, a group of companies come together to provide insurance coverage
to their corporate offices and affiliates against certain specified risks. But the risk
diversification is not spread more in these companies.
In the above cases, the transfer of risk is partial and limited. In order to ensure a
greater spreading of risks, the project manager has only a single option, insurance.
The project manager considers several policies to cover several project risks. Some of
the policies and the risks they cover are discussed below.
Fire and Natural Calamities Insurance
The policy covers all machinery and equipment (movable, immovable) against the
risks of fire, lightning, explosion of boiler and explosion of gas. Fire policies A, B,
and C are issued to cover the equipment from several risks. Fire policy A and Fire
policy B cover simple risks to dwellings offices, hotels, shops and educational
institutions. Fire policy A covers the following perils: (i) fire, (ii) lightning (iii) impact
damage (iv) aircraft damage, (v) riot, strike and terrorist damage, (vi) earthquake, (vii)
explosion / implosion (viii) storm, flood and inundation (ix) landslide. Only policy A
is issued to cover artisans workshops, bio-gas plants, village and cotton industries,
tiny sector or small scale industries.
38
Fire policy B covers the following perils (i) fire (ii) lightning (iii) explosion/implosion
(iv) impact damage (v) aircraft damage (vi) riot, strike and terrorist damage. The riot,
strike and terrorist damage perils can be excluded with specified reduction in the
premium rate. Fire policy C is issued to cover industrial/manufacturing risks and
storage risk from perils like fire, lightning, explosion/implosion, impact damage,
aircraft damage, riot, strike, malicious and terrorist damage. The riot, strike, malicious
and terrorist damage perils can be excluded on specific request with a reduction in the
premium rate.
The consequential loss fire insurance policy protects the loss of gross profit from
interruption of the commissioned project as a result of fire damage to the machinery
and equipment. In the case reduction in output, the financial loss is compensated for
by the insurance company.
Industrial All Risks (IAR) Insurance
This is a comprehensive policy that covers perils like fire, burglary, and machinery
breakdown/boiler explosion. Various risks are covered in a single policy, thus
reducing the premium costs. This policy covers both manufacturing and storage
facilities of all industrial units anywhere in India. The policy holder should bear 5% of
the claim amount in case of material damage, three days of gross profit in the case of
business interruption, subject to a minimum of Rs. 5 lakhs and a maximum of Rs. 50
lakhs.
Projects and Advance Loss of Profits Insurance
This policy is especially designed for large power and construction projects, and
industrial plants. It is a comprehensive policy, provides coverage for various perils.
Under this policy, and material damage is covered until the project is completed and
tested. In addition, if there is any delay in completion of the project because of
material damage, the policy offers partial compensation for the loss of profits. But the
other policies cover the loss of profit from the day the insured peril occurred. But this
policy covers the profit risk from the date the insurance was taken. These policies are
framed to meet the insurance needs of major global project financiers and joint
venture partners who are making large investments in India.
Erection All Risks (EAR) Insurance
This policy protects the property against accidents that result in damage to the
equipment and machinery while constructing or installing. These days, this policy has
become a prerequisite for receiving loans from financial institutions. The sum insured
for a project under this policy represents the value of the project. Big projects like
global infrastructural projects, power generation plants, drugs and fertilizer plants,
cement factories and oil refineries purchase this policy to protect buildings and
equipment.
Workmens Compensation Insurance
The Workmens Compensation Act, 1923, provides compensation to workmen for any
injury, accident, or disease arising out of and in course of the work. The project
manager purchases a policy to cover employees against specified risks. Because of the
increased use and growing complexity of machinery in todays projects, all firms are
protecting their workmen against several risks. This also improves the morale of the
workers of the project.
The other important policies that project managers need to consider are Contractors
All Risk (CAR) policy that protects the civil contractors against damage, Machinery
Breakdown (MB) policy that provides insurance coverage for any sudden breakdown
of expensive plant machinery and equipment, Boiler Explosion Policy indemnifies the
39
insured against damage to the boiler or any specified apparatus, and Electronic
Equipment insurance covers the electronic equipment such as computers, micro
processors, telecommunications equipment.
Check Your Progress
26. In which of the following ways of providing insurance does a group of companies
come together to provide insurance to their corporate offices and affiliates?
a. Pure captives
b. Group captives
c. Self insurance
27. Which of the following options refer to those situations that involve the
likelihood of incurring losses?
a. Risk avoidance
b. Pure risks
c. Risk control
d. Risk transfer
28. _____________ protects a company against loss of profit caused by the
commissioned project being interrupted as a result of damage to machinery and
equipment due to fire.
a. Fire policy A
b. Fire policy B
c. Consequential loss fire insurance policy
29. In insuring the risks of a project, which of the following types refer to a company
undertaking the risk on its own without paying a premium to another company?
a. Captive company
b. Risk mitigation
c. Self insurance
30. Identify the policy that provides for compensation to workmen for any injury,
accident, or disease arising in the course of work.
a. Erection all risks policy
b. Workmens compensation insurance policy
c. Industrial all risks insurance policy
31. Identify the policy that protects the property against accidents that result in
damage to the machinery and equipment during construction and installation.
a. Industrial all risks
b. Consequential loss fire insurance policy
c. Erection all risks
d. Fire policy
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32. Which of the following risks describe the possibility of making profits?
a. Pure risks
b. Speculative risks
c. Risk control
d. Risk mitigation
33. Which of the following types of insurance policy covers all the perils like fire,
burglary, and machinery breakdown/boiler explosion?
a. Consequential loss fire insurance policy
b. Fire policy A
c. Industrial all risks insurance
9. Summary
Risk is defined as the possibility of an outcome being different from the expected
outcome. It refers to the possibility of adverse results flowing from the uncertainty
involved in carrying out the activities.
Broadly, risks can be categorized into technical risks, economic risks, political risks,
production risks, marketing risks, financial risks, and human risks.
Project managers deal with risks in different ways, depending on their level of
tolerance for risks. They can be classified as risk averters, risk neutrals, and risk
seekers on the basis of their attitude toward risk.
The tolerance curve for each type of manager is derived by comparing his/her risk
preference with the utility (the amount of satisfaction the project manager derives
from a payoff). The utility can also be referred as the tolerance for risk.
Risk management can be defined as the formal process by which risk factors are
systematically identified, assessed, and provided for. Risk management is an aspect of
project implementation.
The successful completion of a project depends on the ability of the project manager
to deal with different types of risks. The steps involved in the process of risk
management are risk identification, risk quantification, risk response, and risk
control.
Project managers must be capable of taking good decisions to execute a project
successfully. They take decisions under three conditions: certainty, risk and
uncertainty. Decision-making is easy under conditions of certainty, but it is extremely
difficult under conditions of uncertainty.
The concept of insurance is a kind of risk transfer response. The project manager
enters into an insurance or risk pool to transfer the risk over a wide area and over a
period of time.
Risks are basically of two types: speculative risks (situation where there is the
possibility of making profits) and pure risks (situations where there is the likelihood of
incurring losses). The mechanism of insurance is applicable only for pure risks.
10. Glossary
Decision Tree Analysis: It is used in complex situations when sequential decisions
are involved and when these decisions can be taken only after the happening of an
uncertain event in future.
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Economic Risks: An increase in the rate of inflation, changes in the economic
policies of governments, and distribution of income. Production risks
Financial Risk: Variations in the after tax earnings or the earnings per share of the
firm caused by the capital structure.
Production Risks: The shortage of necessary raw materials, sudden breakdown of
key machinery, and exponential rise in installation and maintenance costs.
Risk Averter: A person who always wishes to avoid risk.
Risk Avoidance: A risk management response technique aimed at eliminating the
cause of a risk to avoid the risk.
Risk Identification: It is the process of determining which risk events are likely to
affect the project.
Risk Management: A process by which risk factors are systematically identified,
assessed, and provided for.
Risk Mitigation: A risk management technique aimed at reducing the loss in the case
of a risk by taking the preventive measures.
Risk Quantification: It involves assessment of the range of risks associated with a
possible project outcome.
Risk Response: The steps by which the project manager responds to the risks
identified and quantified.
Risk Seeker: He/she is a person who wishes to accept the risks.
Risk Symptoms: These are also called triggers. These events are not the actual risk
events, but they reveal the increasing chances of risk.
Risk Transfer: The risk response method aimed at transferring the liability for risk to
a third party. But the scope for this model is often limited as the financial risk only can
be transferred.
Risk: The possibility of an outcome being different from the expected. It is a situation
where the possible events are known but which of those will actually happen is not
known.
Social risks: Social risks refer to risks arising from changes in the needs and changing
preferences of target customers. Economic risks
Technical risk: Risk of failing to meet technical specifications.
1. Every activity of a project involves the risk element. Define risk. What are the
different types of risks to which projects are exposed to?
2. The tolerance curve for each type of manager is derived by comparing his/her risk
preference with the utility. Explain how project managers can be classified
according to their tolerance to risks.
3. The successful completion of a project depends on the ability of the project
manager to deal with different types of risks. Define risk management in projects.
What are the steps involved in the process of risk management?
4. Project managers take decisions to execute a project successfully under three
conditions of certainty, risk, and uncertainty. Explain decision making under
these three conditions.
5. The project manager enters into an insurance to transfer the risk over a wide area
and over a period of time. Describe the techniques followed by project managers
to secure the project against the various types of risks.
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1. (b) Risk
Risk is the function of uncertainty. It involves the possibility of an outcome being
different from the expected outcome. Technical risks involve the failure to meet a
particular performance requirement. Political risks involve the risk of
nationalization, political instability, trade restriction, etc. Both technical risks and
political risks are part of business risks.
2. (b) Marketing risks
Marketing risks refer to the failure of the product or service in the market due to
factors like change in demand, errors in forecasting of demand, and difficulties in
distribution. Financial risks are risks due to financial factors like choice of
investments and mistakes in accounting procedures. Political risks refer to the
risks due to factors like nationalization, political instability, trade restrictions, etc.
Economic risks refer to risks due to changes in inflation, changes in the economic
policies of the government, and distribution of income.
3. (c) Social risks
Social risks arise from changes in the needs and preferences of target customers,
unavailability of natural resources, and labor unrest. Agitations and social
movements against the projects also constitute social risks. Technical risks refer
to the failure to meet a particular performance requirement. Economic risks refer
to risks of an increase in inflation, changes in economic policy, distribution of
income, etc. Human risks refer to the risk of sudden demise of the employee, lack
of availability of competent employees, inter-group politics, etc.
4. (d) Production risks
Production risks refer to the risks which cannot be controlled by the project
manager like shortage of raw materials, sudden breakdown of machinery, and risk
in installation and maintenance costs. Marketing risks refer to the risks arising
due to demand factors and difficulties in distribution. Political risks refer to the
risks due to political factors like nationalization, political instability, trade
restrictions, etc. Economic risks refer to risks due to changes in inflation, changes
in the economic policies of the government, and distribution of income. Social
risks arise from the possibility of changes in the needs and preferences of target
customers, unavailability of natural resources, labor unrest, and agitations and
social movements against the projects.
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Risk is the possibility of an outcome being different from the expected outcome.
Project risk is considered as the function of uncertainty and damage. But
uncertainty and damage are considered while conducting a risk analysis of the
project. Risk may also arise due to hazards. Hazards can be defined as a source of
danger. So risk is also a function of hazard and safeguard.
6. (b) risk management
Risk management is defined as the formal process by which risk factors are
defined, assessed, and tackled. Political risks, financial risks, and economic risks
are different types of risks. Political risks refer to the risks arising out of political
factors like nationalization of a particular industry, political instability, trade
restrictions, etc. Financial risks are the risks arising due to financial factors like
an increase in bad debts, change in interest rates, wrong choice of investments,
and mistakes in accounting procedures. Economic risks refer to the fluctuations in
economic factors like inflation, change in the governments economic policy, and
distribution of income.
7. (c) Only i
When more money is at stake, the risk averters utility increases but at a
decreasing rate. For a risk seeker, the utility increases at an increasing rate as the
amount of money at stake increases. In the case of a risk neutral, the utility
increases in proportion to an increase in the amount of money at stake.
8. (c) risk averter
Project managers are classified into risk averters, risk seekers, and risk neutrals.
A risk seeker is a person who wishes to accept more and more risks, a risk averter
is a person who always wishes to avoid risks, and a risk neutral is a person who
falls between a risk seeker and a risk averter.
9. (c) Maximin criterion
The Maximin criterion is also called the Wald criterion. Under this criterion, the
project manager identifies the minimum payoff values for each strategy and
adopts the strategy that has the highest payoff value. The Maximin criterion finds
the alternative that maximizes the minimum outcome or consequence for every
alternative. In this case, the minimum outcome is located within every alternative
and the alternative with the maximum value is chosen.
10. (d) Data insufficient
Under conditions of certainty, the project manager can choose the strategy if
he/she knows which state of nature is going to exist. If the project manager knows
that N1 is the expected state of nature, he/she can adopt the strategy S1 as it will
provide higher returns than other strategies. However, in the given question, the
expected state of nature is not given. Hence, the data given is not sufficient to
answer the question.
11. (d) Maximax criterion
The Maximax criterion is also called the Hurwicz criterion. Under this criterion,
the project manager chooses the strategy that is likely to earn him/her the highest
returns. The Maximax criterion finds the alternative that maximizes the outcome
or consequence for every alternative. The Maximax approach is used in cases
where the project manager cannot assess the outcome probabilities with
confidence.
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The project manager uses four types of criteria to select a strategy Maximax
criterion, Maximin criterion, Minimax regret criterion, and criterion of realism.
Under the Maximax criterion, the project manager chooses the strategy that is
likely to earn him/her the highest returns. Under the Maximin criterion, the
project manager identifies the minimum payoff values for each strategy and
adopts the strategy that has the highest payoff value. Under the Minimax regret
criterion, the project manager attempts to minimize the maximum regret value.
The regret value is obtained by subtracting the payoff value in each state of nature
from the largest payoff value of that state of nature. Under the criterion of
realism, each state of nature has the same probability of occurrence. The project
manager considers the average value of all the payoffs for each strategy and
selects the strategy that has the highest average payoff value.
13. (b) Decision tree analysis
The decision tree analysis is used by the project manager when a decision
involves a series of several interrelated decisions. The project manager chooses
the strategy with the highest Expected monetary value (EMV).
14. (b) Criterion of realism
The criterion of realism is called the Laplace criterion. As per this criterion, all
the states of nature have the same probability of occurrence. So the project
manager considers the average value of all the payoffs for each strategy and
selects the strategy that has the highest average payoff value.
15. (b) certainty
The project manager takes a decision under three types of conditions Certainty,
uncertainty, and risk. If the project manager takes the decisions under certainty,
he/she is fully aware of all the states of nature available and the expected payoffs
for each state of nature. Under uncertainty and risk, the project manager is not
fully aware of the states of nature available.
16. (b) Risk quantification
Risk quantification is one of the important steps in risk management. It involves
the assessment of the range of risks associated with a possible project outcome.
Risk response refers to the steps taken by the project manager in response to the
risks identified and quantified. Risk transfer and risk mitigation are the different
types of responses to risks.
17. (d) Risk mitigation
Risk mitigation involves taking preventive measures to reduce the loss caused by
the risk. Risk avoidance is the first step in risk response. It involves avoiding the
risk by avoiding the causes of risk. Risk transfer involves the transfer of the
liability to a third party. Risk acceptance involves the project manager accepting
the consequences of risk.
18. (c) Analysis of the project outcome
Following is the data that must be gathered before developing a risk response
policy: List of identified risks, probability of occurrence of each risk, review of
the potential responses that have been identified during the risk identification
stage, list of project stakeholders who play a role in developing a proper risk
response, and defining the acceptable level of risk. Analysis of the project
outcome is one of the steps to identify the potential risks in risk identification.
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The four steps involved in the risk management strategy are risk identification,
risk quantification, risk response, and risk control. Risk identification is the first
step in the process of risk management. It involves scanning the project activities,
identifying potential risks, and documenting the risks. Risk quantification
involves an assessment of the range of risks associated with a possible project
outcome. Risk response follows risk quantification and refers to the steps taken
by the project manager to respond to the risks identified and quantified. The last
step in the risk management process is risk control. This involves identifying
additional risks and their sources, management by wandering around, and
developing more risk response tools.
20. (b) Risk symptoms
Risk symptoms are the events which reveal the increasing chances of risk. Risk
symptoms are also called triggers. Sources of risk are the possible risk events
which may affect the outcome of the project. Risk quantification involves an
assessment of the range of risks associated with the project outcome.
21. (b) ii and iv
The two ways by which risk can be mitigated are by eliminating the causes of risk
and by reducing the impact of risk.
22. (c) Estimating the probability of occurrence of each risk
The project manager should carry out the following activities to identify the
potential risks in risk identification: analyzing the project outcomes, critically
viewing all the processes involved in the project, estimating the costs and
schedules of various activities of the project, identifying the required human
resources, and studying the records and databases of old and successfully
implemented projects. Estimating the probability of occurrence of each risk is the
data to be gathered before developing the risk response policy.
23. (c) risk transfer
The concept of insurance is a kind of risk transfer response among the various
risk responses. This involves transferring the financial risk to a third partner. Risk
avoidance is avoiding the risk by making efforts to eliminate it. Under risk
mitigation, the project manager can take preventive measures to reduce the loss
caused by the risk. Risk control refers to the control of the risk by identifying,
quantifying, and responding to the risks.
24. (c) Workarounds
Workarounds refer to the informal checking up of project activities. Contingency
plans are the alternative ways of doing work when a risk is faced. Contingency
plans and workarounds fall under the head of corrective actions in risk control.
25. (c) Risk transfer
Risk transfer involves shifting the risk to a third party. Only financial risks are
transferred to a third party. Risk avoidance is the first step in risk response. It
involves avoiding the risk by avoiding the causes of risk. Risk acceptance
involves the project manager accepting the consequences of the risk. Risk
mitigation involves undertaking preventive measures to reduce the loss caused by
the risk.
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26. (b) Group captives
Captive insurance companies are divided into two types: Pure captives and group
captives. Group captives refer to the coming together of a group of companies to
provide insurance to their corporate office and affiliates. In the case of a pure
captive, a single company provides insurance coverage to its affiliates. Self
insurance refers to a company assuming the financial risk on its own instead of
paying the premium to another company.
27. (b) Pure risks
Risks are divided into pure risks and speculative risks. Pure risks are the risks that
involve the likelihood of incurring losses. Risk avoidance, risk control, and risk
transfer are the various types of responses to risk.
28. (c) Consequential loss fire insurance policy.
Fire policies A, B, and C are issued to cover the equipment against several risks.
Consequential loss fire insurance policy protects a company against the loss of
gross profit caused by an interruption of the project as a result of fire damage to
the machinery and equipment.
29. (c) Self insurance
Self insurance refers to a company assuming the financial risk on its own instead
of paying a premium to another company. A captive company refers to a separate
entity created to provide insurance to its corporate firm and affiliates. Risk
mitigation is one of the responses to risk.
30. (b) Workmens compensation insurance policy
The Workmens Compensation Act 1923 provides compensation to workmen for
any injury, accident, or disease arising in the course of work. The erection all
risks policy protects the property against accidents that result in the damage to the
equipment and machinery during construction and installation. Industrial all risks
is a comprehensive policy that covers perils like fire, burglary, and machinery
breakdown/boiler explosion.
31. (c) Erection all risks
The erection all risks policy protects the property against accidents that result in
damage to the equipment and machinery during construction and installation. The
industrial all risks policy covers perils like fire, burglary, and machinery
breakdown/boiler explosion. Fire policies A, B, and C are issued to cover the
equipment against several risks. Fire policy A covers fire, lighting, impact
damage, aircraft damage, riot, strike, and terrorist damage, earthquake,
explosion/implosion, storm, flood and inundation, and landslide. Some of the
risks to artisans workshops, bio-gas plants, village and cotton industries, and
small scale industries are covered by only policy A. Fire policy B covers fire,
lighting, explosion/implosion, impact damage, aircraft damage, riot, strike, and
terrorist damage. But the riot, strike, and terrorist damage perils can be excluded
with specific reduction in the premium rate. Fire policy C covers
industrial/manufacturing risks and storage risks from perils like fire, lighting,
explosion/implosion, impact damage, aircraft damage, riot, strike, malicious and
terrorist damage. The riot, strike, malicious and terrorist damage perils can be
excluded on specific request with a reduction in the premium rate.
32. (b) Speculative risks
Risks are divided into pure risks and speculative risks. Speculative risks are the
risks that describe the possibility of making profits. Risk mitigation and risk
control are the various types of response to risk.
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33. (c) Industrial all risks insurance
Industrial all risks is a comprehensive insurance policy that covers perils like fire,
burglary, and machinery breakdown/boiler explosion. Fire policies A, B, and C
are issued to cover the equipment against several risks. Consequential loss fire
insurance policy protects a company against loss of gross profit caused by an
interruption to the project as a result of fire damage to the machinery and
equipment.
A. S3
P (N1) = 0.2, P(N2) = 0.2, and P(N3) = 0.4.
Expected value of S1 = 3 0.2 + 2.5 0.2 + 1 0.4 = 1.5
Expected value of S2 = 4 0.2 + 2 0.2 + 1 0.4 = 1.6
Expected value of S3 = 5 0.2 + 4 0.2 + 0.5 0.4 = 2.0
The project manager chooses strategy S3 as it has the highest expected value.
B. S1
Assume that each strategy is represented by four different tasks A, B, C, and D.
EMV(A) = 0.413 + 0.25 7 + 0.36 8 = 9.83
EMV(B) = 0.410+0.259+0.367 = 8.77
EMV(C) = 0.48+0.257+0.368 = 7.83
EMV(D) = 0.47+0.258+0.369 = 8.04
Strategy S1 should be selected by the project manager as it has the highest
expected value.
Unit 13
Project Quality Management
Structure
1. Introduction
2. Objectives
3. Definition of Quality
4. International Quality Standards
5. The Cost of Quality
6. Project Quality Management Concepts
7. Project Quality Control Tools
8. Process Capability
9. Acceptance Sampling
10. Quality Circles
11. Just-In-Time Management
12. Total Quality Management
13. Summary
14. Glossary
1. Introduction
In the previous unit, we have discussed project risk management. In this unit, we will
discuss project quality management. Earlier, project firms believed that higher quality
increased project costs. But now they realize that improved quality increases business
volumes. The growing size and complexity of projects have forced firms to
concentrate more on quality at every stage. Otherwise, the cumulative effect of each
defect in the various stages will lead to a considerable reduction in the quality of
project end product.
Quality is relative and different people have different definitions of quality. The
project manager however, has to be very specific regarding the quality of a project. He
can use several techniques to meet the quality requirements. Project quality
management includes all the processes required to ensure that the project meets the
specific requirements of its stakeholders. The project manager should prepare a
quality plan and communicate it to team members and ensure that the plan is being
implemented properly.
This unit will discuss quality and the international quality standards. We will discuss
the cost of quality, and explain the various project quality management concepts. We
shall then move on to discuss the different project quality control tools. Finally, we
would be discussing the concepts of process capability, acceptance sampling, quality
circles, just-in-time management, and total quality management.
49
2. Objectives
By the end of this unit, the students should be able to:
define quality, and explain the international quality standards.
discuss the concept of cost of quality.
reproduce the project quality management concepts.
identify the various project quality control tools.
explain process capability and acceptance sampling.
discuss the concepts of quality circles, just-in-time management, and total quality
management.
3. Definition of Quality
The ISO 9000 defines quality as the totality of features and characteristics of a
product or service that bears on its ability to satisfy stated or implied needs.
The client looks at quality as:
Conformance to specifications: The project manager mentions the project end
product and its clear specifications in the POS. The client expects the product or
service to match the specifications provided in the POS. To him, quality is the
conformance of the end products specifications as mentioned in the POS.
Value for money: Clients may define quality as a value or how well the product or
service fulfills the intended purpose for the price they are willing to pay. If they feel
that the price of the product or service is higher than the utility they derive, then they
may conclude that the project is of less quality.
Fitness for use: The client considers the features of a product or the convenience of a
service to decide the project quality. The aspects include appearance, style, durability,
reliability, and serviceability, etc.
Support: Often the support a company provides to its product or service is considered
as the quality. For instance, if the project manager provides servicing facility at a low
price or free of cost, the client feels that quality of the product (project) is high.
Psychological impression: Clients evaluate the quality of a product or service based
on some psychological impressions: physical ambience, the firms image, etc. For
instance, well-dressed, courteous, and friendly project team members make a positive
impact on clients who associate these attributes with quality.
4. International Quality Standards
ISO 9000 Standards are a set of international quality management system standards
and guidelines. ISO stands for International Organization for Standardization. It is
located in Geneva, Switzerland and was established in 1947. The standards are
applicable to all kinds of organizations in areas such as manufacturing, processing,
servicing, electronics, computing, financial services, accounting, banking, retailing,
aerospace, construction, exploration, pharmaceuticals, petrochemicals, shipping,
telecommunications, research and development, health care, agriculture, software
development, instrumentation, biotechnology, insurance etc. ISO published its first
quality standards in 1987 and revised them in 1994. These standards are referred to as
the ISO 9000 Standards:
ISO 9000: This provides a roadmap for the other standards within the series and
defines key terms.
50
ISO 9001: This defines the model for a quality system for companies that design,
produce, install, and service products.
ISO 9002: This is a quality system model for quality assurance in production and
installation.
ISO 9003: This is a quality system model for quality assurance in final inspection and
testing.
ISO 9004: This quality system provides quality management guidelines for firms that
wish to develop and implement a quality system, to determine the extent to which
each quality model is applicable.
ISO 14000: This provides standards for managing environmental impacts, including
management system, environmental performance evaluation, environmental labeling,
and life cycle assessment.
The ISO protocol requires that all standards to be reviewed at least every five years to
check whether they should be retained, revised or withdrawn. The 1994 version of
ISO standards were revised by ISO Technical Committee, TC 176 in year 2000.
In order to reflect the modern management approaches and also to improve
organizational practices, the Committee felt the need for some structural changes,
while maintaining the essential requirements of past standards. One of the primary
objectives of the Year 2000 revisions to the ISO 9000 standards is to simplify the
structure and reduce the number of standards. This was done by the replacement of
ISO 9001:1994, ISO 9002:1994, ISO 9003:1994 standards by a single quality
management system (QMS) requirement standard, ISO 9001: 2000.
Example: The Revised ISO Standards
Standards and guidelines Purpose
ISO 9000:2000, Quality management
systems - Fundamentals and
vocabulary
Establishes a starting point for
understanding the standards and defines
the fundamental terms and definitions
used in the ISO 9000 family to avoid
misunderstandings in their use.
systems - Requirements
This is the requirement standard to
assess the firms ability to meet customer
and applicable regulatory requirements
and thereby address customer
satisfaction. It is now the only standard
in the ISO 9000 family against which
third-party certification can be carried.
systems - Guidelines for performance
improvements
This standard provides guidance for the
continual improvement of quality
management system to benefit all parties
through sustained customer satisfaction.
ISO 19011, Guidelines on Quality
and/or Environmental Management
Systems Auditing (currently under
development)
Provides guidelines for verifying the
system's ability to achieve the defined
quality objectives. You can use this
standard internally or for auditing your
suppliers.
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Standards and guidelines Purpose
- Guidelines for quality plans
Provides guidelines to assist in the
preparation, review, acceptance and
revision of quality plans.
- Guidelines to quality in project
management
Ensures the quality of both project
processes and project products.
- Guidelines for configuration
management
Ensures that a complex product
continues to function when components
are changed individually.
ISO/DIS 10012, Quality assurance
requirements for measuring equipment
- Part 1: Metrological confirmation
system for measuring equipment
Provides guidelines on the main features
of a calibration system to ensure that
measurements are made with the
intended accuracy.
ISO 10012-2:1997, Quality assurance
for measuring equipment - Part 2:
Guidelines for control of measurement
of processes
Provides supplementary guidance on the
application of statistical process control
when this is appropriate for achieving
the objectives of Part 1.
ISO 10013:1995, Guidelines for
developing quality manuals
Provides guidelines for the development,
and maintenance of quality manuals,
tailored to your specific needs.
ISO/TR 10014:1998, Guidelines for
managing the economics of quality
Provides guidance on how to achieve
economic benefits from the application
of quality management.
- Guidelines for training
Provides guidance on the development,
implementation, maintenance and
improvement of strategies and systems
for training that affects the quality of
products.
ISO/TS 16949:1999, Quality systems -
Automotive suppliers - Particular
requirements for the application of ISO
9001:1994
Sector specific guidance to the
application of ISO 9001 in the
automotive industry.
Adapted from www.iso.ch.
Check Your Progress
1. The totality of features and characteristics of a product or service that has a
bearing on its ability to satisfy stated or implied needs is referred to as
_______________.
a. standards
b. quality
c. prevention
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2. Which of the following quality standards provides for managing environmental
impacts, environmental performance evaluation, environmental labelling, and life
cycle assessment?
a. ISO 14000
b. ISO 9000
c. ISO 9001
d. ISO 9002
3. The client looks for various aspect of quality such as physical ambience, the
firms image, and friendliness of the project team members. These aspects are
collectively known as ______________.
a. value for money
b. psychological impression
c. fitness for use
d. support
4. The full form of ISO is ______________.
a. International Standardization Organization
b. International Organization for Standardization
c. International Services Organization
d. International Secret Organization
5. The client judges product quality by looking at the features of the product or the
convenience of a service. This angle from which the client looks at quality is
called _______________.
a. conformance to specifications
b. value for money
c. fitness for use
d. Support
6. The ISO protocol requires all the standards to be reviewed every
______________ years to determine whether they should be retained, revised, or
withdrawn.
a. three years
b. two years
c. five years
d. six years
7. Identify the standard for quality system for organizations that design, produce,
install, and service products.
a. ISO 9000
b. ISO 9001
c. ISO 9002
d. ISO 9003
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Every firm incurs costs when it attempts to improve quality. This is referred to as
cost of quality. Costs are of two types: cost of conformance and cost of non-
conformance. Conformance costs are the costs that firms incur for the means
employed to achieve quality. These costs include costs of training, inspection, testing
and auditing. Non-conformance costs are those costs that are incurred for improving
the quality of a product that has fallen below the desired quality level. These costs
include repairs, reworks, complaint handling, etc. Alternatively, the costs of quality
can be classified as follows -- costs of prevention, costs of appraisal or detection, and
costs of failure.
Costs of Prevention
Prevention costs are the costs incurred by a company to prevent defective goods and
services from being produced and delivered to the customer. These costs include costs
of redesigning the process to remove the causes of poor quality, training project team
members, identifying right suppliers, process studies, etc.
Costs of Appraisal
Appraisal costs are incurred while assessing the level of quality attained by the
operating procedures of the firm. These costs are associated with the evaluation of the
products performance to see if it meets the client requirements or not. These costs
include materials inspection, in-process testing, maintenance of test equipment, etc.
Costs of Failures
Costs of failure are two types: internal failures and external failures. Internal failure
costs result from defects that are discovered during the production of a product or
service and when the product is under the control of the firm. They include costs of
rework, repair, corrective actions, etc. External failure costs arise when a defect is
discovered after the customer has received the product or service. Costs in this
category include costs of returned material, warranty charges, legal expenses from law
suits and costs of concessions made to customers.
To arrive at the optimal cost of quality, the project manager calculates the total cost of
quality at various defect rates. The project manager aims at that defect rate where the
total cost of quality is minimum.
6. Project Quality Management Concepts
It is the project managers responsibility to ensure that the project attains the desired
level of quality. Quality cannot be ensured through continuous inspection alone; it can
be only achieved with the help of proper planning. Quality planning process is a part
of planning phase of the project and it is done on the basis of cost, time and scope of
the project. The project manager studies the following six quality management
concepts -- quality policy, quality objectives, quality assurance, quality control,
quality audit, and quality program plan.
Quality Policy
The quality policy is a document created by quality experts and backed by the top
management. It states the quality objectives of the firm, the acceptable levels of
quality, the responsibilities of the project team, etc. It also provides guidelines for
important quality matters and promotes consistency throughout the organization.
If the project firm does not have quality policy or if the project involves multiple
firms, the project manager and his team develop a quality policy (in consultation with
quality experts) for the project. The project manager should formally disclose the
quality policy of the project to all stakeholders.
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Implementing the quality policy is very important. The top management should
periodically review the performance of middle and lower level management to ensure
that the activities are in line with the overall quality objective of the firm.
A good quality policy provides guidelines to improve the quality of the project;
promotes consistency across all projects of the firm; explains to outsiders how the
firm views quality; and provides for changes and updates in the policy.
Quality Objectives
Quality objectives are a part of the firms quality policy. The quality policy consists of
the firms quality objectives, and the time required meeting those objectives. The
project manager should set the quality objectives so as to meet the expectations of
project stakeholders. The quality objectives of a project should be understandable,
achievable, measurable and time-bound. These objectives should be conveyed to the
project team in order to motivate them to meet the quality requirements.
Some examples of the quality objectives of a firm are: training the project team on the
quality policy and quality objectives before the end of the current fiscal year, and
setting up baseline measurements for all processes in the current quarter.
Quality Assurance
Quality assurance means evaluating the quality performance of the project
periodically to ensure that the project meets the relevant quality standards. Quality
assurance attempts to ensure that the scope, cost, and time of the project match the
clients requirement.
The project manager establishes the administrative procedures and identifies quality
standards to ensure that the scope statement is in line with the clients requirements.
The project manager together with his team prepares the quality processes
(procedures) and determines whether they really ensure the required level of project
quality.
A quality assurance system should list the quality objectives of the project and
identify the required quality standards; collect data continuously for improvement of
quality; establish performance measures; include all project functional areas; and
conduct quality audits at regular intervals.
Quality Control
Quality control is the process of monitoring specific project results and identifying
ways to eliminate the causes of unsatisfactory results. It is a collection of activities
and techniques used to create specific quality characteristics in the projects end
product.
Quality control is a technical aspect of the quality management process and it includes
setting up quality processes and procedures. These procedures ensure that the project
delivers quality output at every stage of the project. It compares the actual results with
the standard results at the end of every phase and measures are then taken up to rectify
the problems. The project manager can employ techniques like inspection, control
charts, and pareto charts in quality control.
A quality control system should -- select the activities to control; set standards to
provide basis for corrective actions; establish procedures to measure quality; and
compare actual results with standard results at every stage of the project.
Quality Audit
Quality audit is an organized, independent evaluation procedure to ensure that the
project standards match the quality requirements. The audits may be random or
periodic and may be conducted by a qualified in-house auditor or an independent
authority. A good quality audit ensures that -- a project activity meets the desired
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quality; rules and regulations pertaining to quality management are followed; quality
improvement opportunities are identified; and corrective actions are taken to meet
desired quality.
Quality Program Plan
The quality program plan is a plan of action prepared by the project manager and his
team by breaking down project objectives into a work breakdown structure. Project
activities are broken down into lower level activities until specific quality actions can
be identified.
A quality program plan enables the project manager to assure the client that he has a
roadmap for delivering a quality product or service. Such a plan will make the client
feel confident about the projects ability to deliver a product/service that will satisfy
his needs.
A good quality plan should -- list the features desired by the customer; respond to
changing customer needs; and ensure that the quality procedures are enough to meet
quality objectives.
Check Your Progress
8. Which of the following options consist of the firms quality objectives, and the
time required to meet those objectives?
a. Quality policy
b. Quality objectives
c. Quality assurance
d. Quality audit
9. The organized, independent evaluation procedure to ensure that the project
standards meet quality requirements is called ________________.
a. quality control
b. quality program plan
c. quality assurance
d. quality audit
10. _____________ attempts to ensure that the scope, cost, and time of the project
match the clients requirements.
a. Quality assurance
b. Quality policy
c. Quality audit
d. Quality control
11. The costs incurred by a firm to improve quality are called costs of quality. The
costs incurred on the means to achieve quality are called _________________.
a. conformance costs
b. non-conformance costs
c. costs of prevention
d. costs of failure
12. Which of the following are the features of a good quality policy?
i. Providing guidelines to improve the quality of the project
ii. Promoting consistency across all projects of the firm
iii. Explaining to outsiders how the firm views quality
iv. Providing for changes and updates in the policy
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a. Only i and ii
b. Only ii and iii
d. Only i and iv
13. What are the costs that are incurred on assessing the level of quality attained by
the operating procedures of the firm?
a. Conformance costs
b. Costs of appraisal
c. Costs of prevention
d. Non-conformance costs
14. The costs of returned material, warranty charges, legal expenses on lawsuits, and
costs of concessions made to customers are examples of
____________________.
a. costs of appraisal
b. external failure costs
c. internal failure costs
d. costs of prevention
15. Which of the following features should a good quality plan have?
i. It should be responsive to customer needs
ii. It should list the features desired by the customer
iii. It should ensure that the quality procedures are stringent enough to meet quality
objectives
iv. It should include all project functional areas
a. i, ii, iii, and iv
b. Only ii and iii
c. i, ii, and iii
d. Only iv
7. Project Quality Control Tools
Statistical methods play a key role in identifying, analyzing, and controlling the
quality of different project activities. These tools help the firm in gathering data,
identifying patterns of data and measuring variation.
Data tables, and Pareto charts are some useful tools for identifying patterns in data;
histograms, scatter diagrams, and control charts are tools used in data analysis; and
cause and effect analysis, and trend analysis are used both in data identification
and data analysis.
Data Tables
Data tables are statistical tools used to collect and present data in a systematic way.
Generally, data tables are designed for collecting situation/product specific data.
These are effective when data has to be organized and presented for the first round
reviews.
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A checklist is a form of data table that is used to record the frequency of occurrence of
a certain products quality characteristic. Suppose a textile firm wants to record the
defects in different aspects like tears in fabric, discolored fabric, broken fiber board
and ragged edges.
Cause and Effect Diagrams
After identifying a problem, the project manager determines the cause of the problem.
Cause-and-effect diagrams help identify the relationship between a key quality
problem and its potential causes. These diagrams are also called fishbone diagrams or
Ishiwaka diagrams. There are six steps in the construction of a cause-and-effect
diagram:
Identifying the quality problem: The project manager uses statistical process control
tools like pareto chart, histograms (discussed later) and brainstorming etc, to identify
the quality problem.
Forming inter-disciplinary team: The project manager forms an inter-disciplinary
team from technical and management areas and encourages discussions to determine
the causes of the problem.
Drawing problem box and prime arrow: The quality problem is labeled in the
problem box (as fishs head) and a prime arrow is drawn to represent major categories
of quality problems. Delivery delay is the fish head.
Specifying major categories: The project manager identifies the major categories for
the given quality problem (shown in the problem box). Usually, the major categories
include materials, production methods, business environment, machinery, human
resources, etc. which are represented as the structural bones of the fish in the
diagram.
Identifying causes of defects: The project manager identifies the causes that
contribute to defects in each of the major categories and lists them down. The causes
are shown as the ribs of the fish. The project manager follows three types of
approaches in listing the causes of defects. They are: random method, systematic
method and process analysis method.
In random method, all major causes in each category are listed at random. In
systematic method, the causes are listed in descending order of their importance. In
process analysis method, the causes are listed on the basis of the sequence of the
process.
Identifying corrective actions: By determining the causes contributing to defects, the
project manager prepares a corrective action analysis. The problem box then becomes
the corrective action box and corrective actions are shown in the place of defects.
Histograms
Histograms are graphical representations of data as a frequency distribution. When
there are a large number of variable data, the histogram summarizes the data into a
number of groups.
Pareto Chart
When the project manager identifies several quality problems that need to be
addressed, then he has to decide which quality problems should be targeted first. The
project manager constructs a Pareto chart to prioritize the quality problems. In this
chart, all the quality problems (defect types) are plotted along the horizontal axis in
descending order.
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The chart has two vertical axes - the one on the left side shows number of defectives
(frequency) and the axis on the right side show the cumulative percentage of
frequency. The cumulative frequency curve identifies the factors that the management
has to address immediately.
Scatter Diagrams
A scatter diagram is a plot of two variables showing how they are related. Data is
represented on XY plane and the relationship between the two variables is understood
on the basis of how they are distributed.
The relationship between these variables can be of several types:
No correlation between the variables when the data points are scattered,
Curvilinear relationship when the data points are in a U-shaped pattern,
Positive and negative correlation if the patterns of data points have positive and
negative slopes respectively.
Trend Analysis
This is a statistical tool that uses mathematical techniques to forecast future outcomes
on the basis of historical data. It quantifies the relationships between the data, and
establishes an equation that best describes the distribution of data points. The trend
line provides a clear, consistent relationship between the dependent (output) and the
independent (input) variables.
Control Charts
A control chart is a graphical representation of the results of a process over a period of
time. Control charts are used to monitor the production process continuously to see
whether the quality of the output is within the acceptable limits.
A typical control chart consists of three horizontal lines:
A central line which indicates the desired standard or control level of the process.
An upper control limit that indicates the upper limit of tolerance.
A lower control limit indicating the lower limit of tolerance.
The central line as well as the upper and lower limits are established by computations based
on the past records for a specific production process. The control charts are two types.
Control charts for variables
Control charts for attributes
Control Charts for Variables
These are aimed at achieving and maintaining satisfactory quality levels for a given
process whose product is amenable to quantitative measurements like thickness,
length, diameter, etc. The control charts used for variables are: Control charts for
mean (X) and Control charts for range (R).
X bar Chart: This is the control chart to determine mean variations. Samples are
taken and mean average is considered to draw the charts. The central line shows the
average quality of the process. The upper and lower control limits are arrived at by
adding and subtracting 3 standard deviations to the average. The upper and lower
limits are shown as dotted lines and the central line is shown as a dark line.
R- Chart: An R- chart is a plot of the range (dispersion) with in each sample. The
range of a sample is the difference between the highest and lowest values. For
example, the range of a sample: 12.0, 12.4, 12.5 and 12.6 is (12.6 12.0), i.e. 0.6. The
59
range is calculated for all the samples, and the average range of all samples gives the
central value of R-chart. The upper and lower control limits are obtained by adding
and subtracting 3 standard deviations to the central value. The range values of all
samples are marked in the chart to observe, whether the process is in control or not.
Control Charts for Attributes
Control charts for attributes are used to measure quality characteristics for classifying
an item as defective or non-defective. The most commonly used control charts for
attributes are:
Control chart for the number of defectives per unit, i.e. c-chart. This chart is used
when products have more than one defect per unit. For example, a television picture
tube may have more than one defect. When the management wants to analyze the
number of defects per unit, this chart is used.
Control chart for fraction defective, i.e. p-chart. Fraction defective is the number of
defective units divided by the sample size. Here, the quality characteristic is counted
rather than measured. Then the entire item or service is declared good or bad. For
example, in the banking industry, the number of non-endorsed deposits or the number
of incorrect financial statements sent are counted. The method involves selecting a
random sample, inspecting each item and calculating the fraction defective.
Control chart for number of defectives, i.e., np-chart. This chart shows the actual
number of defectives found in each sample. This is commonly used when the sample
size for all samples is constant.
Activity: The management of Sahara International Airlines noticed an increase in
the number of delayed flight departures. It called the heads of all departments and
brainstormed to list all possible causes for the problem. The group categorized the
problem into areas such as materials, procedures, personnel and equipment. The
causes for problems in each major category were presented in a cause-and-effect
diagram (fishbone diagram). Describe the procedure for constructing a cause-and-
effect diagram and represent various causes for the given problem.
Answer:
8. Process Capability
Process capability is the ability of an existing manufacturing process to produce a
product that conforms to the design specifications. Since there can be variations
during manufacturing, the process capability can help specify product uniformity. It is
calculated on the basis of various quality characteristics of the product of the process,
and it is given by the mean value plus or minus three standard deviations. i.e,
6
LSL) (USL
p
C
Where, USL is Upper Specification Limit
LSL is Lower Specification Limit
USL and LSL are the specifications given by the client.
60
The project manager can use Cp while selecting production process for his project. He
can compare Cp values of various production processes and select the one that suits
the clients quality specifications.
Some of the generally accepted rules for Cp are:
If C
p
> 1.33, the production process is within customer specifications;
If 1.33 C
p
> 1.0, then the production process can be marginally acceptable. But there
is likelihood of the client rejecting products from this process.
If C
p
1.0, the production process must be rejected.
Let us now look at how a project manager can use the above formula to select a
production process. Suppose a client orders for steel bars of length 10 inches and he
accepts .05 inches variation in length. If the existing process has standard deviation of
0.009, then the C
p
value of the process is
6(0.009)
0.05) ( 0.05
= 1.851. Since the C
p
value is more than 1.33, the project manager is confident that the selected process
would produce the product within the customer specifications.
Check Your Progress
16. The control chart that is used when the products have more than one defect per
unit is known as the ___________.
a. np-chart
b. C-chart
c. X-chart
d. R-chart
17. There are six steps in the construction of a cause-and-effect diagram. What is the
last of these steps?
a. Identifying the causes of defects
b. Specifying major categories
c. Identifying corrective actions
d. Identifying the quality problem
18. Which type of relation does the following scatter diagram represent?
a. Negative correlation
b. Curvilinear correlation
c. Positive correlation
d. No correlation
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19. Which of the following statistical methods help in summarizing the data into
groups when the data is variable and large in number?
a. Data tables
b. Histograms
c. Pareto chart
20. _________ are the statistical tools used to collect and present data in a systematic
way.
a. Data tables
b. Histograms
c. Pareto chart
21. The control chart used for fraction defective is known as _____________.
a. np-chart
b. P-chart
c. X-chart
d. R-chart
22. Which of the following options show the relationship between two variables on
the basis of how they are distributed by plotting the data on a XY plane?
a. Histograms
b. Pareto charts
c. Scatter diagrams
23. Which type of control chart shows the number of defects in each sample?
a. np-chart
b. X-bar chart
c. R-chart
24. What is the statistical tool that uses mathematical techniques to forecast future
outcomes on the basis of historical data?
a. Trend analysis
b. Control charts
c. Scatter diagram
d. Pareto chart
25. The control chart that determines the mean variations of samples is known as
____________
a. the X-bar chart
b. the R-chart
c. control charts
d. trend analysis
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Exercise
A. XYZ is glass manufacturing company. A client orders a steel bar of length 15 feet
and the acceptable level of variation is 0.06 feet. The existing process has a
standard deviation of 0.07. What is the value of process capability (Cp)?
9. Acceptance Sampling
Acceptance sampling is a product quality control technique that monitors the quality
of a product after it has been produced. This technique is also employed to decide
whether to accept or reject a lot on the basis of random samples drawn from a lot. The
project manager can either go in for 100% inspection (by incurring huge costs on
inspection) or 0% inspection (by allowing defects). Neither of these options is very
sound. Therefore, the project manager opts for acceptance sampling as a
compromise between the two options. A sample of the shipment is inspected and if the
number of defective items is more than a stated number, known as acceptance
number, the shipment is not accepted.
There are three types of sampling plans. They are: single sampling, double sampling
and multiple sampling. In single sampling, the project manager either accepts or
rejects a lot after inspecting a single sample chosen from the lot. In double sampling, a
single sample is tested. If results are not favorable, then a second sample is tested. In
multiple sampling, several samples are tested.
Outcome of Acceptance Plan
Whatever be the sample size, sampling errors are likely to occur. A good lot might be
rejected when the sample selected contains a large number of defectives. Similarly, a
bad lot might be selected if the sample selected contains less number of defectives.
Producers risk and consumers risk are the two outcomes of acceptance plan.
Producers Risk
This is the risk to the producer (any firm or department that produces goods for
another firm or another department) that arises because of rejection of a good lot. If
the project manager chose a sample of 5 from a lot of 100 and all chosen items are
defective then the lot will be rejected even if the remaining items are good. It is also
known as risk. The error made by the producer in this context is called Type I error.
Consumers Risk
This is the risk to the consumer (any firm or department that receives an item from the
producer) that arises because of the selection of a bad lot. It is also known as risk.
The error made by the consumer here is called Type II error.
To derive a sampling plan, the producer and consumer should specify the level of the
and risk, and the lot quality level to which these risks pertain. Therefore, there is a
need to define good lot and bad lot in terms of the percent defective in the
population. The usual values of producers risk and consumers risk are 5 percent and
10 percent respectively.
Operating Characteristic (OC) Curve
Operating characteristic curve is a probability distribution that is a function of sample
size n and the acceptance number c expressed as a percentage of items in a lot of
incoming goods. The curve explains how well a sampling plan discriminates the good
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lots from bad lots. If the project manager uses the Total Quality Control (TQC)
principle of 100 percent inspection, then all the incoming goods should be checked.
However, in case of large shipments, 100 per cent inspection is not possible. So, the
project manager chooses a sample size, n and an acceptance number c to determine
whether to accept or reject the lot.
The project manager determines the values of n and c on the basis of four
performance requirements: Acceptable Quality Level (AQL), Lot Tolerance Percent
Defective (LTPD), consumers risk ( ) and producers risk ( ). AQL is the quality
level desired by the consumer. LTPD is the quality level at which one considers that
a lot is bad and if exceeded will be rejected. If the producer and the consumer
accept a lot even with 1 defective item of 100 items, then AQL is 0.01. If they agree
to reject a lot in which there are more than 5 defective items out of 100 items, then
LTPD is 0.05.
10. Quality Circles
A quality circle is a group of employees, normally from a single department who
voluntarily meet periodically to discuss the quality issues in their department. Quality
circles effectively address two issues: the well-being of the employee at personal level
and the well-being of the company. The activities of quality circles include identifying
problems related to quality, analyzing data, recommending solutions, and carrying out
changes approved by the management. This helps the management to understand the
reasons behind the employees failure to meet the required quality levels.
The advantages of quality circles are improved quality of project products and
services; better understanding among employees; better employee performance; and
improved morale of employees. Each department of the project will maintain its own
quality circle to meet the output specifications. Quality circles have proved very
successful in Japan. However, their efficiency depends on how they are handled.
Activity: Indhra Machine Works undertakes projects for manufacturing machine
tools. For many years the company used ordinary lathe and milling machines for
manufacturing tools. To survive in the current competitive environment, the
management of the firm has modernized the company's manufacturing process. It
has replaced its machines with modern equipment, e.g., Computer Numerically
Controlled (CNC) machines, robots, etc. This change has led to an increase in
production, however, the firm is having problems maintaining the required quality
levels. Several lots of products have been rejected by its customers. The
management of the firm has realized that even though the workmen in the
production department were trained to use the new equipment, they have not yet
become fully accustomed to the new production system. So the management has
started encouraging each department to form quality circles to reduce quality
problems. Do you think quality circles can improve the situation? How?
Answer:
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Check Your Progress
26. The risk that arises because of the rejection of a good lot is called ___________.
a. consumers risk
b. producers risk
c. acceptance sampling
27. The product quality control technique that monitors the quality of a product after
it has been produced is called ___________.
a. P-chart
b. acceptance sampling
c. R-chart
28. The probability distribution that is a function of sample size n and the
acceptance number c expressed as a percentage of items in a lot of incoming
goods is called ______________.
a. quality circles
b. operating characteristic curve
c. just-in-time management
29. In which type of sampling does the project manager either accept or reject a lot
after inspecting a sample chosen from the lot?
a. Single sampling
b. Double sampling
c. Multiple sampling
30. Groups of employees from normally a single department who meet periodically
to discuss the quality issues in their department are called ___________.
a. quality circles
b. total quality management
c. re-engineering
11. Just-In-Time Management
Just-in-time (JIT) is an operations philosophy based on continuous improvement of
organizational processes by reducing wastage from all project operations. It is an
integrated set of activities designed to achieve high- quality production using minimal
inventories. The principle here is not to produce anything until it is required. This
result in eliminating costs associated with maintenance, storage, etc. Under JIT
purchasing, firms reduce their procurement costs by developing long-term
relationships with a few supplies.
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Shiego Shingo of Toyota Motor Company identified seven wastes that the manager
should watch out for to ensure continuous improvement of quality. They are waste
of overproduction; waste of waiting of machinery (idle time); waste of transportation;
waste of processing itself; waste of stocks; waste of motion/movement; and waste of
making defective products.
There are two important concepts in JIT manufacturing: value-added manufacturing,
and stockless production. In value-added manufacturing the project manager aims at
eliminating any step in the manufacturing process that does not add value to the end
product. For example, processes like process delays, work-in-progress inventories,
excessive paper work, etc., are eliminated. In stockless production, the project
manager maintains less inventories and reduces waste considerably.
Various purchasing characteristics under the procedures of JIT management are
discussed below --:
Purchase lot size: JIT purchasing practices involve procuring of products in small lots
with frequent deliveries. This practice ensures lower storage and maintenance costs,
which are normally high in a traditional purchasing system.
Rejections from suppliers: In traditional purchasing systems, firms rely on multiple
sources of supply for each part or item, on short-term contracts. But in JIT system,
suppliers who are located close by are selected. In these systems, firms rely on a
single source of supply and make long term contracts.
Conditions with suppliers: Both traditional and JIT purchasing systems emphasize
product quality, delivery performance, and price. But the conditions with suppliers
about the rejection of incoming parts and materials are different in JIT systems. Any
product without an acceptable quality level or which arrives late is rejected.
Mode of transportation: In JIT systems, determining the mode of transportation is
based on both inbound and outbound freight, and on time delivery. But the delivery
schedule is given by the buyer.
Product specification: In JIT systems, the buyer relies more on performance
specifications than on product design, and the supplier is encouraged to be more
innovative. But in traditional systems, product specifications are very rigid.
Several organizations prefer JIT manufacturing systems because of the following
advantages:
Cost of materials is reduced in JIT systems as this system involves lower inventory
carrying costs, lower storage and maintenance costs and lower scrap and waste.
Since the contract between supplier and buyer is long term, the supplier provides
quality materials.
JIT purchasing systems also provide increased responsiveness from the suppliers as
they are geographically close. Flexibility is also ensured as materials are purchased
only when there is a need.
Administrative efficiency is also possible in JIT systems as the delivery schedules are
more flexible and there is less paper work.
Production is improved because of fewer inspections, easier receiving, and better
plant layout.
As the required materials are not purchased all at once, the capital requirements of the
firm are reduced considerably.
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Example: JIT at Toyota
The philosophy of JIT was pioneered by the Toyota Motor Company and several
firms implemented it successfully. Taichi Ohno of Toyota Motor Company
pioneered the concept of JIT management. According to Ohno, methods like
economic order quantities will not work in Japan as Japan's total domestic demand
is low and the domestic market demands production of small quantities of different
models. Accordingly, Ohno devised a new system of production that aimed at
eliminating waste. According to Ohno, waste includes time, costs, and materials.
He identified overproduction, time spent in waiting, transportation/movement, and
defects as the main sources of waste.
Waste can be eliminated by:
Purchasing items only when they are needed
Automating the production system
Since the demand in Japan is low, manufacturers have no other option but to reduce
costs to increase their profits. Toyota understood this and it changed its factory
layout. Earlier, machines with similar functions (e.g. presses, lathes, etc.) were
placed together. Therefore, items had to be transported back and forth as and when
needed. Now, various machines were clustered together at a single place to reduce
the transportation of items from one place to another.
To help the workforce adapt to the new production environment, Ohno introduced the
analogy of teamwork similar to a baton relay race. Factory floor workers were
encouraged to think of themselves as members of a team - passing the baton (processed
items) between themselves with the goal of reaching the finishing line fast. To have
control over production, Toyota introduced the kanban system. The kanban is a
rectangular piece of paper within a transparent vinyl envelope that contains information
to a worker about what items to collect or what items to produce.
In Toyota, two types of kanban are used to control the flow of items:
a withdrawal kanban- which is a list of items that should be withdrawn from the
preceding step in the process
a production ordering kanban - which is a list of items to be produced.
Kanbans control movement throughout the factory. If a defective component is
found while processing a production ordering kanban, then the quantity specified
on the kanban is not produced. Another aspect of the Toyota production system is
to reduce the setup times of the machines and processes. All production processes
were re-engineered to reduce the setup before processing of a new item.
Adapted from http://www.ms.ic.ac.uk/.
Activity: Indus Projects Ltd. is involved in projects like constructing National
Highways. The firm has a traditional purchasing system. On several occasions, the
firms suppliers failed to send the required materials on time. The firm is also
incurring heavy storage and maintenance costs because it purchases in bulk to get
quantity discounts. The company recruited Ram Sinha as the project manager. Sinha
decided to replace the current purchasing system by a JIT purchasing system. Discuss
how a JIT purchasing system can help project firms handle inventory problems.
Contd
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Contd
Answer:
Total Quality Management (TQM) is a philosophy that seeks organization-wide
improvement of quality by involving every individual in the firm to improve the
quality at every stage of the production process. The concept focuses on ensuring that
the products meet the set of specifications required by the customers.
The concept divides customers into two categories: external customers and internal
customers. External customers are those who consume final goods and services
offered by the company. Each department considers employees in other departments
who continue the product processing as internal customers.
To improve the quality of the product, firms:
Build teams and empower employees
Solicit ideas to improve organizational activities
Adopt practices like benchmarking, and bench trending to improve quality of the
products to meet future market trends.
Increase employee participation through initiatives like quality circles, self-managed
groups etc.
Use process management techniques to improve customer service and reduce cycle
time.
Develop and train staff to improve customer service
Adhere to widely accepted international standards.
Apart from these activities, firms can take up the following activities to improve
quality in long-run:
Interact constantly with end customers to understand their latent needs and demands
Maintain closer relationships with suppliers to improve product/service quality.
Update information and communication technologies to improve customer service.
Organize training, education programs, and knowledge development workshops for
employees.
Focus on productivity, timeliness, flexibility and profitability.
Check Your Progress
31. The philosophy that seeks improvement in quality throughout the organization by
involving every individual at every stage of production process is called
_________.
a. business process re-engineering
b. total quality management
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c. just-in-time management
32. Under which concepts of manufacturing under JIT does the manager aim to avoid
any step in the manufacturing process that is not useful?
a. Stockless production
b. Value added manufacturing
c. Total quality management
13. Summary
Quality has been defined by the ISO (International Organization for Standardization)
9000 as the totality of features and characteristics of a product or service that bears on
its ability to satisfy stated or implied needs. The client looks at quality as conformance
to specifications, value for money, fitness for use, support, and psychological
impression.
ISO 9000 Standards are a set of international quality management system standards
and guidelines.
Every firm incurs costs when it attempts to improve quality, and these costs are
referred to as cost of quality.
Costs are of two types: cost of conformance and cost of non-conformance.
Conformance costs are the costs that firms incur for the means employed to achieve
quality like costs of training, inspection, testing, and auditing. Non-conformance costs
are those costs that are incurred for improving the quality of a product that has fallen
below the desired quality level like repairs, reworks, and complaint handling.
The costs of quality can also be classified as follows -- costs of prevention, costs of
appraisal or detection, and costs of failure.
The project manager should ensure that the project attains the desired level of quality.
Quality can be achieved only through proper planning. The project manager studies
the following six quality management concepts -- quality policy, quality objectives,
quality assurance, quality control, quality audit, and quality program plan.
Statistical methods play a key role in identifying, analyzing, and controlling the
quality of different project activities. These tools help the firm in gathering data,
identifying patterns of data and measuring variation.
Data tables, and Pareto charts are some useful tools for identifying patterns in data;
histograms, scatter diagrams, and control charts are tools used in data analysis; and
cause and effect analysis, and trend analysis are used both in data identification
and data analysis.
Process capability is the ability of an existing manufacturing process to produce a
product that conforms to the design specifications. Since there can be variations
during manufacturing, the process capability can help specify product uniformity.
Acceptance sampling is a product quality control technique that monitors the quality
of a product after it has been produced. This technique is also employed to decide
whether to accept or reject a lot on the basis of random samples drawn from a lot.
Sampling plans can be of three types -- single sampling, double sampling and multiple
sampling.
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A quality circle is a group of employees, normally from a single department who
voluntarily meet periodically to discuss the quality issues in their department. Quality
circles help the management to understand the reasons behind the employees failure
to meet the required quality levels.
Just-in-time is an operations philosophy based on continuous improvement of
organizational processes by reducing wastage from all project operations. The
principle is not to produce anything until it is required.
Total quality management is a philosophy that seeks organization-wide improvement
of quality by involving every individual in the firm to improve the quality at every
stage of the production process. The concept focuses on ensuring that the products
meet the set of specifications required by the customers.
14. Glossary
Acceptance Sampling: A product quality control technique that monitors the quality
of a product after it has been produced.
Appraisal costs: Costs incurred while assessing the level of quality attained by the
operating procedures of the firm. These costs are associated with the evaluation of the
products performance to see if it meets the client requirements or not.
Cause and Effect (or fishbone or Ishikawa) Diagrams: After identifying a
problem, the project manager determines the cause of the problem. These diagrams
help identify the relationship between a key quality problem and its potential causes.
Checklist: A form of data table that is used to record the frequency of occurrence of a
certain products quality characteristic.
Conformance and non-conformance costs: Costs are of two types: conformance
and non-conformance. Conformance costs are the costs that firms incur for the means
employed to achieve quality. Non-conformance costs are those costs that are incurred
for improving the quality of a product that has fallen below the desired quality level.
Consumers Risk: The risk to the consumer (any firm or department that receives an
item from the producer) that arises because of the selection of a bad lot.
Control Chart: A graphical representation of the results of a process over a period of
time.
Data Tables: Statistical tools used to collect and present data in a systematic way.
Histograms: Graphical representations of data as a frequency distribution. When
there are a large number of variable data, the histogram summarizes the data into a
number of groups.
Internal and external costs of failure: Costs of failure are two types: internal
failures and external failures. Internal failure costs result from defects that are
discovered during the production of a product or service and when the product is
under the control of the firm. External failure costs arise when a defect is discovered
after the customer has received the product or service.
Just-in-time: An integrated set of activities designed to achieve high-quality
production using minimal inventories. The principle here is not to produce anything
until it is required.
Operating Characteristic Curve: A probability distribution that is a function of
sample size (n) and the acceptance number (c), expressed as a percentage of items in a
lot of incoming goods.
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Pareto Chart: The project manager constructs a Pareto chart to prioritize the quality
problems. In this chart, all the quality problems (defect types) are plotted along the
horizontal axis in descending order.
Prevention Costs: Costs incurred by a company to prevent defective goods and
services from being produced and delivered to the customer.
Process Capability: The ability of an existing manufacturing process to produce a
product that conforms to the design specifications.
Producers Risk: The risk to the producer (any firm or department that produces
goods for another firm or another department) that arises because of rejection of a
good lot.
Quality Assurance: The process of evaluating the total performance of the project
regularly, in order to ensure that the project conforms to the quality standards.
Quality Audit: An organized, independent evaluation procedure to ensure that the
project standards match the quality requirements.
Quality Circle: A group of employees, normally from a single department who
voluntarily meet periodically to discuss the quality issues in their department.
Quality Control: The process of scrutinizing specific project results in order to check
their compliance with the quality standards.
Quality Policy: It is a document created by quality experts and backed by the top
management. It states the quality objectives of the firm, the acceptable levels of
quality, the responsibilities of the project team, etc.
Quality Program Plan: A plan of action prepared by the project manager and his/her
team by breaking down project objectives into a work breakdown structure.
Quality: It is the totality of features and characteristics of a product or service, which
influence its ability to satisfy a stated or implied need.
Scatter Diagrams: A plot of two variables showing how they are related. Data is
represented on XY plane and the relationship between the two variables is understood
on the basis of how they are distributed.
Total Quality Management: A philosophy that seeks organization-wide
improvement of quality by involving every individual in the firm to improve the
quality at every stage of the production process.
Trend Analysis: A statistical tool that uses mathematical techniques to forecast future
outcomes on the basis of historical data. It quantifies the relationships between the
data, and establishes an equation that best describes the distribution of data points.
1. The growing size and complexity of projects have forced firms to concentrate
more on quality at every stage. Define quality. What are the International quality
standards?
2. Every firm incurs costs when it attempts to improve quality, and these costs are
called as costs of quality. What are the various types of costs? Explain the
different types into which the costs of quality are classified.
3. The project manager has to ensure that the project attains the desired level of
qauality. Describe the detail the various quality management concepts.
4. The project manager uses project quality control tools and statistical methods to
gather data, identify patterns in the data, and measure variation. Discuss these
project quality control tools.
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5. Describe the following concepts in detail.
a. Process capability
b. Acceptance sampling
c. Quality circles
d. Just-In-Time management
e. Total Quality Management
1. (b) quality
According to ISO 9000, quality refers to the totality of features and
characteristics of a product or service that has a bearing on its ability to satisfy
stated or implied needs. ISO 9000 is a group of standards for quality management
systems. It is maintained by the International Organization for Standardization.
The standards are applicable to all types of organizations in areas such as
manufacturing, processing, servicing, electronics, computing, petrochemicals,
shipping, etc.
2. (a) ISO 14000
ISO 14000 is one of the industrial and commercial standards which fall under the
ISO 9000 standards. It provides standards for managing environmental impact,
environmental performance evaluation, environmental labelling, and lifecycle
assessment. These standards help organizations to minimize the negative effects
on the environment to comply with the applicable laws and environmentally
oriented requirements, etc.
3. (b) psychological impression
Physical ambience, the firms image, and the friendliness of project team
members are some of the aspects which create a psychological impression on the
mind of the client.
4. (b) International Organization for Standardization
ISO stands for the International Organization for Standardization. It is an
international standard-setting body comprising representatives from various
standards organizations. The purpose of the organization is to propagate standards
in businesses worldwide. It was established at Geneva in 1947.
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5. (c) fitness for use
Fitness for use is one of the angles from which the client looks at quality. The
client considers the features of the product or the convenience of a service to
decide project quality. Some of the aspects of fitness for use include appearance,
style, durability, reliability, and serviceability. Conformance to specifications
refers to the product or service matching the specifications in the project
overview statement (POS). Value for money refers to how well the product or
service fulfills the purpose for which the project is intended in relation to the
price the client is willing to pay. Support refers to the help extended by the
project manager to the client with reference to the project.
6. (c) five years
The ISO protocol requires that all standards should be reviewed at least every five
years to check whether they should be retained, revised, or withdrawn. The 1994
version of the ISO standards were revised by the ISO technical committee (TC,
176). ISO TC 176 was the umbrella committee under which the ISO 9000 series
of quality management and quality assurance standards were developed. The
committee developed standards and guidance documents in the year 2000.
7. (b) ISO 9001
The ISO 9001 standard defines the model for a quality system for companies that
design, produce, install, and service products. It lists out a number of
requirements regarding products and services, which an organization needs to
fulfill to achieve the satisfaction of customers. ISO 9000 is a group of standards
for quality management systems. It is maintained by the International
Organization for Standardization. The standards are applicable to all types of
organizations in areas such as manufacturing, processing, servicing, electronics,
computing, petrochemicals, shipping, etc. The ISO 9002 standard defines the
model for quality system for production and installation. The ISO 9003 standard
defines the model system for quality assurance in final inspection and testing.
8. (a) Quality policy
Quality objectives are a part of the firms quality policy. It specifies the quality
objectives of the firm and the time required to meet those objectives. The quality
policy is a document which states the quality objectives of the firm, the
acceptable levels of quality, the responsibilities of the project team, etc. Quality
assurance means evaluating the quality performance of the project periodically to
confirm that the project meets the relevant quality standards. Quality audits are
organized, independent evaluation procedures to ensure that the project standards
meet the quality requirements.
9. (d) quality audit
Quality audits are organized, independent evaluation procedures to ensure that the
project standards meet quality requirements. Quality control refers to the process
of the collection of activities and techniques used to create specified quality
characteristics in the projects end product. A quality program plan is the
breaking down of project objectivities into a work breakdown structure. Quality
assurance refers to evaluating the quality performance of the project periodically
to ensure that the project meets quality standards.
10. (a) Quality assurance
Quality assurance means evaluating the quality performance of the project
periodically to confirm that the project meets the relevant quality standards.
Quality assurance confirms that the scope, cost, and time of the project meet the
clients requirements. Quality policy is a document which states the quality
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objectives of the firm, acceptable levels of quality, the responsibilities of the
project team, etc. Quality audits are organized, independent evaluation procedures
to ensure that the project standards meet the quality requirements. Quality control
refers to the activities and techniques used to create specified quality
characteristics in the projects end product.
11. (a) conformance costs
Conformance costs are the costs incurred on the means to achieve quality. Non-
conformance costs are called costs that are incurred on improving the quality of a
product that has fallen below standards. Costs of prevention are the costs that are
incurred on preventing defective goods and services from being produced and
delivered to the customer. Failure costs are divided into internal failure costs and
external failure costs. These are the costs that are incurred on rework, warranty
charges, legal expenses, concessions made to the customers, etc. for defective
products.
The features of a good quality policy are: Providing guidelines to improve the
quality of the project, promoting consistency across all projects of the firm,
explaining to outsiders how the firm views quality, and providing for changes and
updates in the policy.
13. (b) Costs of appraisal
Costs of appraisal are the costs incurred on assessing the level of quality attained
by the operating procedures of the firm. Conformance costs are the costs that are
incurred on the means to achieve quality. Costs of prevention are the costs
incurred on preventing defective goods and services from being produced and
delivered to the customer. Non-conformance costs are the costs incurred on
improving the quality of a product that has fallen below standards.
14. (b) external failure costs
External failure costs are the costs that are incurred when a defect is discovered
after the customer has received the product or service. Some examples of external
costs are: costs of returned material, warranty charges, legal expenses on law
suits, and costs of concessions made to customers. Costs of appraisal are the costs
that are incurred to assess the level of quality attained by the operating procedures
of the firm. Internal failure costs result from defects discovered during the
production of the product or service before the product reaches the customer.
Costs of prevention are the costs that are incurred to prevent defective goods and
services from being produced and delivered to the customer.
The features of a good quality plan are: It should list the features desired by the
customer, respond to changing customer needs, and ensure that the quality
procedures are stringent enough to meet quality objectives. Including all the
project functional areas is one of the features of quality assurance system.
16. (b) C-chart
The C-chart is a type of control chart used to find out the number of defects per
unit. This chart is used when there is more than one defect per unit. The np-chart
shows the actual number of defects found in each sample. The X-bar chart is the
control chart to determine mean variation of samples. The R-chart is the plot of
range dispersion within each sample.
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17. (c) Identifying corrective actions
The project manager prepares the corrective analysis by determining the causes
contributing to defects in the last step of preparing the cause and effect diagrams.
This process is also known as identifying corrective actions. Identifying the
quality problems using the statistical process control tools like the Pareto chart,
histograms, brainstorming, etc,. is the first step. Specifying major categories and
identifying the causes of defects are the fourth and fifth stages.
18. (b) Curvilinear correlation
The relation between the data points is said to be curvilinear when the data points
of the scatter diagram are in a U-shaped pattern. There is said to be no correlation
if the data points are scattered. If the data points have positive and negative slopes
then they are said to have positive and negative correlation.
19. (b) Histograms
Histograms are used to graphically represent data in the form of frequency
distribution. They help in summarizing the data into groups when the data is
variable and large in number. Data tables are statistical tools used for collecting
situation/product specific data. Pareto charts are used to prioritize the quality
problems.
20. (a) Data tables
Data tables are statistical tools used to collect and present data in a systematic
way. Histograms are a graphical representation of data as a frequency
distribution. Pareto charts are used to prioritize quality problems.
21. (b) P-chart
The P-chart is the control chart used for fraction defective. Fraction defective is
the number of defective units divided by the sample size. The np-chart shows the
actual number of defects found in each sample. The X-bar chart is the control
chart to determine mean variation of samples. The R-chart is a plot of the range
dispersion within each sample.
22. (c) Scatter diagrams
Scatter diagrams show the relationship between two variables on the basis of how
they are distributed by plotting the data on a XY plane. Histograms are used in
graphically representing the data in the form of frequency distribution. Pareto
charts are used to prioritize quality problems.
23. (a) np-chart
The np-chart shows the actual number of defects found in each sample. The X-bar
chart is the control chart used to determine mean variation of samples. The R-
chart is the plot of the range dispersion within each sample.
24. (a) Trend analysis
Trend analysis is the mathematical technique used to forecast future outcomes on
the basis of historical data. The trend line provides a clear and consistent relation
between the output and input. Scatter diagrams show the relationship between
two variables on the basis of how they are distributed by plotting the data on a
XY plane. Control charts are used to monitor the production process to see
whether the quality of output is within the permissible limits. Pareto charts are
used to prioritize quality problems.
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25. (a) the X-bar chart
The X-bar chart is a control chart to determine the mean variation of samples. The
R-chart is a plot of the range dispersion within each sample. Trend analysis is a
mathematical technique to forecast future outcomes on the basis of historical data.
26. (b) producers risk
The two outcomes of the acceptance plan are: producers risk and consumers
risk. The risk that arises because of the rejection of a good lot is called producers
risk. The risk that arises because of the selection of a bad lot is called consumers
risk. Acceptance sampling is a product quality control technique that monitors the
quality of a product after it has been produced.
27. (b) acceptance sampling
Acceptance sampling is a product quality control technique that monitors the
quality of a product after it has been produced. It is also employed to decide
whether to accept or reject a lot on the basis of random samples drawn from the
lot. The P-chart is the control chart used for fraction defective. Fraction defective
is the number of defective units divided by the sample size. R-chart is a plot of
the range dispersion within each sample.
28. (b) operating characteristic curve
The operating characteristic curve is the probability distribution that is a function
of sample size n and the acceptance number c expressed as a percentage of
items in a lot of incoming goods. Quality circles are groups of employees usually
from a single department who meet periodically to discuss the quality issues in
the department. Just in time philosophy seeks to improve the organizational
process by reducing wastage in all project operations.
29. (a) Single sampling
In single sampling, the project manager accepts or rejects a lot after inspecting a
sample chosen from the lot. Under double sampling, a second sample is tested if
the results from testing the first sample are not satisfactory. Under multiple
sampling, several samples are tested.
30. (a) quality circles
Quality circles are groups of employees usually from a single department who
meet periodically to discuss the quality issues in the department. Total quality
management is a philosophy that seeks organization-wide improvement of quality
by involving every individual to improve the quality at every stage of production
process. Re-engineering is the radical redesigning of the organizations business
processes.
31. (b) total quality management
Total quality management is a philosophy that seeks organization-wide
improvement of quality by involving every individual to improve the quality at
every stage of production process. Just in time philosophy seeks improvement in
the organizational process by reducing the wastage from all project operations.
32. (b) Value added manufacturing
Value added manufacturing is one of the concepts of just-in-time management. It
aims to eliminate any step in the manufacturing process that does not add value to
the end product. Stockless production inventory levels can reduce waste
considerably.
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A. 0.286
Since the acceptable level of variance is 0.06 feet, the upper specification limit
and the lower specification limits are 0.06 and -0.06. The standard deviation is
taken as 0.07. The value of process capability (Cp) arrived at is:
42 . 0
12 . 0
07 . 0 6
06 . 0 06 . 0
6
LSL USL
Cp = 0.286.
Unit 14
Project Auditing
Structure
1. Introduction
2. Objectives
3. Project Evaluation and its Purpose
4. Project Auditing
5. Construction and use of the Audit Report
6. Responsibilities of the Auditor
7. The Project Audit Life Cycle
8. The Essentials of an Audit
9. Performance Measurement
10. Summary
11. Glossary
1. Introduction
In the previous unit, we have discussed project quality management. In this unit, we will
discuss about project auditing. As discussed earlier, project control tries to enhance the
firms chances of meeting future project goals, on the basis of lessons learnt in the
present projects. An organization can benefit from its past experience only when it tries
to understand them through the process of evaluation. The term evaluate means to
make a judgment as to the worth or value of a product or an activity. In project
management context, project evaluation is the process of appraising the progress and
performance of the project in comparison to the planned objectives.
A project can be evaluated by using evaluation tools such as Project Audits and
Project Reviews. Although many authors use the terms evaluation and audit
synonymously, an audit is a formal inquiry in to various aspects of the project. In this
unit, the word audit is associated with any formal inquiry into various project
aspects that are of interest to the top management.
This unit will discuss project evaluation and its purpose. We will discuss project auditing,
and the construction and use of the audit report. We shall then move on to discuss the
responsibilities of the auditor, and the project audit life cycle. Finally, we would be
discussing the essentials of an audit, and the concept of performance measurement.
2. Objectives
discuss project evaluation and its purpose.
define project auditing.
find out how to construct and use an audit report.
identify the responsibilities of the auditor.
explain the project audit life cycle.
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discuss the essentials of an audit.
recall the concept of performance measurement.
3. Project Evaluation and its Purpose
Project evaluation is a process of evaluating a projects progress and performance in
comparison with its planned progress and performance or with that of identical
projects. Also, project evaluation should be supportive to all the management
decisions that the project requires. So the manner in which a project is evaluated
should make the management feel that all the relevant data has been considered.
Project evaluation is considered to be as important as the project itself.
The primary objective of project evaluation is to measure the degree of a projects
success. A survey on industrial projects of different nature and size identified four
critical parameters for measuring the success of a project. A survey on industrial
projects of different nature and size identified four critical parameters for measuring
the success of a project. They are --
Completion of a project within a given budget and time
Extent to which the project is able to satisfy the client
Commercial success of the project and the market share captured by the product
delivered by the project
Ability of the product or service to succeed if it enters a new market or its ability to
lead to a new product or technology.
Apart from measuring the success of a project, project evaluation aims at identifying
the various strengths and weaknesses of a project (in various phases). This will help
the organization manage its future projects better. Project evaluation helps the
organization and project team to
identify problems during the early stages of the project.
ensure clarity in performance, cost and time relationships.
enhance the performance of the project.
explore opportunities for technology advancements in the future.
appraise the quality of project management.
minimize costs of the project.
accelerate the process of achieving results.
find, correct and avoid mistakes in the future.
communicate information as desired by the client.
check the firms interest and commitment to the project.
All the above benefits resulting from project evaluation are concerned with the
primary goals of the project team. Apart from unearthing information related to a
projects teams success in meeting its primary goals, evaluation also studies other
secondary goals that are crucial for the success of the project and the organization.
These secondary goals are not defined at the starting of the project, but they are
crucial for the well being of the organization. Secondary goals are concerned with
Understanding the importance and role of projects in an organization
Improving the way in which projects are organized and managed
Attempting to create a healthy working environment and encouraging the creativity of
the team members
Project Auditing
79
Exploring the strengths and weaknesses of the organization concerned with projects
team members, management and decision making processes.
Trying to identify the risk factors associated with the projects taken up by the
organization.
Attempting to enhance the contribution of projects towards the professional growth of
the team members.
Identifying individuals with excellent managerial and leadership skills.
It is relatively easier to find out primary goals than to identify secondary goals.
Primary goals can be identified simply by interpreting of the project proposal or by
scrutinizing any document describing the reasons for project selection. Such
documents state the primary goals of a project. But the implicit nature of secondary
goals makes it difficult for the auditor to identify and evaluate them. For example, the
behavioral aspects of the employees working in an organization are generally hidden.
Since these secondary goals are not stated in any of the organizations manuals, team
members are quite likely to ignore them.
People tend to meet their individual goals along with their organizational goals, but
they generally give more attention to the achievement of individual goals. A problem
may crop up when the auditor tries to discover the secondary goals of the team
members. Moreover, people are generally reluctant to reveal their personal goals,
because of the feeling that their goals are not in agreement with the firms objectives.
For example, people may take part in a project to gain knowledge of new skills that
improve their career prospects but they will not reveal this to the auditor.
Lack of trust in the auditor would also create problems in identifying the secondary
goals. The presence of an auditor, external or internal, would make team members feel
uncomfortable and insecure. As a result, they would not like to reveal their personal or
secondary goals to the auditor.
On the whole, exploring secondary goals is a difficult task. Generally, project auditors
do not take secondary goals into consideration when conducting an audit, but it is
always advantageous to consider them as they provide some qualitative information
related to the success or failure of a project.
Example: Fundamental Elements that Determine the Success or
Failure of Projects
1. A clean and objective description of the product or service to be developed,
and the projects scope, budget and schedule will contribute greatly to the
success of the project. Lack of clarity in these aspects of project management
will lead to the failure of the project.
2. Involving people with expertise in relevant disciplines at all the hierarchical
levels of the project will help develop and preserve a collaborative and
problem-solving environment. This approach can lead to the success of a
project.
3. Proper allocation of authority and responsibility between the clients project
manager and the contractors project manager will lead to speedy and accurate
decision making.
4. Making major stakeholders accountable will ensure that their performance
matches their promises. The responsibilities of the stakeholders should be
described as clearly as possible in contracts, agreements and purchase orders.
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Check Your Progress
1. Which of the following options are not the primary goals of project evaluation?
i. To identify problems during the early stages of the project
ii. To identify the risk factors associated with the projects taken up by the
organization
iii. To enhance the performance of the project
iv. To identify the individuals with excellent managerial and leadership skills
a. Only i and ii
b. Only ii, iii, and iv
c. Only ii and iv
d. Only iii and iv
2. Identify the statements that are true with regard to project evaluation.
i. Project evaluation is a process of evaluating a projects progress and performance
in comparison with that of identical projects.
ii. The main objective of project evaluation is to measure the degree of the success
of a project.
iii. Project evaluation has to be supportive of all the management decisions that the
project requires.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
3. Which of the following options refers to the process of appraising the progress
and performance of the project with reference to the planned objectives?
a. Project auditing
b. Project evaluation
d. Project control
4. From the following options, identify the secondary goal of project evaluation.
a. To check the firms interest and commitment to the project
b. To explore the strengths and weaknesses of the organization in terms of the
project team members, management and decision-making processes
c. To appraise the quality of project management
d. To explore opportunities for technology advancements in the future
5. Which of the following options are the parameters on which the success of a
project is measured?
i. Whether the project is completed within a given budget and time
ii. Whether the project is able to satisfy the client
iii. Whether the project deliverable has the ability to succeed when it enters a new
market
iv. Whether the project is commercially successful
Project Auditing
81
6. Identify the primary goal of project evaluation from the following options.
a. To understand the importance and role of projects in an organization
b. To ensure clarity in performance, cost, and time relationships
c. To identify the risk factors associated with the projects taken up by the
organization
d. To improve the way in which projects are organized and managed
7. Which of the following options are the secondary goals of project evaluation?
i. To attempt to enhance the contribution of projects toward the professional growth
of the team members
ii. To check the firms interest and commitment to the project
iii. To find and correct mistakes and avoid them in the future
iv. To attempt to create a healthy work environment and encouraging the creativity
of the team members
a. Only i and iv
b. Only ii and iv
c. Only iii and iv
4. Project Auditing
Project auditing can be defined as the process of detailed inspection of the
management of a project, its methodology, its techniques, its procedures, its
documents, its properties, its budgets, its expenses and its level of completion. Project
auditing can be carried over on the whole project or on a part of the project. Though a
formal audit report can be presented in various formats, certain aspects must be
contained in report without fail. They are
Present status of the project: Is the work performed ahead or behind the planned
schedule?
Future status of the project: Will there be any significant change in the schedule?
Indicate the nature of change if there is a possibility of change.
Status of crucial tasks: Measuring the progress of the crucial tasks on which the
success of a project depends.
Assessing risk: What are the chances of the project failing or running into losses?
Information relating to other projects: What lessons can be learned from the project
audit that can be used in the future to improve the management of other projects of the
organization?
Audit and its limitations: What are the limitations, assumptions or constraints that
have an impact on the audit data?
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Though the inspection methodology for both the financial and project audit is similar,
the outcome of both the processes varies widely. The scope of a financial audit is
limited, it emphasizes on utilization and preservation of the organizational assets. But
the scope of a project audit is very wide and can involve the whole of the project or
any of its components. Though project auditing deals with all the aspects of project
management, it is not a traditional management audit. Management audits are
designed to examine the operation of a firms management systems. Project auditing
goes beyond this to make sure that the project is properly managed. A management
audit examines the utility of the managerial systems, while a project audit examines
the impact of managerial, financial and technical parameters on a particular
organizational climate.
Depth of an Audit
There are many practical constraints that limit the scope of an auditors evaluation of
the project. Time and money are two such constraints; they not only limit the depth of
the investigation but also affect the amount of detail presented in the audit report.
Costs are incurred as a result of the audit process itself, (i.e., professional and clerical
costs for conducting an audit) and for gathering, storing and preserving the data to be
audited.
There are two other costs that are important and are usually ignored. The first one is
the distraction caused by the auditing process to the people working on the project.
The project team members may become distracted or anxious when the project is
being audited and as a result, they pay less attention to their work and spend more
time and energy on securing themselves from the auditors criticism. The second cost
is the drop in the morale of the individuals working on the project. Even though an
audit report is presented in a constructive and positive style it can demoralize team
members and affect the project negatively.
The depth to which an audit is conducted varies with the situation and the needs of the
project. Although this is purely a top management decision, a project audit generally
carries out the following three levels of audit -- the general audit, the detailed audit,
and the technical audit.
The general audit is usually a brief review of the project, carried out within a limited
time period and with only a few resources. It usually touches on all the six dimensions
of the auditing report, i.e., the present status of the project; the future status; the status
of the crucial tasks; assessing the risk; information relating to other projects and the
limitations of the project.
The detailed audit is usually conducted as a follow-up to the general audit. This
detailed audit is conducted when an unacceptable level of risk has been discovered by
the general audit. The depth of a detailed audit depends on the seriousness of the
issues and their impact on the objectives of the project; the more serious the issue, the
greater the depth of the audit.
The technical audit is conducted when a detailed audit fails to evaluate the technical
aspects of a project satisfactorily because of the auditors lack of technical knowledge.
The project auditor then employs a technically qualified individual to conduct the
audit along certain guidelines. When highly sophisticated and confidential technology
is used, it is often difficult to find technical auditors from the organization itself. In
such cases, academic consultants are often employed by the organization. To ensure
confidentiality, the consultants have to sign the document of nondisclosure. Although
it is not a hard and fast rule, a technical audit is generally conducted in a detailed
manner.
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Timing of the Audit
Similar to the depth, the timing of an audit is also project specific. Generally, the first
audit is conducted early in the project life cycle, as early problem detection would
make the rectification process easier. Usually, early audits concentrate on technical
issues and focus on solving key technical problems. Auditing conducted towards the
end of the project life cycle becomes a value addition to the parent organization than
to the project. As the project progresses, concern for the technical factors takes a back
seat. At this stage, adherence to the schedule and budget become important. Also,
management concerns like disposing of equipment and reallocating personnel become
key issues when a project is evaluated towards the end of its life cycle. Auditing
conducted at different phases of project life cycle gives specific benefits to the project
and the organization.
Post Project Evaluation
Post project evaluation could be necessary for the following reasons --
It is specified by the client in the agreement and is required legally.
It constitutes a major part of the project report. Also, its the key source of information
for giving feedback to the parent organization.
It accounts for all the assets and expenses of the project.
Check Your Progress
8. Identify the process that involves a detailed inspection of the management of a
project, its methodology, its techniques, its procedures, its documents, its
properties, its budgets, its expenses, and its level of completion.
a. Project control
b. Project auditing
d. Project evaluation
9. Which of the following options is false with regard to the aspects that should be
covered in the formal audit report?
a. The audit report should properly assess the risk associated with the project.
b. The audit report should include the limitations, assumptions, and constraints that
would have an impact on the audit data.
c. The audit report should include information about the other projects.
d. The audit report should include the current status of the project while it need not
include the future status of the project.
10. From the following options, identify the costs involved in the audit process.
i. Professional and clerical costs for conducting an audit
ii. Costs incurred in gathering, storing, and preserving the data to be audited
iii. Distraction caused by the auditing process to the people working on the project
iv. The drop in the morale of the individuals working on the project
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11. Which of the following levels of audit covers dimensions of the auditing report
such as the present status, the future status, and the status of the crucial tasks?
a. General audit
b. Detailed audit
c. Technical audit
d. Both (a) and (b)
12. Identify the reasons that make the post project evaluation audit necessary.
i. It is specified by the client in the agreement and is required legally
ii. It constitutes a major part of the project report
iii. It accounts for all the assets and expenses of the project
iv. It is the key source of information for giving feedback to the parent organization
13. Which of the following audits is conducted when a serious issue has been
discovered and it is known that it will have a major impact on the project?
a. General audit
b. Detailed audit
c. Technical audit
d. Both (b) and (c)
14. Which of the following statements is true regarding the timing of a project audit?
a. An early audit in the project life cycle would help in early problem detection and
would make the rectification process easier.
b. As the audit process progresses to an advanced stage, the project auditors
concentrate on the technical issues, and therefore, focus on solving key technical
problems.
c. A project audit conducted during the end of the project life cycle checks on
whether the project is adhering to the schedule and budget.
d. All of the above
15. A detailed audit is carried out when
b. an unacceptable level of risk has been discovered by the general audit.
c. a technical audit fails to evaluate the technical aspects of a project satisfactorily
due to the auditors lack of technical knowledge.
d. the project auditor carries out the general and technical audits in a satisfactory
manner.
e. All of the above
16. _____________ is a brief review of the project, carried out within a limited time
period and with only a few resources.
a. General audit
b. Detailed audit
c. Technical audit
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5. Construction and Use of the Audit Report
The format of an audit report depends on the nature of the project under evaluation
and the purpose of the evaluation. It is always advantageous to use a standard format
for presenting audit reports. Such a format makes it easy for the project manager and
the top management to understand and comprehend it. If the audit report is to be
distributed within the organization, then the management should prepare a distribution
list. If the distribution of audit reports is restricted, it can attract the attention of every
individual thinking it to be a confidential report, which will finally lead to
interpersonal and inter-group conflicts.
Though some project managers prefer complex and custom made formats of audit
reports for their projects, it is always better to have a simple and straightforward
structure. The information should be arranged in such a manner that it is easy to
compare the planned and the actual output. The report should focus on the deviations
of the delivered output from the planned output, along with explanations and
comments. Such a simple and straight forward structure will make it easy for
management to identify problems with the project.
The audit report should not make negative comments about the people involved in the
project. The content of the report should be limited to the information and the issues
that pertain to the project. The report should be written in a professional style without
any scope for emotional overtones. A typical audit report must provide the following
basic information:
Introduction
This part of the report presents the framework of the project. A clear representation of
project objectives is a must in this section. In the case of highly complex objectives, it
is advisable to add an appendix to the report, providing additional information on the
project objectives.
Present Project Status
The projects current status has to be reported when auditing the project. This section
of the report is concerned with the following performance measures:
Cost: This part of the audit report compares the actual costs incurred to the planned
costs. The report should also mention the timeframe during which the comparison is
made. This section usually concentrates on computing the direct costs of the project.
In case it is necessary to highlight the total costs of the project along with the
overheads, a cost data sheet should be provided as a supplementary table.
Schedule: This part of the project audit report gives project performance in terms of
the milestones accomplished. The auditor must clearly report which tasks have been
completed and which are still incomplete. The percent of work completed must also
be stated.
Progress: This part of the audit report compares the tasks that have been completed
with the resources that have been spent to achieve this task. There should be enough
information in the report, to help the project manager zero in on the activities or group
of activities that are the sources of the problem. Also, the information helps project
managers estimate the time and expenditure necessary to complete the remainder of
the project.
Quality: The degree of importance of quality as a factor of evaluation depends on the
nature of the project. Quality can be defined as the totality of features and
characteristics of a product or service which bear on its ability to satisfy a stated or
implied need. These needs, in terms of projects, are pre-specified characteristics. If
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detailed quality specifications are attached to a project, this part of the project status
report should contain a detailed review of the quality control procedures, along with
the latest results of the quality tests conducted.
Future Project Status
This part of the report consists of the project evaluators conclusions. It indicates the
progress of the project and makes suggestions regarding the remaining tasks of the
project. The purpose of the audit report is not to rewrite the project proposals of
existing projects, but to provide guidance to future projects.
Critical Management Issues
This part of the report should address all the critical issues that top management has to
monitor constantly. It should explain the link between the critical issues and the
project objectives. In addition, this part of the audit report should describe the time,
cost and performance trade-off in a brief manner. Such a description would help top
management make decisions in the future projects.
Risk Analysis
This part of the audit report describes all the major risks involved in a project. It also
discusses the impact of these risks on the time, cost and performance of the project.
The report can recommend an alternative course of action for minimizing risks.
Limitations and Assumptions
This part of the report can be included in the introduction or can be placed towards the
end of the report. Though accuracy and timeliness of the audit report is the
responsibility of the project auditor, the top management is totally responsible for the
interpretation and actions taken based on the information given in the report.
Therefore, it is important to state the limitations on the validity of the audit report.
Example: Extent of Benefits Derived from Auditing at
Different Stages in a Project
Stage in Project Life Cycle Extent of Benefit
Initial An audit in the early stages of the project is very
valuable, especially if it is conducted before 25%
of the project has been completed.
During feasibility study A technical audit at this stage is highly beneficial.
Preliminary planning Beneficial for developing measurement standards
so as to validate the performance standards set.
Scheduling phase Less beneficial because the flexibility of the
project team at this stage is usually limited.
When project team is
analyzing the data
Beneficial to a certain extent only.
Implementation phase Benefits depend on the significance of the project
processes and techniques.
Post-project Benefits are realized to the extent the results of the
audit are utilized in future projects.
Adapted from Jack R. Meredith & Samuel J. Martel, Project Management A Managerial
Approach, Fourth Edition, p.519.
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Activity: Odissy Automobiles WLL is a Japan-based automobile manufacturing
company that specializes in producing 4x4 sports utility vehicles (SUV). A month
ago, the company produced and launched its new model Odissy Roar during the
Dubai shopping festival (DSF). The response to the vehicle was tremendous. So,
Odissys top management asked the project manager of Roar, Shan Wang, to
conduct a post project evaluation and submit the report as soon as it is finalized.
Why do you think a post project evaluation report was required after the project
had been successfully closed? How does a project manager conduct a post project
evaluation? Also, discuss the procedure for preparing an audit report.
Answer:
6. Responsibilities of the Auditor
The basic responsibility of any project auditor is to convey the facts. This
responsibility is not as simple as it seems to be. It is required to acknowledge the
presence of different kinds of biases of the people involved in the project. The auditor
should be aware of his limitations and seek external help when he has to audit aspects
of the project that are beyond his area of expertise. All the information gathered
should be kept confidential until the audit report is released officially. He should not
allow any political or technical pressures to influence his audit report.
The seriousness with which the top management and the project team regards the
audit report depends on the credibility of the information being presented in the
report. The data should be checked and calculated very carefully in order to ensure its
accuracy. It is the responsibility of the auditor to explore the ways in which he can
enhance the effectiveness, efficiency and value of the auditing process.
The steps to be carried out in a project audit are: gathering a small team of
experienced experts; informing the project team about the project requirements;
conducting on-site project auditing; briefing the management after completing the
audit; preparing and producing an audit report as per the predetermined format;
distributing the report to the key stakeholders for their feedback; and ensuring follow-
up till the suggestions are implemented.
Example: Steps in Carrying Out a Project Audit
1. Gathering a small team of experienced experts.
2. Informing the project team about the project requirements.
3. Conducting on-site project auditing.
4. Briefing the management after completing the audit.
5. Preparing and producing an audit report as per the predetermined format.
6. Distributing the report to the key stakeholders for their feedback.
7. Ensuring follow- up till the suggestions are implemented.
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Check Your Progress
17. Which of the following sections in the audit report would contain a comparison of
the actual costs incurred with the planned costs, a comparison of the tasks that
have been completed with the resources that have been spent to achieve the task,
etc.?
a. Introduction
b. Present project status
c. Future project status
d. Risk analysis
18. Which of the following statements is not true regarding the way the audit report
is presented?
i. The format of the audit report should be custom made by the project managers for
their projects.
ii. The content of the audit report should be limited to the information and the issues
pertaining to the project.
iii. The format of an audit report depends on the nature of the project under
evaluation and the purpose of the evaluation.
iv. The audit report should contain detailed information about the people who were
responsible for making the project a success or a failure.
a. Only i and ii
b. Only i and iv
c. Only ii and iii
d. Only iii and iv
19. Following are the steps in carrying out a project audit. Put them into the proper
sequence.
i. Briefing the management after completing the audit
ii. Informing the project team about the project requirements
iii. Gathering a small team of experienced experts
iv. Ensuring follow-up till the suggestions are implemented
v. Distributing the report to the key stakeholders for their feedback
vi. Preparing and producing an audit report as per the predetermined format
vii. Conducting on-site project auditing
a. iii-vii-ii-vi-i-iv-v
b. iii-ii-vii-i-vi-v-iv
c. iii-ii-i-vi-vii-iv-v
d. iii-vii-vi-vi-v-iv-i
20. Which of the following sections in the project audit report should describe the
trade-off between time, cost, and performance in a brief manner?
a. Risk analysis
b. Critical management issues
c. Limitations and assumptions
d. Both (a) and (c)
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21. The introduction part of the audit report should contain
i. the framework of the project.
ii. a clear representation of the project objectives.
iii. the major risks involved in the project.
iv. an appendix to the report stating the complex project objectives.
a. Only i and ii
c. Only iii and iv
22. The projects current status section of the audit report should contain:
i. The percentage of work completed.
ii. The limitations and assumptions taken into consideration by the project auditor.
iii. Project performance in terms of the milestones accomplished.
iv. Detailed quality specifications along with a detailed review of the quality control
procedures and latest results of the quality tests conducted.
a. Only i and ii
d. Only iii and iv
7. The Project Audit Life Cycle
Just as the project has a life cycle, a project audit too has a life cycle. A project life
cycle involves a systematic advancement of pre-defined events. The following are the
six events that constitute a project audit life cycle.
Audit Initiation
This step marks the beginning of the audit process. The purpose and scope of the
project audit is defined in this step. In this phase a suitable audit methodology is
selected.
Defining the Project Baseline
The objective of this phase is to set performance standards to enable the auditor to
measure the project performance and achievements against them. This stage in the life
cycle involves identifying the areas of performance that require evaluation, setting
standards through benchmarking, getting the performance expectations from top
management, designing a program that measures the performance and gathering the
information required.
Setting up an Audit Database
The audit process starts only after the baseline standards have been set. The next step
in this phase is to develop a database that is to be used by the audit team. The
information stored in the database is dependent on the purpose and the scope of the
audit. Usually it contains all the information necessary to assess the projects
management and control activities, the past, present and future status of the project,
the schedule and cost performance of the project and the quality of the delivered
output. The information included in the database can range from a highly technical
detailing of performance to details on interaction among the team members of the
project.
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The project master plan should specify the type of information that must be stored in
the database. This will ensure the availability of the information when needed.
Preliminary Analysis of the Project
This phase in the audit life cycle begins only when the baseline standards are set and a
database has been developed. In this phase the auditor analyzes the data and reports
his findings to the managers in a manner that conveys the precise meaning of the
findings of the audit. It is the responsibility of the project auditor to report his findings
and judgments to the project manager prior to the formal release of the audit report.
The project manager must be informed in advance since the purpose of the audit is to
enhance the performance of the current project under evaluation and at the same time
to improve the way future projects are managed.
Preparing Audit Report
This phase of the audit life cycle involves presenting an audit report in the format that
is chosen at the beginning of the project audit. This section of the audit report gives
recommendations along with the implementation plan. If the recommendations move
beyond the scope of the organization, then they have to be supported right from the
policy-making level of management. This support should be obtained prior to the
distribution of the audit report. If the top management does not support the
suggestions, they should be modified.
Project Audit Termination
The audit should be terminated after it has achieved its desired task. The audit process
should be reviewed after the final audit report and the suggestions have been released.
This is done to improve the audit process.
Activity: The top management of a software development firm, while going
through an audit report submitted by an auditor from an external auditing firm,
found that some of the facts and findings were misreported and miscalculated.
What are the responsibilities of an auditor? Describe the method that auditors
should follow while auditing a project.
Answer:
8. The Essentials of an Audit
To be effective, accurate, credible and acceptable to the top management, project team
and the client, an audit has to be carried out by a competent audit team that has access
to all the records and files of the project.
Selecting a Proper Audit Team
The success of an audit depends on the selection and the composition of the audit team.
Auditors should be selected on the basis of their competence. Generally, the size of the
audit team is directly proportional to the complexity and the scale of the project. The main
task of an audit team is to examine and evaluate the project completely and thoroughly.
The team must decide what issues are to be brought to the managements attention. The
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members of the audit team should not get involved in conflicts among project team
members. Auditing is a strict and highly disciplined function, and all auditors and team
members should confirm to this discipline with sincerity and dedication.
Access to Records and Files
Access to all the information and data pertaining to the project determines the
effectiveness of an audit team. In situations where the access to information is
restricted because of security reasons, forming a sub group of the audit team,
composed of the qualified individuals, is an appropriate move.
Most of the information required is sourced either from the records of the project team
or from functional departments like accounts, personnel and purchasing. Careful and
thorough information gathering would result in an effective and highly credible audit
report.
The information that is gathered should be organized and filed in a systematic manner.
Appropriate methods have to be designed to classify the information. Safeguards have
to be developed to prevent the duplication of efforts. Careful development of
procedures will ensure the standardization of processes.
Access to Project Personnel
There should be frequent interaction between the audit team and the members
involved in the project. Though interaction between the audit team and the client is
necessary, it is always restricted even in the case of client being represented on the
audit team. This restriction can be relaxed after obtaining permission from top
management.
While conducting the audit, the audit team will have to deal with a considerable
amount of political pressure. In situations where the project is under political pressure,
the opposing parties may also try to take the advantage of the situation. So the audit
team should avoid the involvement of such parties as much as possible. The
information conveyed (by the project manager) to the audit team is highly
confidential. Information should be used only after confirming the reliability of the
source of information. The confidentiality of such sources should be preserved by the
audit team.
9. Performance Measurement
Measurement is a vital part of the audit/evaluation process. The success of a project
can be judged by measuring the project teams ability to accomplish various
milestones. Many project milestones are tangible and hence it is easy to find the
completion of activities associated with it. Measuring the expenses incurred against
the amount allocated in the budget is slightly complicated, requiring a thorough
understanding of the methodology adopted by the accounting department.
Even though an auditor uses the cost data sheet, which is filled with a more accurate
and precise data than what is required, there would still be some distinct problems
while measuring the time, cost and performance parameters of the project. There
would be more persistent problems in measuring, when the project objectives are
defined in terms of profits, rates of return or discounted cash flows. Measurement
problems increase when multi objective scoring models are used rather than financial
models. Also, it is comparatively easier to measure some objective parameters. But for
a credible measurement of subjective parameters, standard measurement techniques
are required. To measure various aspects of the project, interviews and questionnaires
are used for collecting data. The scoring methodology and the criteria to be used for
weighing the scores should be determined at the project initiation phase itself.
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Example: Auditing a Terminated Project at ABC Chemical Testing Services
ABC Chemical Testing Services has entered into a contract with mould aluminum
to test the commercialization of the latter's newly invented compound. The contract
did not mention a time limit, but laid more stress on quality and speed of testing.
Payment was to be on a monthly basis. The contract also mentioned that the client's
project leader will have free access to ABC's total testing procedures. After some
time, the client's project leader started probing into the matters of the contractor, to
the extent that the contractor's project team was forced to change the way they
approached the problem. They were even made to skip the regular verification
checks all for the sake of saving time. Even when the contractor came up with
feasibility options of commercializing the compound, the procedures were re-tested
by mould aluminum just to mention that those procedures will not work. The client
had indeed become very hard to please. The contractor was taken by surprise when
he received a letter from the client, asking for the termination of the project,
although ABC was not evidently at fault. ABCs CEO commissioned an audit to
unearth the anomalies. The report mentioned the following:
General outline:
The original procedure and approach to the problem was changed because of the
client's project leader. In spite of this, the project team of ABC made good
progress.
The testing was effective.
ABC's project team was successful in testing the compound for commercialization
many times, but they were not accepted (for no proper reasons).
Though ABC was not responsible for commercialization, it did suggest a few
methods.
The client's project leader interfered way too much. He misguided the contractor's
methodology and ultimately misdirected the project.
ABC Chemical Testing Services neither documented the ongoing project
management decisions nor did it communicate the decisions to the client.
Analysis of the clients feedback
Additional points:
Based on the evidence that ABC's commercialization feasibility was implemented
successfully in similar conditions, the client's criticism is proved to be false.
ABC's reports which were criticized by the client were actually prepared as per the
guidelines of the client's project manager. The reports were not user-friendly; they
could only be understood by the technical staff or the project manager.
The contractors project manager was not guided properly to interact with the
client.
Suggestions:
ABC needs to develop a formal procedure to identify projects involving high risks
at the time of entering the contract. ABC should also have provisions for
monitoring the deviations in the project from its initial plan. Some of the reasons
behind terminating the current project are lack of sufficient funds, lack of time,
lower probability of success, unsophisticated client and excess interference from
the client in the project activities.
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Activity: System Ltd. is a software and hardware research institute based in
Hyderabad, India. The company is into developing software for cellular equipment.
Currently it is working on developing software for Delhi based Reach Cellular.
Since the project is coming to a close, the top management sent a fax to one Sukesh
Singh to audit the project. How should Singh conduct the project audit?
Answer:
Check Your Progress
23. In which of the following phases in the audit life cycle are recommendations
made regarding the project along with the project implementation plan?
a. Preparing an audit report
b. Setting up an audit database
c. Defining the project baseline
d. Project audit termination
24. In which of the following phases in the audit life cycle does the auditor analyze
the data and reports his/her findings to the managers in a manner that conveys the
precise meaning of the findings of the audit?
a. Audit initiation
b. Preparing audit report
c. Setting up an audit database
d. Preliminary analysis of the project
25. Which of the following statements is false about the setting up an audit database
phase of the project audit life cycle?
a. The information stored in the database is dependent on the purpose and scope of
the audit.
b. An audit database contains all the information necessary to assess the projects
management and control activities.
c. The audit database contains only the past and present status of the project, but
does not mention the future status of the project.
d. The audit database contains information about the schedule and cost performance
of the project and the quality of the delivered output.
26. The defining of the project baseline stage involves
i. identifying the areas of performance that require evaluation.
ii. setting standards through benchmarking.
iii. getting the performance expectations from the top management.
iv. designing a program that measures the performance and gathering the information
required.
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a. Only i and ii
b. Only ii and iv
c. Only iii and iv
27. Identify the statements that are not true with regard to the selection of an audit
team.
i. Generally, the size of the audit team is indirectly proportional to the complexity
and the scale of the project.
ii. The main aim of the audit team is to examine and evaluate the project completely
and thoroughly.
iii. The members of the audit team should try to solve conflicts among the project
team members.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
28. Following are some of the stages involved in the project audit life cycle. Arrange
them in the sequence in which they should be conducted.
i. Preparing an audit report
ii. Setting up an audit database
iii. Defining the project baseline
iv. Preliminary analysis of the project
v. Project audit termination
a. i-ii-iv-v-iii
b. ii-iv-iii-i-v
c. iii-ii-iv-i-v
d. iv-v-iii-i-ii
29. The success of an audit does not depend on
a. the selection and composition of the audit team.
b. access to all the information and data pertaining to the project.
c. the frequency of interaction between the audit team and the project members.
d. the structure of the organization and the constitution of the top management.
10. Summary
Project evaluation is a process of evaluating a projects progress and performance in
projects.
documents, its properties, its budgets, its expenses and its level of completion. It can
be carried over on the whole project or on a part of the project.
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Though a formal audit report can be presented in various formats, certain aspects must
be contained in report without fail. The format of an audit report depends on the
nature of the project under evaluation and the purpose of the evaluation.
A typical audit report must provide the following basic information: introduction,
present project status, future project status, critical management issues, risk analysis,
and limitations and assumptions.
The basic responsibility of any project auditor is to convey the facts. All the
information gathered should be kept confidential until the audit report is released
officially. The auditor should not allow any political or technical pressures to
influence his audit report.
Just as the project has a life cycle, a project audit too has a life cycle. The various
stages of the project audit life cycle are audit initiation, defining the project baseline,
setting up an audit database, preliminary analysis of the project, preparing audit
report, and project audit termination.
To be effective, accurate, credible, and acceptable to the top management, project
team, and the client, an audit has to be carried out by a competent audit team that has
access to all the records and files of the project. The essentials of an audit are --
selecting a proper audit team, access to records and files, and access to project
personnel.
Measurement is a vital part of the audit/evaluation process. The success of a project
can be judged by measuring the project teams ability to accomplish various
milestones.
11. Glossary
Detailed Audit: It is usually conducted as a follow-up to the general audit, when an
unacceptable level of risk has been discovered by the general audit.
General Audit: A brief review of the project, carried out within a limited time period
and with only a few resources.
Project Auditing: A process of detailed inspection of the management of a project,
its methodology, its techniques, its procedures, its documents, its properties, its
budgets, its expenses and its level of completion.
Project Evaluation: A process of evaluating a projects progress and performance in
projects.
Technical Audit: It is conducted when a detailed audit fails to evaluate the technical
aspects of a project satisfactorily because of the auditors lack of technical knowledge.
1. An organization can benefit from its past experience only when it tries to
understand them through the process of evaluation, even in case of projects. What
is project evaluation? Explain the reasons why projects are evaluated.
2. Though the terms, evaluation and audit are used interchangeably, they are
different. What is project auditing? Explain the depth and timing aspects of a
project audit.
3. The format of an audit report depends on the nature of the project under
evaluation and the purpose of the evaluation. Explain the contents of an audit
report. What are the responsibilities of a project auditor?
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4. Just as the project has a life cycle, a project audit too has a life cycle. Describe the
stages involved in a project audit life cycle. What do you think are the basic
requirements of an audit? Explain the role played by performance measurement in
the audit/evaluation process.
1. (b) Only ii and iv
Project evaluation aims at identifying the various strengths and weaknesses of the
project and helps in measuring the success of the project and managing future
projects better. Some of the primary goals of project evaluation are: to ensure
clarity in performance, cost, and time relationships, identify problems during the
early stages of the project, enhance the performance of the project, explore
opportunities for technology advancements in the future, and minimize the costs
of the project. To identify the risk factors associated with the projects taken up by
the organization and to enhance the performance of the project are the secondary
goals of project evaluation.
Project evaluation is an important task. It is a process of evaluating the projects
progress and performance with reference to its planned progress and performance
or in comparison with that of identical projects. Project evaluation should be
supportive of all the management decisions that the project requires. The main
objective of project evaluation is to measure the degree of a projects success.
3. (b) Project evaluation
Project evaluation is the process of appraising the progress and performance of
the project with reference to the planned objectives. A project can be evaluated
using evaluation tools like project audits and project reviews. Project auditing is a
process of detailed inspection of the management of a project, its methodology,
techniques, procedures, documents, budgets, expenses, and level of completion.
Project screening refers to the screening of the project ideas that have been
collected. It helps in rejecting ideas that cannot be considered for implementation.
Project control is the process of collecting information related to the performance
of the project system, comparing it with the desired level of performance, and
taking corrective action to decrease the gap between the actual and the desired
performance levels.
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4. (b) To explore the strengths and weaknesses of the organization in terms of
the project team members, management, and decision-making processes
projects better. Some of the secondary goals of project evaluation are to explore
the strengths and weaknesses of the organization in terms of the project team
members, management, and decision-making processes, understand the
importance and role of projects in an organization, improve the way in which
projects are organized and managed, and identify individuals with excellent
managerial and leadership skills.
Four critical parameters have been identified for measuring the success of a
project based on a survey conducted on industrial projects of different natures and
sizes. These are: completion of the project within a given budget and time; extent
to which the project is able to satisfy the client; the commercial success of the
project and the market share captured by the product delivered by the project; and
ability of the product or service to succeed if it enters a new market or its ability
to lead to a new product or technology.
6. (b) To ensure clarity in performance, cost, and time relationships
projects better. Some of the primary goals of project evaluation are: to ensure
clarity in performance, cost, and time relationships; identify problems during the
early stages of the project; enhance the performance of the project; explore
opportunities for technology advancements in the future; and minimize the costs
of the project.
7. (a) Only i and iv
projects better. The secondary goals of project evaluation are to attempt to
enhance the contribution of projects toward the professional growth of the team
members, to try and create a healthy work environment, and to encourage the
creativity of the team members. To check the firms interest and commitment to
the project and to find and correct mistakes and avoid them in the future are
primary goals of the project.
8. (b) Project auditing
Project auditing is a process of detailed inspection of the management of the
project, its methodology, techniques, procedures, documents, budgets, expenses,
and level of completion. It can be done for the whole project or for a part of the
project. Project control is the process of collecting information related to the
performance of the project system, comparing it with the desired level of
performance, and taking corrective action to decrease the gap between the actual
and the desired performance levels. Project screening refers to the screening of
the project ideas that have been collected. It helps in rejecting the ideas that
cannot be considered for implementation. Project evaluation is the process of
appraising the progress and performance of the project in comparison with the
planned objectives.
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9. (d) The audit report should include the current status of the project while it
need not include the future status of the project.
Project auditing is the process of detailed inspection of the management of a
project, its methodology, its techniques, its procedures, its documents, its
properties, its budgets, its expenses, and its level of completion. After a project
audit is conducted, it is presented in the form of an audit report. Following are
certain aspects that are covered in a project audit report: the present status of the
project; the future status of the project; the status of critical tasks; the risk factor
involved in the project; the information pertaining to the other projects; and the
limitations, assumptions, or constraints that have an impact on the audit data.
Time and money are the two constraints that limit the scope of an auditors
evaluation of the project. These two constraints limit the depth of the
investigation and also affect the amount of detail presented in the audit report.
Various types of costs are incurred in the audit process. Some are professional
and clerical costs that are incurred on conducting the audit while others are costs
that are incurred in the course of gathering, storing, and preserving the data to be
audited. Certain other types of costs are also incurred in the audit process. These
are, however, ignored. Such costs rise due to the distraction caused by the
auditing process to the people working on the project, and due to a drop in the
morale of the individuals working on the project.
11. (a) General audit
A project audit is generally carried out at three levels: general audit, detailed
audit, and technical audit. The general audit is usually a brief review of the
project, carried out within a limited time period and with only a few resources. It
usually touches on all the six dimensions of the auditing report, i.e., the present
status of the project, the future status, the status of the crucial tasks, assessing the
risk, information relating to other projects, and the limitations of the project. The
detailed audit is conducted when an unacceptable level of risk has been
discovered by the general audit. The technical audit is conducted when a detailed
audit fails to evaluate the technical aspects of a project satisfactorily because of
the auditor's lack of technical knowledge.
Post project evaluation audit is carried out for the following reasons -- it is
specified by the client in the agreement and is required legally, it constitutes a
major part of the project report and is also a key source of information for giving
feedback to the parent organization, and it accounts for all the assets and expenses
of the project.
13. (b) Detailed audit
The detailed audit is usually conducted as a follow-up to the general audit. It is
conducted when an unacceptable level of risk has been discovered by the general
audit. The depth of a detailed audit depends on the seriousness of the issues and
their impact on the objectives of the project the more serious the issue, the
14. (a) An early audit in the project life cycle would help in early problem
detection and would make the rectification process easier.
Auditing conducted at different phases of the project life cycle gives specific
benefits to the project and the organization. The timing of an audit depends on the
type of project. The first audit is generally conducted early in the project life
cycle. This would help in early problem detection, which would make the
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99
rectification process easier. Early audits concentrate on technical issues and focus
on solving key technical problems. Auditing conducted toward the end of the
project life cycle becomes more a value addition to the parent organization than to
the project. As the project progresses, importance is given to adherence to the
schedule and budget. Management concerns like disposing of equipment and
reallocating personnel become key issues when a project is evaluated toward the
end of its life cycle.
15. (a) an unacceptable level of risk has been discovered by the general audit.
The detailed audit is usually conducted as a follow-up to the general audit. It is
conducted when an unacceptable level of risk has been discovered by the general
audit. The depth of a detailed audit depends on the seriousness of the issues and
their impact on the objectives of the project the more serious the issue, the
16. (a) General audit
A project audit is generally carried out at three levels: general audit, detailed
audit, and technical audit. The general audit is usually a brief review of the
project and is carried out within a limited time period and with only a few
resources. It usually touches on all the six dimensions of the auditing report, i.e.,
the present status of the project, the future status, the status of the crucial tasks,
assessing the risk, information relating to other projects, and the limitations of the
project. The detailed audit is conducted when an unacceptable level of risk has
been discovered by the general audit. The technical audit is conducted when a
detailed audit fails to evaluate the technical aspects of a project satisfactorily
because of the auditors lack of technical knowledge.
17. (b) Present project status
The projects current status has to be reported when auditing the project. In the
section on the present project status, various aspects like cost, schedule, progress,
and quality are covered. The report contains a comparison of the actual costs
incurred with the planned costs; the project performance in terms of the
milestones accomplished; a comparison of the tasks that have been completed
with the resources that have been spent to achieve this task; and the quality aspect
of the project.
18. (b) Only i and iv
The format of an audit report depends on the nature of the project under
evaluation and the purpose of the evaluation. It is advantageous to use a standard
format for presenting audit reports as this makes it easy for the project manager
and the top management to understand and comprehend it. Though some project
managers prefer complex and custom made formats of audit reports for their
projects, it is always better to have a simple and straightforward structure that will
make it easy for the management to identify problems with the project. The audit
report should not make negative comments about the people involved in the
project. The content of the report should be limited to the information and the
issues that pertain to the project.
19. (b) iii-ii-vii-i-vi-v-iv
documents, its properties, its budgets, its expenses, and its level of completion.
Following are the various steps involved in the project audit: gathering a small
team of experienced experts; informing the project team about the project
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requirements; conducting on-site project auditing; briefing the management after
completing the audit; preparing and producing an audit report as per the
predetermined format; distributing the report to the key stakeholders for their
feedback; and ensuring follow-up till the suggestions are implemented.
20. (b) Critical management issues
In the section on critical management issues, the audit report should address all
the critical issues that the top management has to constantly monitor. It should
explain the link between the critical issues and the project objectives. It should
also describe the time, cost, and performance trade-off in a brief manner. Such a
description would help the top management make decisions in the future projects.
The introduction part of the audit report presents the framework of the project. A
clear representation of project objectives is a must in this section. In the case of
highly complex objectives, it is advisable to add an appendix to the report,
providing additional information on the project objectives. The major risks
involved in the project are described in the section on risk analysis.
The projects current status has to be reported when auditing the project. In the
section on the present project status, various aspects like cost, schedule, progress,
and quality are covered. The report contains a comparison of the actual costs
incurred with the planned costs; the project performance in terms of the
milestones accomplished; a comparison of the tasks that have been completed
with the resources that have been spent to achieve this task; and the quality aspect
of the project. The limitations and assumptions taken into consideration by the
project auditor are not covered in this section of the audit report.
23. (a) Preparing an audit report
In the preparing an audit report phase of the audit life cycle, the audit report is
presented in the format that is chosen at the beginning of the project audit. In this
stage, recommendations regarding the project are given along with the
implementation plan. If the recommendations move beyond the scope of the
organization, then they have to be supported right from the policy-making level
of management. This support should be obtained prior to the distribution of the
audit report. If the top management does not support the suggestions, they should
be modified.
24. (d) Preliminary analysis of the project
In the preliminary analysis of the project phase, the auditor analyzes the data and
reports his/her findings to the managers in a manner that conveys the precise
meaning of the findings of the audit. This phase is taken up only when the
baseline standards are set and a database has been developed.
25. (c) The audit database contains only the past and present status of the
project, but does not mention the future status of the project.
An audit database is set up after the baseline standards have been set. The
information stored in the database is dependent on the purpose and scope of the
audit. The audit database contains all the information necessary to assess the
projects management and control activities. It also contains the past, present, and
future status of the project; the schedule and cost performance of the project; and
the quality of the delivered output. The information included in the database can
range from a highly technical detailing of performance to details on interaction
among the team members of the project.
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In the defining of the project baseline stage, performance standards are set to
enable the auditor to measure the project performance and achievements against
them. This stage in the life cycle involves identifying the areas of performance
that require evaluation, setting standards through benchmarking, getting the
performance expectations from the top management, designing a program that
measures the performance, and gathering the information required.
The success of an audit depends on the selection and composition of the audit
team. Auditors should be selected on the basis of their competence. The size of
the audit team is directly proportional to the complexity and scale of the project.
The main task of an audit team is to examine and evaluate the project completely
and thoroughly. The team must decide what issues are to be brought to the
managements attention. The members of the audit team should not get involved
in conflicts among project team members.
28. (c) iii-ii-iv-i-v
A project audit life cycle involves six events that constitute a project audit life
cycle. These are: audit initiation, defining the project baseline, setting up an audit
database, preliminary analysis of the project, preparing the audit report, and
project audit termination. In the audit initiation stage, the purpose and scope of
the project audit are defined. In defining the project baseline stage, the
performance standards are set to enable the auditor to measure the project
performance and achievements against them. In the setting up an audit database
phase, a database is developed for use by the audit team. In the preliminary
analysis of the project stage, the auditor analyzes the data and reports his/her
findings to the managers in a manner that conveys the precise meaning of the
findings of the audit. In preparing audit report stage, the audit report is presented
in the format that is chosen at the beginning of the project audit. Finally, in the
project audit termination stage, the audit is terminated after it has achieved its
desired task.
29. (d) the structure of the organization and the constitution of the top
management.
The success of an audit depends on the audit team, access to all the information
and data pertaining to the project, and the frequency of interaction between the
audit team and the project members. The success or failure of an audit does not
depend on the organizational structure and the constitution of the top
management. These are not essentials of an audit.
Unit 15
Project Closing
Structure
1. Introduction
2. Objectives
3. Closing a Project
4. Ways of Closing a Project
5. Reasons for Terminating an Unsuccessful Project
6. The Process of Closing a Project
7. Summary
8. Glossary
1. Introduction
In the previous unit, we have discussed project auditng. In this unit, we will discuss
the process for closing a project. A project comes to a close after it accomplishes its
objectives or when it is terminated due to other reasons. Closing a project not only
marks the completion of all administrative activities, but also audits the project
performance which is a high-value learning tool for the project manager and others.
The project manager should evaluate specific project records for a historical
understanding of the project activities which can be of use in the future. All records
without value should be scrapped and the rest should be stored for future reference.
The final task is to sell off the physical assets after making sure that they can be of no
use in any future activities and placing project team members back in their original
positions. Once the members of project team finish their respective tasks in the
project, they should be made available for other assignments. The project manager
should provide feedback on an individuals performance and contribution to the
project to his supervisor.
This unit will discuss the closing of a project. We will discuss the various ways in
which a project can be closed. We shall then move on to discuss the reasons for
terminating an unsuccessful project. Finally, we would be discussing the process of
closing a project.
2. Objectives
define closing of a project.
discuss the various ways of closing a project.
identify the reasons for terminating an unsuccessful project.
explain the process of closing a project.
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3. Closing a Project
The closing phase of a project has very little impact on the success or failure of any
project technically, but it certainly has an impact on the attitude of the client, top
management and the project team towards the project. It also has a significant impact
on learning the reasons behind the success or failure of the project. During this phase,
there is no joy when new things are unearthed, because problems have either been
solved already or overlooked. A project is terminated when the work on the project
has come to a point where there is no further progress is possible. Such a situation is
likely when the project is running far behind schedule or when its resources are
transfered to other projects. Following are the steps involved in formally closing a
project.
End the external contracts of the company formally with the vendors, clients and other
parties who expect early termination of services.
Suspend the assignments of the team members formally.
Seek the acceptance of the client formally on the project work and the output.
Make sure of proper installation and/or implementation of the delivered output on
time, with in budget and as per specifications.
Make sure of the availability of sufficient project documentation that can facilitate any
change occuring in the future.
Submit the final report and get it approved.
Close the established relationships internally and externally
It is the project managers responsibility to set a formal project closing date and get it
approved by way of getting it signed by the client. The closing date should match the
one mentioned in the master plan. Also the process of closing is to be initiated by the
project manager with support from the administrative department of the clients firm,
after getting a green signal from the client.
Check Your Progress
1. Terminating the activities of the project when work on the project has come to a
point where further progress is not possible is called ____________.
a. project termination
b. project ending
c. project closing
2. Which of the following steps should be taken before closing a project?
i. Suspending the assignments of the team members formally
ii. Seeking the acceptance of the client formally
iii. Ending the external contracts of the company formally
iv. Submitting the final report and getting it approved
a. Only i and ii
b. Only ii and iii
c. Only iii and iv
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4. Ways of Closing a Project
When a project has achieved all the goals and objectives set under the stipulated cost,
time and performance and the delivered output is accepted by the client, then it is said
to be a successful project. Since such projects have reached a point from which there
is no progress possible even in terms of improving the effectiveness and efficiency of
the output, the project has to be closed. The checklist helps the project manager in
assessing if the project is ready for closing or not.
Basically there are four ways in which a project can be closed. They are -- closing by
extinction, closing by addition, closing by integration and closing by starvation.
Closing by Extinction
Projects are closed by way of extinction either when they are successful in
accomplishing the goals or when they fail to deliver within the budgeted time and
cost. Some of the examples where in projects can be said to be closed by extinction
are:
Successful Projects:
A new product is produced and is launched successfully in the market.
L&T has successfully constructed the cybertowers complex at Hyderabad and handed
it over to the government of Andhra Pradesh.
An ERP solution is suggested and is successfully implemented in a firm.
Unsuccessful Projects:
Kinetic Motors failed to produce a two seater car that it planned to produce.
In some cases, projects are closed suddenly and using drastic measures. This is called
killing a project. The reasons for killing a project may not be related to its
effectiveness or ability to deliver the end product.
Some Reasons for Killing a Project Are:
Political
Mergers and acquisitions
Demergers
Project closure by extinction is characterized by the termination of all activities
associated with the key project deliverables. But there remain the major activities like
putting back project team members to their respective departments and disposing or
distributing the assets of the project.
Closing by Addition
This method is adopted when in-house projects are to be closed. When a project
team undertakes an in-house project for implementing it in its parent organisation and
if it is successful in meeting its objectives, then the project can be closed by
incorporating it as a functional and formal part of the organisation. When a project is
closed or terminated by addition, then it is made a part of the parent firm. But this
process of merging it back with the parent firm takes place in a slow and phased
manner. The project derives support from all the functional areas of the parent
organization and once it attains a stable position economically, then support is slowly
withdrawn enabling it to function independently within the firm.
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105
Closing the project both by extinction and by addition share a similarity, i.e, the
project is closed when its existence is no more a viable option for the organization.
In the process of closing a project by addition, the project can either be added to the
parent organization as a department or as an independent subsidiary depending on the
projects ability to be economically independent. Although a project is given financial
and tactical support in the initial stages of addition to the parent organization, it is
expected to show economical independence with time.
Transfering project resources after closing it by addition is different from that of
closing by extinction. In closing a project by addition, the resources of the project are
transferred from the account of the successful project to the account of the newly
created department or subsidiary. The addition of the project and its subsequent
transformation is supported by adequate budgetary allocations as per the rules of the
parent organization.
All the assets including the human capital of the closed project are transferred to the
new department. During the process of transition from a project to a new department
or a subsidiary, the administrative practices and the budgetary style of the parent
organization are adopted. There is also the possibility of some individuals in the
project requesting for a transfer to the other projects, because of the sharp decline in
the freedom during the transformation. It is the responsibility of the project manager
to ensure a smooth and free transition of the project into a department. However, it is
not an easy process; it is one of the most challenging tasks for the project manager.
For successfully transforming a project into a department, the project manager should
manage several political issues diplomatically.
Closing by Integration
This type of closing is used for technically complex projects which on completion will
form a part of the operating system of the parent organization or the client. It is the
responsibility of the project team to integrate the product into the operating system of
the parent or client organization. The difficulties in integration can be minor or major.
When a new machine center is installed by the project team and they have detailed its
operation and maintenance to the customer, minor operational problems can be solved
by the operations manager.
However, when a flexible manufacturing system is installed by the project team, then
the difficulty of integration is higher. The difficulty in integrating a project is
inversely proportional to the expertise and experience level of the parent or clients
firm in technology and project integration.
The problems faced while closing a project by integration are similar to the ones that
are encountered while closing it by addition. Also the project may not fuction as
effectively as it used to function when it was in the project phase. There is a
possibility that members of the project team lose interest in the old project as they
come back to their respective departments in the organization. Some significant issues
related to the functional aspects of closing a project by integration are:
Human capital: Where to send the project team? Should it continue as a team? Who
will perform the functions of the team if required? What should be the guidelines for
the availability of the ex-team members of the closed project for any support required,
if they are assigned any new projects?
Production: Is the training fulfilled? Is there a need for replanning the layout of the
production system? Are there any bottlenecks because of the change in the layout? Is
a new procedure in operations required? Is the new operation integrated with the
firms information systems?
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Finance: Are the project accounts terminated and evaluated? Is there a provision for
the extra work needed by the project in the budgeting of new departments? Are all the
assets distributed as per the contract?
Engineering: Have all the drawings been filed? Is there a proper understanding of the
operating manuals and change procedures? Are the training programmes tailored as
per the needs of the new employees? Are the maintenance plans modified according to
the changes? Are there adequate number of spares in inventory?
Information systems: Is the new system tested and evaluated thoroughly? Is the
documentation of the software complete? Is there complete integration between the
new and the existing systems? Have the end users been trained properly to use the
new system?
Marketing: Are the marketing and sales departments aware of the changes made?
What is the level of comfort for the marketing department in the new line? Is the
strategy ready to be implemented by the marketing personnel?
Procurement, logistics and legal: Have the changes been communicated to all these
and other functional areas ?
Closing by Starvation
This method of project closing cannot be considered a closing in the strict sense,
because here the projects existence comes to an end as a result of declining budgets.
Budget cuts are common during periods of recession and they can also be used as a
supporting reason to terminate a project.
There is substantial resistance from the top management in closing a project that is not
successful, especially when it is politically risky to acknowledge failure. And under
such circumstances, the budget of the project is cut to a level at which progress of any
activity of the project is hindered. As a result, the project is shelved, although it may
still be shown as an ongoing project.
Example: Checklist to Find the Readiness of the Project for Closing
Parameter Yes No
1. Consistency with organizational goals.
2. Practicality and Utility.
3. Management support to run the project.
4. Consistency of scope with the economic strength.
5. Consistency with all the technical issues of interest.
6. Support from the functional departments.
7. Organization project support is diluted.
8. Supporting individual project can lead to success.
Contd
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107
Contd
9. Project involves advanced technology-ahead or outdated
technology.
10. Innovative project team.
11. Possibility of protecting new knowledge with patents and
copyrights.
12. Termination without loss of quality.
13. Ability of the current project team to continue the project.
14. Presence of skills required to execute the project fully.
15. Explore the subject area of the project thoroughly.
Note: When all the above parameters are satisfied, then the project can be said to
be terminated successfully. When majority of the parameters are satisfied, then the
project is said to be terminated under conditions of time i.e., by extinction. But
when only a few of the parameters are met, then the project is terminated because
of budgetary constraints i.e., by starvation.
Adapted from Robert Buttrick The Interactive Project Workout, Financial Times Prentice
Hall, Second Edition, p 545.
Activity: Ding Dong Telecommunication Ltd. (DDTL) is a Noida based
telecommunication equipment manufacturing company. It is working on a project
for manufacturing CDMA (Code Division Multiple Access) technology switches
for a cellular company in Bangalore. A month after the submission of the audit
report, the top management of DDTL asked the project manager to close the
project. Why does the top management of the firm want to close the project? What
are the ways in which a project manager can close a project? Specify the situations
in which a project manager can close a project?
Answer:
Check Your Progress
3. What type of project closing is used to close a project that has succeeded in
accomplishing its goals or has failed to deliver within the budgeted time and cost?
a. Closing by starvation
b. Closing by extinction
c. Closing by integration
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4. From the following options, identify the reasons for ending the project under
closing the project by extinction?
i. Mergers and acquisitions
ii. Political Pressure
iii. Introduction of a new product in the market
iv. Demergers
a. Only i and ii
c. Only ii and iii
5. The type of project closing used to close a project when its existence comes to an
end as a result of declining budgets is known as _______________.
a. closing by starvation
b. closing by addition
c. closing by integration
d. closing by extinction
6. ___________ is the method adopted when in-house projects are closed.
a. Closing by addition
b. Closing by extinction
c. Closing by integration
d. Closing by starvation
7. Which of the following options are significant issues related to the functional
aspects of closing the project by integration?
i. Production
ii. Information systems
iii. Finance
iv. Engineering
a. Only i and ii
b. Only ii and iii
c. Only iii and iv
5. Reasons for Terminating an Unsuccessful Project
A project can be called an unsuccessful one when it fails to meet its established
objectives on time, budget and performance. Failure to meet any of these three
fundamental parameters can result in project failure and such projects qualify to be
closed. Some other key factors that call for project termination are:
Probability of meeting technical objectives is very low.
Inability of R&D to resolve the technical problems.
Return on investment is not significant or is very low.
High cost involved in running it as an individual project.
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Market potential of the delivered output is very low.
Constantly changing market needs.
Requires a very long time to gain profits
Bears a negative impact on other projects.
Problems created by intellectual property rights.
6. The Process of Closing a Project
The process of closing a project is equally complex and lengthy as planning the scope
of the project. So a project manager is always in need of a systematic methodology
that will help him close projects smoothly. There are also situations where
termination managers are employed to handle the process of closing the project. A
termination manager should be a person who is well versed with the administrative
parameters of closing and is equally good at analyzing the organizational climate in
which the successful project would be put to work. The basic responsibilities of a
termination manager are as below:
To make sure that all tasks are accomplished, even those of external contractors and
vendors.
Inform the client about the completion of the project and deliver the product/project.
Make sure that project documentation is completed along with a final auditing of the
delivered output and submit a final project report.
Ensure that the final invoices are sent to the client and get them cleared.
Put all the resources and assets back to their respective positions in the parent or
clients organization.
Get clearance from the legal consultant on the project.
Find out all the documents that are worth storing
Check for the proper closing of the project books.
The following are the steps to follow while terminating a project: (i) getting clients
acceptance, (ii) installing the projects delivered output, (iii) documenting the project
and (iv) signing and submitting the final report.
Getting Clients Acceptance
It is the project managers responsibility to show to the client that the delivered
product or service matches the specifications set by the client. Acceptance can either
be informal or formal. Acceptance involves a test on the delivered output to check its
performance against the standards established by the client.
Informal or Ceremonial Acceptance
Informal acceptance by the customer involves no signing on the final report to
acknowledge the projects success. Ceremonial acceptance is given by the client in
two cases. The first is wherein the client accepts the project as closed at a particular
time. The second is where there is no need to measure the conformity of the final
product.
Formal Acceptance
This is a situation in which the client has a formal acceptance methodology in place
while entering into a contract with the project manager. In many projects, both the
client and the members of the project team develop the acceptance methodology. This
happens at a very early stage in the project life cycle. This methodology involves the
110
project team proving to the client about the delivered outputs conformance with the
clients specifications. This method involves a detailed step-by-step and feature-by-
feature signing off on the performance tests conducted. The performance tests
conducted are done in the presence of both the client and the team members. The
checklist should be designed in such a manner that it requires no further interpretation
to find out whether there is conformance to performance or not.
Installing the Projects Delivered Output
This is the most common step in the closing of an information system project or a
manufacturing set-up project. This phase can involve some steps or strategies in itself.
However it is considered as a single event or a process that transfers the product into
the clients control. This phase initiates several activities of closing pertaining to
documentation and preparation of the final report.
Documenting the Project
Documenting is the most difficult task in project closing. The following are the
reasons behind documenting a project:
Documentation acts as a reference for any future changes in the delivered output of
the project, even after the completion of the project. Changes that arise out of a strong
reason to follow-up, repair or upgrade the project require documents for reference.
Utilizing delivered output enables the client to explore the chances of improvement,
including new features and functions.
It provides historical data that help clients to estimate the time and cost of future
projects. Past projects can act as an encyclopedia to provide relevant information for
all future projects, activities and tasks. But this is possible only when a project is
properly documented to be retrieved in the future. The data containing the scheduled
and actual duration, planned and actual cost of each task etc. will prove highly
valuable in planning these parameters in future projects.
It acts as a source of training new project managers. It teaches new project managers
valuable lessons like determining the work breakdown structure, analyzing and
examining the requests for change and taking decisions on the same and exploring
problem situations and solving them.
It becomes an input for further training and development required by the project team
members. Project documentation helps project team members to handle any situation.
The way in which a similar situation was handled in earlier projects will be a good
reference.
Documentation becomes the basis for evaluating the performance of the project team
members. Most of the firms use project documents as a source of evaluating the
project manager and the project team members. Functional managers or individuals
using this tool for evaluation should be extremely careful because even the best or
exceptionally good performance of the team members may result in a failed project,
or vice-versa.
Signing and Submitting the Final Report
One of the most significant characteristics of an ideal project management system is
its ability to report project history. Project history is best reported in a final project
report. It is the content of the report that is of prime concern in a final report than the
way it is organized. The topics that need to be covered in a final report are -- the
performance of the project; project performance in terms of administration; the
organizational structure; project and administrative teams; and techniques of project
management.
Project Closing
111
The Performance of the Project
One of the most important parts of the report is the comparison between the
accomplished tasks of the project and the tasks proposed. The comparison should
involve description of the reasons behind the variation of the delivered product from
the planned product. It is advisable to have a final end value discussion. Including
project performance in the final report can also give the judgement of the project
manager elaborating on the reasons for deviation, since it is not a formal evaluation.
This section of the report should also include suggestions for future projects that may
involve similar situations.
Project performance in terms of administration
This part of the project is often overlooked until problems crop up. Though the
administrative department of a project cannot resolve the technical issues of the
project, it can provide substantial help in implementing an appropriate technology.
After examining the administrative procedure, the practices that worked well or not so
well need to be highlighted. It is also advisable to describe the reasons behind the
effectiveness or ineffectiveness of an administrative practice. This enables project
members to discuss future strategies.
The organizational structure
Every organizational structure used in a project has its own merits and demerits. This
section of the report should describe the role of the organizational structure in the
success or failure of the project. Suggestions should be made if it is felt that a slight
modification or change in the organaizational structure would have been beneficial to
the project. The suggestions should be rational and substantiated with examples.
Project and administrative teams
Under some circumstances, even the most competent individuals do not perform as
well as expected in a team. In such situations, a report on the performance of the team
should be given to the top management of the parent firm. Any recommendations
should be made in a confidential manner. Recommendations can also be made by the
project manager to the top management recommending those individuals who were
very effective in running a team, be retained for future projects.
Techniques of project management
The quality of a project output depends on the efficiency with which it is planned,
budgeted, assigned resources and controlled. Since the quality of the output is linked
strongly with the efficiency in planning, budgeting and controling, it is very important
to check the way in which these tasks were accomplished. The report should contain
the ways of increasing efficiency of the forecasts, budgets and schedules, if they were
not upto the desired standards. The procedures used in planning, controling and
managing risk should also be checked thoroughly.
There is also another format in which a project termination report can be made
depending on the nature of the project. All topics covered in a final project report
should be listed along with suggestions for altering the existing practices. These
suggestions should also be properly justified. It is important to mention the remarks
and suggestions on the issues of the project that performed exceptionally well, but
covering this topic in the report is usually overlooked. The final report should also
highlight all the informal methods used by the project managers and the team
members to speed up the process of preparing the budget, scheduling and improving
predictions. Such methods can be tested and if proven successful can be
instituitionalised as a part of the project management methodology in the parent
organization.
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The basic purpose of a final project report is to improve the way in which future
projects are to be handled. It highlights the project and the way in which it is
executed.
Though data on the projects results are available in reports and audits conducted
throughout the project life cycle, the project manager can certainly use his experience
to talk about result oriented projects. It is the project managers job to maintain a diary
on all significant issues. This practice will ensure the inclusion of such issues in the
final report. Though a project managers diary is not a formal document, it is an
informal collection of thoughts and remarks on the various incidents during the
project. On the whole, it prevents the ideas from getting lost.
Example: Contents of a Project Closing Report
Section Contents
1. Business
objective
The objectives of the business as mentioned in the initial
project proposal, approved changes along with the reasons.
2. Closing
statement
The situation in which the project is being terminated for
example, on successful completion of the project or termination
of the project before completion.
3. Measuring
the benefits
The process of measuring the advantages offered by the project
and also the person responsible for measuring the same. Also
includes the reflection of the advantages offered by the project
in the existing business plan along with the review periods.
4. Risks, issues
and
outcomes
All the issues and outcomes that are not yet approved along
with the kind of risk involved and the reason for not being
approved. The person to be held responsible.
5. Efficiency of
the project
Compare the resources and costs incurred with what is actually
planned in the project plan along with schedule.
Adapted from Robert Buttrick The Interactive Project Workout, Financial times Prentice
Hall, Second Edition, p 414.
Activity: Pure Acoustics Inc. is a US-based home theatre system manufacturing
company. The company had initiated a project for developing a state-of-the-art
digital signal receiver. After the design was approved, the project team was given
18 months to complete the project. Because of high employee turnover, the project
took more than double the time, and yet there were some problems with the
functioning of the product. Soon, top management decided to terminate the project.
What are the reasons behind terminating an unsuccessful project? Also, explain the
procedure of closing a successful project (assuming that this project was
successful)?
Answer:
Project Closing
113
Check Your Progress
8. The process of closing the project is a complex and lengthy affair. The person
who is specifically appointed to close the project is called the _______________.
a. closing manager
b. termination manager
c. project manager
9. When there is no need to measure the conformity of the final product to
predetermined standards, the kind of acceptance taken from the client for closing
the project is called
a. informal acceptance.
b. ceremonial acceptance.
c. formal acceptance.
10. From the following options, pick the ones that need to be covered in a final
project report.
i. Performance of the project
ii. Project performance in terms of administration
iii. Project and administrative teams
iv. Techniques of project management
a. Only ii
b. Only ii and iii
c. Only iii and iv
11. Which of the following steps in the closing of the project will help in providing
historical data that will help the clients estimate the time and cost of future
projects?
a. Getting the clients acceptance
b. Documenting the project
c. Installing the projects delivered output
d. Signing and submitting the final report
12. Which of the following options do not form the basic responsibilities of the
termination manager before he/she closes the project?
a. Getting clearance from the legal consultation on the project
b. Finding all the documents that are worth storing
c. Ensuring that the implementation of the project is profitable to the project
organization
d. Ensuring that the final invoices are sent to the client and getting them cleared
13. There are four steps in terminating a project. Which of the following is the last of
these steps?
a. Getting the clients acceptance
b. Signing and submitting the final report
c. Documenting the project
d. Installing the projects delivered output
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14. ____________ becomes an input for further training and development required
by the project team members.
a. Documenting the project
b. Final project report
15. One of the most significant characteristics of an ideal project management system
is its ability to report project history. Project history is best reported in the
__________ report.
a. project termination statement
b. final project
c. closing report
16. Identify the step in the process of closing a project that involves transfer of the
product into the clients control.
a. Documenting the project
b. Getting the clients acceptance
d. Signing and submitting the final report
17. ______________ involves the project team proving to the client that the delivered
output conforms to the clients specifications.
a. Acceptance methodology
b. Formal acceptance
c. Informal acceptance
7. Summary
A project comes to a close after it accomplishes its objectives or when it is terminated
due to other reasons.
A project is terminated when the work on the project has come to a point where there
is no further progress is possible. This might happen when the project is running far
behind schedule or when its resources are transferred to other projects.
A project can be closed in four ways closing by extinction, closing by addition,
closing by integration, and closing by starvation.
A project can be called an unsuccessful one when it fails to meet its established
objectives on time, budget, and performance. Failure to meet any of these three
fundamental parameters can result in project failure and such projects qualify to be
closed.
The process of closing a project is equally complex and lengthy as planning the scope
of the project. So a project manager is always in need of a systematic methodology
that will help him close projects smoothly.
Project Closing
115
Termination managers are employed, in some cases, to handle the process of closing
the project. He/she should be a person who is well versed with the administrative
parameters of closing and is equally good at analyzing the organizational climate in
which the successful project would be put to work.
Following are the steps to follow while terminating a project: (i) getting clients
acceptance, (ii) installing the projects delivered output, (iii) documenting the project,
and (iv) signing and submitting the final report.
8. Glossary
Project closing by addition: This method is adopted when in-house projects are to
be closed. When a project team undertakes an in-house project for implementing it in
its parent organisation and if it is successful in meeting its objectives, then the project
can be closed by incorporating it as a functional and formal part of the organisation.
Project closing by extinction: Projects are closed by way of extinction either when
they are successful in accomplishing the goals or when they fail to deliver within the
budgeted time and cost.
Project closing by integration: This type of closing is used for technically complex
projects which on completion will form a part of the operating system of the parent
organization or the client.
Project closing by starvation: This method of project closing cannot be considered a
closing, because here the projects existence comes to an end as a result of declining
budgets.
1. A project comes to a close after it accomplishes its objectives or when it is
terminated. Under what circumstances can a project be closed? What are the steps
involved in the formal closure of a project?
2. A project can be closed when it has reached a point where there is no progress
possible even in terms of improving the effectiveness and efficiency of the
output. What are the various ways in which a project can be closed?
3. A project is terminated when it is running far behind schedule or when its
resources are transferred to other projects. What are the various factors that call
for project termination?
4. The process of closing a project is very complex and lengthy. Explain in detail
the steps involved in closing a project. Who is a termination manager? What are
the basic responsibilities of a termination manager?
116
1. (c) project closing
A projects activities are terminated when the project has come to a point when
further progress is not possible in its implementation. This is called project
closing.
The steps that are taken by a project organization before closing the project are:
Ending the external contracts of the company formally, suspending the
assignments of the team members formally, seeking the acceptance of the client
formally, making sure of the proper installation and implementation of the
delivered output, making sure that proper project documentation is done,
submitting the final report and getting it approved, and closing the established
relationships internally and externally.
3. (b) Closing by extinction
Closing by extinction is the method of closing a project when it has succeeded in
accomplishing the goals set or when it has failed to deliver within the budgeted
time and cost. Under closing by starvation, the project comes to an end as a result
of declining budgets. Closing by integration is the type of project closing used for
technically complex projects, which become a part of the operating system of the
organization.
The reasons for ending a project under closing the project under extinction are:
political pressures, mergers and acquisitions, and demergers. The introduction of
a new product is one of the reasons for closing successful projects.
5. (a) closing by starvation
The project is closed by starvation when its existence comes to an end as a result
of declining budgets, resistance from the top management, when it is politically
risky to continue or when the projects have a negative effect on the image of the
company in the market. Closing by addition is adopted when in-house projects
are to be closed. When a project team undertakes an in-house project for
implementing it in the parent organization and if it is successful, the project is
closed by incorporating it as a formal part of the organization. Closing by
integration is one of the methods by which the project is closed. This method is
used for technically complex projects which become part of the organizational
system of the organization. Closing by extinction is used to close the project
when it has succeeded in accomplishing the goals set or when it fails to deliver
within the budgeted time and cost.
6. (a) Closing by addition
Closing by addition is the method followed when integrating an in-house project
into the functional and formal part of the organization. Closing by extinction and
starvation are the methods followed when it is not feasible to run the project
further. Closing by integration is the type of project closing used for technically
complex projects which will become a part of the operating system of the
organization.
Project Closing
117
Closing by integration is one of the methods by which a project is closed. This
type of closing is used for technically complex projects which become part of the
organizational system of the organization. There are some significant issues
related to the functional aspects of closing a project by integration. They are:
Human capital, production, finance, engineering, information systems, marketing,
procurement, logistics, and legal.
8. (b) termination manager
The person who is employed to look into the termination of the project is called
the termination manager. The termination manager is a person who is well versed
with the administrative parameters of project closing. A project manager may also
look after the project closing activities of the organization. However, he/she is not
specifically employed for this purpose.
9. (b) ceremonial acceptance.
Ceremonial acceptance is given by the client in two cases. The first is where the
client accepts the project as closed and the second is when there is no need to
measure the conformance of the final product to predetermined standards.
Informal acceptance is taken when there is no need to sign on the final report to
acknowledge the projects success. Formal acceptance is taken in situations where
the client has a formal acceptance methodology in place while entering into a
contract with the project manager.
The important topics that need to be covered in the final report are performance
of the project, project performance in terms of administration, organizational
structure, project and administrative teams and techniques of project
management.
11. (b) Documenting the project
Documenting is a crucial and difficult step in closing the project. It enables
clients to estimate the time and cost of future projects.
12. (c) Ensuring that the implementation of the project is profitable to the
project organization
There are some basic responsibilities that a termination manager has like making
sure that all the tasks are accomplished, informing the clients about the
completion of the project, making sure that the project documentation is
completed, ensuring that the final invoices are sent to the client and cleared,
putting all the resources and assets back into the respective positions in the parent
and clients organization, getting clearance from the legal consultant, finding out
the documents that are worth storing and checking out the proper closing of the
project books. Ensuring that the implementation of the project is profitable to the
organization is not his/her responsibility.
13. (b) Signing and submitting the final report
The four steps in the termination of a project are in sequence: Getting the clients
acceptance, installing the projects delivered output, documenting the project, and
signing and submitting the final report.
118
14. (a) Documenting the project
Documenting the project is one of the most difficult and crucial tasks in project
closing. Documenting becomes an input for further training and development
required by the project team members. It also helps the project team members to
handle any situation by giving insights into how a similar situation was handled
in earlier projects.
15. (b) final project
The ability to report project history is one of the significant characteristics of an
ideal project management system and project history is best reported in the final
project report. The project termination statement is a statement that is agreed on
and signed by the client after he/she accepts the completion of the project to
his/her level of satisfaction. The project closing report is another form of
preparing the project termination statement. In this type of report, all the topics
covered in the final report should be listed along with the suggestions for altering
the existing practices.
16. (c) Installing the projects delivered output
Installing the projects delivered output is the second step in the process of
closing the project. This involves transferring the product into the clients control.
Transferring the project into the clients control is undertaken after the acceptance
is received from the client.
17. (a) Acceptance methodology
Acceptance methodology involves the project team proving to the client that the
delivered output conforms to the clients specifications. The situation of formal
acceptance arises when the client has a formal acceptance methodology in place
while entering into a contract with the project manager. Informal acceptance does
not require the client to sign on the project final report to acknowledge the
projects success.
Course Components
Block
IV
INTRODUCTION TO OPERATIONS
MANAGEMENT
UNIT 16
Operations Management and Operations Strategy 1-22
UNIT 17
Forecasting Demand 23-55
UNIT 18
Allocating Resources to Strategic Alternatives 56-83
UNIT 19
Design of Production Processes 84-97
Expert Committee
Hyderabad Hyderabad


Hyderabad


Prof. Vivek Gupta
Hyderabad

Hyderabad

Ms. Smita Singh
IU, Sikkim

Mr. Ch Syamala Devi
IU, Meghalaya

Hyderabad

IU, Mizoram
Aizawal

IU, Dehradun

Mr. Manoj Kumar De
IU, Tripura
Agartala






Block IV
Introduction to Operations Management
The fourth block of the course on Project & Operations Management deals
with the fundamental concepts relevant to operations management. The block
contains four units. The first unit explains operations management and
operations strategy. The second unit focuses on the importance of forecasting
in the field of operations management. The third unit discusses how to allocate
resources to strategic alternatives in operations strategy. The fourth unit
examines the design of production processes.
The first unit, Operations Management and Operations Strategy, discusses the
definition of operations management and operations management decisions.
The unit focuses on the evolution of operations management and the use of
computers and advanced technology in the field. The unit also deals with the
use of operations strategy as a competitive weapon, its elements, and the ways
to develop it. The unit also provides an idea about the financial and economic
analysis in operations.
The second unit, Forecasting Demand, deals with forecasting in operations,
and its various components. The unit also explains the demand forecasting
process and the different forecasting methods used. The unit discusses the
steps involved in the demand forecasting process, and the ways to measure the
forecasting accuracy. It also discusses how to monitor and control forecasts.
The third unit, Allocating Resources to Strategic Alternatives, provides an idea
about allocation decisions in operations strategy. The unit explains the concept
and use of linear programming in operations management. It discusses how to
formulate linear programming problems, and how to find solution to such
problems. The unit also discusses transportation problems in linear
programming.
The fourth unit, Design of Production Processes, explains planning and
design of production processes. The unit discusses the major factors affecting
process design decisions, and the various types of process designs. It also
examines the different process planning aids. The unit also discusses how to
select the type of process design.
Unit 16
Operations Management and Operations Strategy
Structure
1. Objectives
2. Introduction
3. Operations Management Decisions
4. Historical Evolution of Operations Management
5. Computers and Advanced Operations Technology
6. Operations Strategy as a Competitive Weapon
7. Elements of Operations Strategy
8. Developing an Operations Strategy
9. Financial & Economic Analysis in Operations
10. Summary
11. Glossary
1. Introduction
In this unit, we introduce you to operations management and operations strategy.
Business organizations today are facing a highly competitive and challenging business
environment. Firms face various barriers in the form of archaic technology,
underdeveloped infrastructure, inappropriate payment systems, and ineffective
scheduling and control systems. At the same time, they also face a threat from foreign
companies. Therefore, it has become imperative for the operations managers of
companies to reduce manufacturing costs, optimize productivity, and improve product
quality to survive in the market.
Operations management can be defined as the management of direct resources such as
machine, material, and manpower, which are required to manufacture goods and
services. The process involves planning, organizing, controlling, directing, and
coordinating all the activities of production systems which convert resource inputs
into products or services. Operations management deals with the designing of
products and processes, acquisition of resources, conversion of resource inputs into
outputs, and the distribution of goods and services.
To succeed in a competitive business environment, an organization needs a sound
strategy. Strategies are broad, long-term plans, conceived of to achieve business
objectives and are developed at the corporate, business, and functional levels.
Operations decisions are normally taken with the business objectives and functional
objectives of marketing, finance, and human resources departments in mind. The
nature of the goods or services to be produced and the markets to be served influences
the operations strategies.
This unit will define operations management and operations management decisions.
We will discuss the historical evolution of operations management and the use of
computers and advanced technology in operations. We shall then move on to discuss
the use of operations strategy as a competitive weapon, identify the elements of an
operations strategy, and explain how to develop an operations strategy. Finally, we
would discuss financial and economic analysis in operations.
2
2. Objectives
define operations management and operations management decisions.
discuss the historical evolution of operations management.
computerization of operations and advanced operations technology.
recognize operations strategy as a competitive weapon.
identify the elements of an operations strategy.
explain how to develop an operations strategy.
financial and economic analysis in operations.
3. Operations Management Decisions
Operations managers have to take decisions regarding the designing and
implementation of operational strategies, which indicate how the companies utilize
their production capabilities to achieve their organizational objectives. The decisions
taken by the operations managers can be classified into strategic, tactical, and
operational decisions. Strategic decisions are long term in nature and have a time
period of five years or more. Tactical decisions are medium term in nature and have a
time period of one or two years. Decisions on manpower requirement, inventory
levels, determining the reordering level and order quantity, identifying vendors, etc.
come under tactical decisions. The operations managers have to ensure that the
tactical decisions are properly aligned with the strategic decisions. Operational
decisions are short-term decisions and have a time period of less than a week.
Activity: Kevin works for a local mobile manufacturing company operating in
Africa. The company had been facing a downturn due to the entry of foreign
players. The top management of the company asked Kevin to suggest ideas to fight
the competition. Kevin felt that the company was relying too much on outdated
technology, was incurring huge costs, and had a faulty control system. He
recognized that the company needed a good operations management team. Help
Kevin in the process of explaining to the management about the importance and
need for good operations management.
Answer:
4. The Historical Evolution of Operations Management
The concept of modern operations management evolved in the early eighteenth
century when Adam Smith acknowledged the significance of division of labor. In his
book, The Wealth of Nations, he said that to enhance productivity, jobs should be
divided into sub-tasks, and these tasks assigned to workers based on their individual
skills and capabilities. Frederick W. Taylor in his book The Principles of Scientific
Management, a milestone in the field of operations management, adopted this
3
concept. The term Production Management was used till the early 1970s. But with
the inclusion of purchasing, dispatch, and other allied activities and the growing
influence of the service sector, it was replaced by a more general term Operations
Management, that incorporated both production as well as service related concepts
and procedures.
4.1 Scientific Management
The concept of scientific management was introduced by Taylor in his book The
Principles of Scientific Management. According to the concept, the productivity of a
worker is governed by scientific rules and the management needs to study and apply
these rules in its operations. Some of the key concepts are given here:
1. Each worker should be assigned a task based on his/her skill, strength, and
ability to learn.
2. A standard output time should be set for each task, using stopwatch studies. This
should be used to plan and schedule future tasks.
3. Instruction cards, routing sequences, and material specifications should be used
for coordinating the activities in a shop, and work methods and work flow should
be standardized.
4. There should be proper supervision by carefully selected and trained supervisors.
5. There should be incentive pay systems to motivate workers.
4.2 Moving Assembly Line
Henry Ford applied the principles of scientific management to a moving assembly line
in 1911 while manufacturing the Model T Ford automobile, where he employed
standardized product designs, mechanized assembly lines, specialized labor, and
interchangeable parts in production units. This reduced the production time for the car
chassis from twelve-and-a-half hours to ninety minutes. This was the first ever
successful application of the principles of scientific management and it had the effect
of increasing their popularity worldwide.
4.3 Hawthorne Studies
In 1927, a Harvard Business School research team led by George Elton Mayo carried
out a study at the Hawthorne plant of Western Electric in Chicago. The team carried
out illumination studies to study the relationship between the intensity of light on the
shop floor and employee productivity. The team found that the employee productivity
increased irrespective of the increase or decrease in the intensity of light. Through
these observations, the team concluded that it was the attention and the importance
received by the workers during the study that had resulted in the increased
productivity and not the light or other physical conditions. The study initiated an
extensive research into the behavior of employees in the working environment.
Example: Hawthorne Experiments A Human Relations Initiative
Between 1924 and 1927, Mayo along with a team of scientists conducted
experiments on human behavior. The series of experiments were carried out
at the Hawthorne Works of the Western Electric Company in Chicago. The
findings contributed to organizational development in terms of human relations
and motivation theory. In the first series of experiments, Mayo wanted to find
out the effects of fatigue and monotony on job productivity and the various
ways to control them through rest breaks, work hours, temperature, and humidity.
Contd
4
Contd
He selected six women employees from the assembly line and made them work
separately under a friendly observer. Mayo made frequent changes in the working
conditions of these employees but informed them in advance about the changes. He
changed the working week, the hours in the workday, the number of rest breaks, the
time of lunch break, etc. and at times returned the employees to their original, more
difficult working conditions. The observations were that these workers became a
team and participated freely in the experiment. They worked wholeheartedly, and felt
that they were working under less pressure and without coercion. Absence from work
dropped by 80% and regular medical checks showed no signs of fatigue.
The second series of experiments was the relay assembly. In this experiment, two
girls were selected and they were asked to select another four. They were put to
work in assembling telephone relays, small but complex mechanisms composed of
forty separate parts. The girls were to assemble these parts and to drop them into a
chute when they completed them. The relays were mechanically counted as they
were dropped into the chute. The production rate was noted at the beginning of the
experiment. Changes were subsequently introduced to test whether the production
of relays increased or decreased. It was observed that, each girl had her own
technique of assembling the component parts, and sometimes varied her technique
to avoid repetitiveness. It was also observed that the more intelligent the girl was,
the greater were the number of variations. The experimental group had
considerable freedom of movement. They were not pushed around or supervised by
anyone. These conditions resulted in an increased sense of responsibility which
came from within the group, instead of it being imposed by the top management.
Through these experiments, Mayo found out that workplaces are social
environments and that the people in them are motivated by social relationships
more than economic self interests.
Adapted from, Mayo's Hawthorne Experiments,
<http://www.telelavoro.rassegna.it/fad/socorg03/l4/Elton%20Mayo-Hawthorne.htm>
Activity: Syeda works for an engineering company. The management noticed that
the productivity of the workers had been decreasing over the years and asked Syeda
to find out the reasons for this. Syeda decided to carry out a study on the
relationship between the increase in monetary or non-monetary benefits and
employee productivity. Assist her in the process and also suggest ways in which the
workers productivity can be improved.
Answer:
4.4 Operations Research
World War II created problems of logistics control and weapon systems design and
manufacture for many countries. To tackle these problems, the US and many
European nations formed operations research teams in their military branches. These
5
teams developed mathematical techniques to assist them in taking appropriate
decisions in complex logistical situations. After the war, these operations research
techniques were used by many businesses to make their decision-making processes
more effective.
Check Your Progress
1. On the basis of Hawthorne studies, Elton Mayo and his team concluded that
________had a major impact on employee productivity.
a. Physical work conditions
b. Importance and recognition given to employees
c. Job content
d. Fear of losing job
2. Which company first adopted the concept of scientific management in the
assembly line production system?
a. General electric
b. Ford motors
c. General motors
d. Westinghouse
3. Decisions on production and process design, facility location and layout etc, are
part of which decision category?
a. Strategic decisions
b. Tactical decisions
c. Operational decisions
d. All of the above
4. Which of the following decision do not fall within the basic scope of operations
management?
a. Analyzing the firms financial position
b. Designing a new assembly line
c. Determining the location of a new distribution center
d. Improving product quality
5. Division of labor or specialization is an outcome of ____________.
a. Industrial revolution
b. World War II
c. Scientific management
d. Computerization of production systems
6. The decisions that operations managers take can be broadly classified into various
categories. What is the usual time-frame for tactical decisions?
a. Seven years or more
b. One or two years
c. Two to four months
d. A couple of weeks
6
7. Operations Management deals with which of the following?
a. Design of products
b. Design of services
c. Acquisition of resources
d. All of the above
8. The term Production Management was replaced by a more general term
Operations Management in the 1970s. What led to the enlargement of the field
and use of the new term?
i. Inclusion of purchasing function
ii. Inclusion of dispatch and other related activities
iii. Inclusion of services related concepts and procedures
iv. Inclusion of manufacturing technologies
a. i, ii, iii
b. iii, iii, iv
c. i, iii, iv
d. i, ii, iii, iv
9. Who was involved in the Hawthorne experiments at the Western Electric plant?
a. Frederick Taylor
b. Henry Ford
c. Elton Mayo
d. Adam Smith
5. Computers and Advanced Operations Technology
Computerization of operations began in 1954 with the installation of the first
computer at the General Electric Appliance Park. The only use that computers were
put to then was to prepare salary and accounting statements. In the 1960s, operations
managers began using computers to enhance the efficiency of the production system.
In the 1970s, organizations began using manufacturing information systems for
planning and controlling operations. During the 1980s with the growing complexity in
software and hardware technologies, advanced production systems like computer-
aided design (CAD), computer-aided manufacturing (CAM), flexible manufacturing
systems (FMS) and automated storage and retrieval systems (AS/RS) were developed.
CAD is specialized software used for designing products and processes. Advanced
CAD systems enable engineers to test the performance of their design through
computer simulation. CAM is a specialized computer system used for translating
CAD design information into instructions for numerically controlled automated
machines. The use of CAM in manufacturing reduces the workers involvement in the
production process. The FMS is a set of automated machines controlled by a central
computer. These systems can produce a large quantity of products that have similar
processing requirements. AS/RS is a computer-controlled warehouse system which
automates inflow and outflow of materials from the warehouse and the shop floor on
the basis of production requirements.
In the 1990s, many new concepts and technologies like artificial intelligence and
expert systems influenced manufacturing systems. Programmable machines like
robots capable of tackling multiple tasks were introduced in the production process.
7
Activity: Sahiti works for a small automobile manufacturing company as an
operations manager. The company manufactures two-wheelers manually, using few
machines and equipment. The top management has decided to introduce new
technology and to computerize its production processes with the profits gained in
the previous financial year. Sahiti has therefore been asked by the management to
identify the advanced computer technology tools that are available for enhancing
production process. Can you assist Sahiti in this process?
Answer:
Example: Robotics in Automobile Manufacturing
Robots were first introduced in 1971 at X Motor Co. plant in Japan. The use of
robots increased in the company thereafter and the number of robots it had rose
to 730 by 1981. Robots were used for performing welding operations in body
assembly shops. They were also used for painting. Other technologies like
CAD, CAM, transfer machines, and automobile loads were also used by the
company. Robots were mainly used to do heavy, dangerous, and repetitive
work for which few workers were available. The use of robots led to improved
product quality, fewer instances of human error, and increased mechanical
reliability. Between 1970 and 1980, due to the use of robots and other
technologies, the output of the company rose by 186% and productivity
increased by 139%. The welding robots enhanced the product quality, and
reduced the price of automobiles, thus resulting in increased demand for
automobiles. The employment in the plant increased in skilled jobs requiring
operating, maintaining, and programming robots, work injuries decreased, and
job satisfaction was enhanced as workers were relieved of noise, oscillation,
and other job hazards. Apart from the use of robots, the companys success in
terms of enhanced product quality and output can also be attributed to
rationalization of the production process, automation, improved equipment, and
efforts by quality circles.
Adapted from Kazutoshi Koshiro, Robots are a big success at auto plant in Japan,
http://stats.bls.gov/opub/mlr/1984/08/rpt5full.pdf
3. Operations Strategy as a Competitive Weapon
Any business organization aims to attract more customers than its competitors.
Organizations thus identify their distinct competencies to gain a competitive
advantage over others. The companys operations function determines its choice of
products and markets and its competencies. The following topics indicate how
operational strengths can be used effectively as competitive weapons:
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Example: McDonalds Operations
McDonalds Corporation is a renowned fast food restaurant chain with a presence
in more than 100 countries worldwide. To lead the fast food industry, McDonalds
offers healthy food to its customers with better service and at cheaper prices. The
company has competitive advantages in many fields price, quality, employee
training, management, etc. compared to the other players in the industry. It
provides its customers with nutritious foods at affordable prices with shorter
service times. According to the company, its major priority is to make customers
happy. Regular checks, regular surveys, menu changes, and short-term and long-
term continuous improvements, are made to ensure customer satisfaction. The
company also makes strategy changes from time-to-time. McDonalds has
incorporated quality management factors like measuring the speed of customer
service, quality inspections, taking care of the five Ps (People, Product, Price,
Place, and Promotion), and employee training into its business processes.
McDonalds makes sure that good quality raw materials arrive on time and are
maintained properly. It maintains good relations with the supply chain partners.
This has resulted in proper supply, distribution, sharing of costs, and ultimately in
an efficient supply chain. The company also forecasts and makes short-, medium-,
and long-term decisions from the information collected from internal (various
levels in the organization) and external (customers) sources. All these strategies
help it to withstand the competition in the industry.
Adapted from Dr. Rotimi Aderohunmu, McDonalds Restaurant, STAT 2800, Survey of
Operations Management, Project II,
https://portfolio.du.edu/portfolio/getportfoliofile?uid=38214
Product/Process Expertise
To gain a competitive advantage over its competitors, an organization can use its
expertise in product functionalities and process capabilities over its competitors.
Quick Delivery
With flexible capacity and an adaptive production process, an organization can
produce a product quickly and satisfy customer needs.
Shorter Product Cycle
The first company that enters a market gains a greater market share than the
subsequent ones. With a flexible and adaptable production system, the company can
introduce a product into the market before its competitors can and take the advantage
of the market demand, thus garnering a greater market share.
Production Flexibility
A highly flexible and responsive operations environment helps some organizations to
achieve a competitive advantage over others. For example, IBM built an integrated
infrastructure solution for DaimlerChrysler, which helped the latter to provide on-
demand solutions. As a result, the operations of DaimlerChrysler became more
flexible and more responsive to the environment.
Low-cost Process
With an efficient production system or access to low-cost resources, an organization
can make standard products at lower costs than its competitors. For example, low cost
airline companies such as Deccan Airways in India are providing no-frills, low price
air travel to their customers. These airlines do not provide on board meals or other
entertainment facilities that traditional airline companies do. Therefore the costs come
down drastically for them and they pass these benefits on to customers in the form of
low prices. This helps them to gain an edge over other airline companies that provide
full services at high prices.
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Convenience and Location
Facility location provides a substantial competitive advantage. For example, Reliance
Infocomm has a deeper penetration into the rural areas than its competitors.
Product Variety and Facility Size
The variety of products offered and the size of operations can provide a competitive
advantage in some industries. For example, grocery stores and supermarket retailers
have larger stores and display a greater variety of products than the small traditional
shops thus benefiting from the economies of scale.
Quality
A higher quality product, even if it is priced higher, helps an organization increase its
sales volume compared to its competitors. For example, Japan based Toyota Motor
Corporation manufactured the Toyota Prius, a hybrid vehicle. The car was
environment friendly and gave good mileage and low emissions. Though the car was
priced high, the demand for the car was also high due to the high quality standards
maintained by the company.
Example: Apples Quality iMacs
In June 2005, Apple announced that Intel-powered Macs would be ready by June 2006.
However, the company managed to release the new iMacs in January 2006 itself.
Customers were surprised by the companys move to introduce the new systems well
before the scheduled date. Apples CEO Steve Jobs released iMac and a new MacBook
Pro laptop. Both were powered by Intels Duo dual-core chip replacing the IBM
processors used by the company for years. Mac users were happy with the new Mac
software that Apple had introduced. The company also introduced iWeb, which was
designed to create websites that combined video, audio, and blogs. The company also
upgraded other features which helped the users share and edit photos, edit sound, and
create podcasts (Podcasting is the method of distributing multimedia files, such as
audio programs or music videos, over the Internet, for playback on mobile devices and
personal computers.) The company started distributing the new iMacs in January and
the MacBook Pros in February to reach the customers.
Adapted from Greg Sandoval, Fans jazzed by Apples quick delivery, January 10, 2006,
http://news.com.com/Fans+jazzed+by+Apples+quick+delivery/2100-1041_3-6025633.html
Check Your Progress
10. The computerization of operations began when the first computer was installed in
General Electric Appliance Park in 1954. What was the basic objective of
computer applications then?
a. Reducing manpower
b. Reducing clerical costs
c. Enhancing worker safety
d. Increasing production
11. With a flexible and adaptable production system, the company can introduce a
new product into the market faster than its competitors and take the advantage of
the market demand, thus garnering greater market share. Which operational
strategy are we talking about in this context?
a. Quality
b. Low-cost process
c. Shorter product cycle
d. Convenience and location
10
12. HDFC Bank offers deposits, loans, insurance products, mutual funds, trading in
stocks, etc, under one roof and positions itself as a financial supermarket. Which
type of competitive advantage strategy does the bank seek to focus on?
a. Quality
b. Product variety
c. Convenience
d. Low cost
13. Which of the following is a computer-controlled warehouse system which
automates inflow and outflow of materials from the warehouse and the shop floor
on the basis of production requirements?
a. Computer-Aided Design (CAD)
b. Computer-Aided Manufacturing (CAM)
c. Flexible Manufacturing System (FMS)
d. Automated Storage and Retrieval System (AS/RS)
4. Elements of Operations Strategy
An operations strategy is a high-level integrated plan for business effectiveness or
competitiveness. The following are the key components of operations strategy:
4.1. Designing the Production System
Designing the production system involves selecting the product design, the production
system, and the inventory policy for finished goods for each product line.
Product Design - There are two types of product design: Customized product design
and Standard product design. A customized product design is used when the level of
customization is high and the quantity to be produced is low. For example, industrial
products like boilers and turbines are customized products. A standardized product
design is used when the organization produces a limited variety of products in large
batch sizes. For example, consumer durables like refrigerators, fans, washing
machines and televisions are standardized products.
Production systems These can be classified into: Product-focused systems and
Process-focused systems. Product-focused systems are used in mass production
organizations where groups of machines, tools, and workers are arranged according to
their respective tasks in order to put together a product. Product-focused systems are
used in the production of cars, televisions, computer systems, etc. Process-focused
systems are used for supporting production departments which perform a single task
like painting or packing.
Finished goods inventory policy Policies regarding finished goods inventory are of
two types: Produce-to-stock policy and Produce-to-order policy. In the produce-to-
stock policy, products are produced in advance and stored in warehouses from where
they are dispatched as per customer orders. Organizations that manufacture products,
parts, or components that have seasonal demand like refrigerators, air coolers, or those
which can be put to general use like bolts and nuts, use this policy. In a produce-to-
order policy, the company starts production only after receiving orders from the
customer. Organizations which produce high value products or components like the
spare parts of an aircrafts or those meant for specific purposes like dyes, castings, etc.
use this policy.
11
4.2. Product/Service Design and Development
Every product has a life cycle and goes through various stages of the life cycle
namely, introduction, growth, maturity, and decline. The operations department plays
an important role in the introduction stage of the product life cycle and its role
diminishes as the product moves up the life cycle.
The following are the different stages involved in the development of new products:
Idea Generation The development of a new product starts with idea generation.
Ideas are sourced from employees, customers, intermediaries, vendors, market
research, etc.
Feasibility Studies Feasibility studies are conducted to test whether the idea
generated is technically and economically feasible.
Prototype Design If the idea is feasible, a prototype of the product is developed.
While the prototype is not a perfect replica of the final product, it has all its basic
features.
Prototype Testing After the prototype has been developed, it is tested under
standard conditions and the defects are listed. Based on the test results, necessary
changes are then made to it. The prototype is tested again and again until it
reaches an acceptable level of performance. After arriving at the final structure,
the profitability of the prototype is evaluated.
Initial Design of Production Model The prototype enters the production design
stage if the production of the model is profitable.
Economic Evaluation The initial production design model is tested for its
economical feasibility before it is transformed into the final production design.
Market Testing The initial production design model is put through performance
tests, production trials, and testing and test marketing before the final product is
designed.
Final Design of Production Model After conducting the economic evaluation
and market testing, the initial production design model reaches a stage where it
performs satisfactorily and can be produced in the required quantities.
The product development process continues even after the launch of the product. The
new product is modified or improved to constantly adapt it to the changing market
conditions and/or to incorporate the latest technology in it.
Activity: Keerti works in the Research & Development wing of a pharma
company. She is a part of a team involved in developing a new drug for reducing
hypertension among old age people. The team has also been exploring various
ways to keep the price of the drug low to make it affordable for everyone. Help
Keerti in listing out the steps involved in developing this new product. Also
suggest ways in which she and her team can reduce the manufacturing costs of the
new drug so that they can pass on the benefit to the customers by pricing it low.
Answer:
12
4.3. Technology Selection and Process Development
After finalizing the product design, managers should determine the way in which the
product will be produced. This involves detailed analysis and planning of the
production processes and facilities.
4.4. Allocation of Resources to Strategic Alternatives
Manufacturing companies have to constantly deal with the problem of scarce
resources like capital, machines, and materials. Operations managers should therefore
plan to make optimal use of the resources by minimizing wastage and by allocating
them to the best strategic use.
4.5. Facility Planning
The location of the production facilities is critical to the success of an organization. As
the setting up of a production facility involves huge initial investment, operations
managers have to tactically select the correct options from the available set of
alternatives. They have to consider future decisions regarding capacity expansion
plans and factors like availability of raw materials and market access. The operations
managers should also make layout decisions such as the internal arrangement of
workers and departments within the facility.
Check Your Progress
14. Rainbow Electronics manufactures a limited number of models of television sets.
What kind of product design system does the company have?
a. Customized production design
b. Standardized product design
c. Stock-to-order
d. Assemble-to-order
15. Selecting product design, production system, and inventory policy for finished
goods fall under which component of operations strategy?
a. Designing the production system
b. Product/service design and development
c. Technology selection and process development
d. Allocation of resources to strategic alternatives
16. Which among the following products are generally customized as per user
requirements?
i. Industrial boilers
ii. Turbines
iii. Televisions
iv. Ceiling fans
a. i and ii
b. ii and iii
c. iii and iv
d. iv and i
13
17. Pick the statement that pertains to the relationship between the role of operations
department and the product life cycle.
a. The role of operations department increases as the product moves up the lifecycle.
b. The role of operations department decreases as the product moves up the
lifecycle.
c. There is no change in the role of operations department across the lifecycle.
d. The role of operations department increases or decreases as the product moves up
the lifecycle.
18. What is the basic use of a prototype during the new product development
process?
a. A prototype is used to test the technical and economical feasibility.
b. A prototype helps test the product performance under standard conditions.
c. A prototype is developed as part of test marketing.
19. Availability of raw materials and nearness to markets are some of the factors that
are considered while making decisions regarding plant location. Which
component of operations strategy deals with decisions such as plant location?
a. Allocation of resources to strategic alternatives
b. Technology selection and process development
c. Product design and development
d. Facility planning
20. Allocation of resources to strategic alternatives is a component of operations
strategy. What is the main objective of this component?
a. To minimize efficiency
b. Optimize the use of resources for best strategic use
c. Ensure capacity expansion
d. Maintain proximity to resources
5. Developing an Operations Strategy
The operations strategy should always be in tune with the organizational strategy,
which in turn, should be based on the corporate vision and mission.
Activity: Bobby is an operations manager of a company engaged in manufacturing
tires for automobiles. The top management has made a suggestion that the existing
manufacturing facility be expanded and a new plant set up to manufacture automobile
accessories. As operations manager, Bobby has been given the task of selecting a
proper location for setting up the new plant and also deciding on the expansion of the
existing one. List out the various steps that he has to take to go ahead with the given job
and also assist him in proper decision making regarding the two proposals.
Answer:
14
Operations strategy aims at accomplishing the long-term goals established by the
business strategy.
The selection of markets is the key to any strategy. Operations managers should
develop appropriate processes and designs to achieve the organizational objectives,
after analyzing the markets based on their attractiveness. By utilizing its strengths and
identifying ways to improve its competitive position, an organization can achieve its
corporate objectives, which are a major focus of the organization strategies. A flexible
operations strategy helps an organization to support a product or service throughout its
life cycle and adjust to future changes in the market demand or business objectives.
The operations strategy should also be consistent with the functional strategies in the
areas of marketing, finance, and human resources.
Activity: SuperFast is a seven-year old courier and parcel company operating in
Asia and the Middle East. Two years ago, the company began operations in Africa.
Though the company is strong in Asia and the Middle East, it has been facing stiff
competition from SpeedCrew in Africa. Both the companies are equally quick in
dispatching couriered mail and parcels and have strong infrastructure to support
their businesses. However, as SpeedCrew is a local company, it has the added
advantage of having deeper access to various part of Africa. Suggest various ways
in which SuperFast can develop a competitive advantage over SpeedCrew and gain
access to a wider market in Africa.
Answer:
6. Financial and Economic Analysis in Operations
Financial and economic analysis is used to evaluate the costs of operations and
ascertain the profitability levels of the firm. Of the many methods, payback period
method and net present value methods are two popularly used methods.
6.1. Payback Period Method
Payback period is the time taken to recover the investment made. Usually the initial
investment and subsequent annual cash inflows are considered in this method. The
mathematical representation of payback period method is
investment from income annual Net
investment Net
period Payback
The Net investment is investment made in the business and the net annual
income is the expected annual revenue minus the expenses. This method
ignores cash flow beyond the payback period, and does not take into account the
time value of money.
15
Activity: Arvind Builders Ltd has decided to invest in a housing project. The
company has three potential locations to choose from and wants to explore the
possible pros and cons of these locations in order to select the best location. The
following table gives the expected investments and the expected annual income for
each location. Help Arvind Builders select the best location (in terms of best
investment) using payback period method.
Answer:
Location
Initial investment
(Rs. Crores)
Expected annual income
(Rs. Crores)
A 100 20
B 120 25
C 80 15
6.2. Net Present Value
Net Present Value (NPV) helps calculate present value of future returns discounted at
the marginal cost of capital, minus the present value of the cost of investment. Like
payback period method, this method compares and analyzes multiple investment
options. NPV for a project can be calculated using the formula.
I
i
r) (1
i
CF
NPV
n
1 i
Where CFi is the cash flow at time i, r is the discounted rate of return, t is the
time horizon, and I is the initial investment.
Check Your Progress
(Questions 18 to 21) The given data below shows the initial investment of three
projects and their payback periods. Use this data to answer the following four
questions.
Project Initial Investment
Expected Annual Income
from the Project
A Rs.10,00,000 Rs.2,00,000
B Rs.12,00,000 Rs.2,50,000
C Rs.8,00,000 Rs.1,50,000
16
21. Calculate the payback period for Project A
a. 5 years
b. 4 years
c. 3 years
d. 6 years
22. What is the payback period for Project B?
a. 5.0 years
b. 4.8 years
c. 3.8 years
d. 4.5 years
23. Calculate the payback period for Project C.
a. 5.0 years
b. 4.8 years
c. 5.3 years
d. 4.5 years
24. Based on the results for product A, B and C, which is the best investment in terms
of faster returns?
a. Project A
b. Project B
c. Project C
d. Either project A or C
25. All the statements given below are true regarding payback period, except:
a. It is the time taken to recover the investment made.
b. It considers initial investment and subsequent annual cash inflows.
c. It includes cash flows that are beyond the payback period.
d. It does not consider the time value of money.
26. Which of the following statements are true regarding net present value?
i. It compares and analyzes multiple investment options.
ii. It refers to the time taken to recover the investment made.
iii. It helps calculate present value of future returns discounted at the marginal cost of
capital, minus the present value of the cost of investment.
iv. It is calculated as net investment divided by the net annual income from
investment.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. Only iii and iv
6. Summary
Operations management can be defined as the management of direct resources such as
machine, material, and manpower, which are required to manufacture goods and
services. The decisions taken by the operations managers can be classified into
strategic decisions, tactical decisions, and operational decisions.
17
The growing complexity in software and hardware technologies has led to the
development of advanced production systems like computer-aided design (CAD),
computer-aided manufacturing (CAM), flexible manufacturing systems (FMS), and
automated storage and retrieval systems (AS/RS). Also, many new concepts and
technologies like robotics, artificial intelligence, and expert systems have influenced
manufacturing systems.
Operations decisions are influenced by the nature of the goods or services to be
produced and the markets to be served.
Organizations should try to identify their distinct competencies to gain a competitive
advantage over others.
The key components of operations strategy are: designing the production system,
designing and developing the product/service, selecting the technology and
developing the process, allocating resources to strategic alternatives, and planning the
facility.
Designing the production system involves selecting the product design, the production
system, and the inventory policy for finished goods for each product line.
Operations strategy should always be in tune with the organizational strategy, which
in turn, should be based on the corporate vision and mission.
A flexible operations strategy helps an organization to support a product or service
throughout its life cycle and to adjust to future changes in the market demand or
business objectives.
Financial and economic analyses helps compare and analyze the costs and benefits
involved in various investments made by a company. Payback and Net Present Value
(NPV) are two popular methods used to evaluate such investments.
7. Glossary
Automated Storage and Retrieval Systems: A computer-controlled warehouse
system which automates inflow and outflow of materials from the warehouse and the
shop floor on the basis of production requirements.
Computer-Aided Design: A specialized software used for designing products and
processes. Advanced CAD systems enable engineers to test the performance of their
design through computer simulation.
Computer-Aided Manufacturing: A specialized computer system used for
translating CAD design information into instructions for numerically controlled
automated machines. The use of CAM in manufacturing reduces the workers
involvement in the production process.
Customized product design: It is used when the level of customization is high and
the quantity to be produced is low.
Flexible manufacturing system: A set of automated machines controlled by a central
computer. These systems can produce a large quantity of products that have similar
processing requirements.
Net Present Value: It helps calculate present value of future returns discounted at the
marginal cost of capital, minus the present value of the cost of investment.
Operational decisions: Decisions that are short-term decisions and have a time
period of less than a week.
Operations management: The management of direct resources such as machine,
material, and manpower, which are required to manufacture goods and services.
18
Payback period: The time taken to recover the investment made. Usually the initial
investment and subsequent annual cash inflows are considered in this method.
Process-focused systems: These are used for supporting production departments
which perform a single task like painting or packing.
Produce-to-order policy: In this, the company starts production only after receiving
orders from the customer.
Produce-to-stock policy: In this, products are produced in advance and stored in
warehouses from where they are dispatched as per customer orders.
Product-focused systems: These are used in mass production organizations where
groups of machines, tools, and workers are arranged according to their respective
tasks in order to put together a product.
Scientific management concept: The productivity of a worker is governed by
scientific rules and the management needs to study and apply these rules in its
operations.
Standardized product design: It is used when the organization produces a limited
variety of products in large batch sizes.
Strategic decisions: Decisions that are long term in nature and have a time period of
five years or more.
Strategies: Broad, long-term plans, conceived of to achieve business objectives and
are developed at the corporate, business, and functional levels.
Tactical decisions: Decisions that are medium term in nature and have a time period
of one or two years.
1. Operations management has become a key discipline in management science and
its scope has spread from the manufacturing sector to the service sector. Explain
the importance of operations management in organizations.
2. Operations managers have to take decisions regarding the designing and
implementation of operational strategies, which indicate how the companies
utilize their production capabilities to achieve their organizational objectives.
What are the different operations management decisions? Give examples of each
category of decisions which are required to be taken by an operations manager.
3. The concept of modern operations management has evolved from the beginning
of the eighteenth century. Explain the evolution process of operations management.
4. Computerization has resulted in a significant improvement in the overall
performance of an organization. Explain the advantages and disadvantages of
computerization of operations. Also explain the various technologies which aid in
improving the performance of an organization.
5. Operations strategy has become an integral part of the strategic planning process
of most companies in the current competitive scenario. Explain the uses of
operations strategy. How can a business organization use operations strategy as a
competitive weapon?
6. Operations strategy is a high-level integrated plan for business competitiveness.
Explain the various elements of an operations strategy.
7. Operations strategy should always be flexible and in tune with organizational
strategy. How can an organization develop an operations strategy?
8. Explain payback period and net present value methods.
19
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Delhi: Tata McGraw Hill Publishing Company Limited, 2000.
2. Ashwathappa, K and K Sridhara Bhatt. Production and Operations Management.
First Edition. Mumbai: Himalaya Publishing House, 1999.
3. Krajewski, Lee J and Larry P Ritzman. Operations Management: Strategy and
Analysis. Fifth Edition. USA: Addison-Wesley Publishing Company, Inc.
4. Chase, Richard B, Nicholas J Aquilano and F Robert Jacobs. Production and
Operations Management: Manufacturing and Services. Eighth Edition. New
Delhi: Tata McGraw-Hill Publishing Company Limited, 1999.
5. Adam, Everette E and Ronald J Ebert. Production and Operations Management:
Concepts, Models and Behavior. Fifth Edition. New Delhi: Prentice-Hall of
India Private Limited, 1996.
6. Operations Management
<http://www.managementhelp.org/ops_mgnt/ops_mgnt.htm>
7. Operations Research
<http://www.me.utexas.edu/~jensen/ORMM/models/index.html>
8. Assembly Line
<http://www.pbs.org/wgbh/aso/databank/entries/dt13as.html>
9. Hawthorne Studies
<http://www.accel-team.com/human_relations/hrels_01_mayo.html>
<http://www.analytictech.com/mb021/Hawthorne.html>
<http://www.cs.unc.edu/~stotts/204/nohawth.html>
12. Facility Planning
<http://www.strategosinc.com/facilities_planning.htm>
13. Product Life Cycle
<http://www.marketingteacher.com/Lessons/lesson_plc.htm>
14. Product Life Cycle
<http://www.valuebasedmanagement.net/methods_product_life_cycle.html>
15. Analysis Techniques
<http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page15.htm>
1. (b) Importance and recognition given to employees
Elton Mayo in 1927 carried out studies at Western Electrics Hawthorne plant.
The initial studies tried to examine the relationship between light intensity on the
shop floor and employee productivity. Finally, Mayo and his team concluded that
it was not light or other physical conditions, but the attention and importance the
workers received during the study that was responsible for their increased
productivity.
2. (b) Ford Motors
Henry Ford applied the concepts of scientific management of Taylor in the
assembly line production system of Ford Motors in 1911.
20
3. (a) Strategic decisions
Strategic decisions are long-term and broad in nature and usually span five years
or more. Long-term strategic decisions are concerned with production and
process design, facility location and layout, capacity, expansion of existing
facilities, etc. These decisions impact the long term profitability of an
organization.
4. (a) Analyzing the firms financial position
Analyzing the firms financial position falls under the basic function of financial
management and not operations management.
5. (c) Scientific management
Division of labor or work specialization is a development of scientific
management. According to Taylor, each worker should be assigned a task based
on his or her skill, strength and ability to learn.
6. (b) One or two years
Tactical decisions are medium-term in nature and have a time-frame of one or
two years. These decisions are concerned with identifying manpower
requirements, determining the appropriate inventory level for various materials,
determining reordering level and order quantity, identifying vendors and so on.
Operations management, as a whole, deals with design of products and processes,
acquisition of resources, transformation of resource inputs into outputs and
distribution of goods and services.
8. (a) i, ii, iii
Inclusion of purchasing functions, dispatch, and other allied activities in this field
and the influence of service-related concepts and procedures broadened the scope
of this field of study. As the term Production Management did not cover the
entire field, it was replaced with Operations Management.
9. (c) Elton Mayo
In 1927, Elton Mayo and his team carried out studies at Western Electrics
Hawthorne plant. The initial studies tried to examine the relationship between
light intensity on the shop floor and employee productivity. Finally, Mayo and his
team concluded that it was not light or other physical conditions, but attention and
importance the workers received during the study that was responsible for their
increased productivity.
10. (b) Reducing clerical costs
The computerization of operations began when the first computer was installed in
General Electric Appliance Park in 1954. The sole purpose of computerization
those days was to reduce manual labor and the costs involved in tasks like
preparing salary statements and accounts statements.
11. (c) Shorter product cycle
Shorter product cycle is one of the operational strategies that can be used by an
organization as a competitive weapon. With a flexible and adaptable production
system, the company can introduce a new product into the market faster than its
competitors. Through this, the company can take the first mover advantage of the
market demand, and in turn, gain a larger market share.
21
12. (b) Product variety
When an organization focuses on product variety as a competitive advantage it
offers a large number of different products to various customer segments. This is
true in the case of HDFC that offers different financial products to different
segments.
13. (d) Automated Storage and Retrieval System (AS/RS)
AS/RS is a computer-controlled warehouse system which automates inflow and
outflow of materials from the warehouse and the shop floor on the basis of
production requirements. CAD is specialized software used for designing
products and processes. Advanced CAD systems enable engineers to test the
performance of their design through computer simulation. The FMS is a set of
automated machines controlled by a central computer.
14. (b) Standardized product design
Standardized production is used when a company manufactures a limited variety
of products in large batches to reduce costs.
15. (a) Designing the production system
Designing the production system is one of the key responsibilities of any
operations manager. It involves selecting the product design, the production
system and the inventory policy for finished goods for each product line.
16. (a) i and ii
Industrial products like boilers and turbines are made based on specific
requirements of customers, while televisions and ceiling fans are produced in
large numbers (also termed as standardized production) where customization of
each piece is not possible.
17. (b) The role of operations department decreases as the product moves up the
lifecycle.
As the product moves up the lifecycle, the organizations focus shifts towards
increasing the market share and improving the quality of the product. Hence, the
role of operations department decreases.
18. (b) A prototype helps test the product performance under standard
conditions.
A prototype may not have all the features of the final product however it has all
the products basic characteristics. The prototype is tested under standard
conditions and defects are noted. This would enable the organization to improve
the product in terms of quality and performance. Once the final structure of the
prototype is in place, the prototype design is evaluated for profitability.
19. (d) Facility planning
Facility planning deals with location of the facility and its layout. Decisions
regarding facility location are based on the accessibility to raw material and
nearness to markets. Allocation of resource deals with the allotment of existing
resources like men, machines, material, etc, to different strategic alternatives.
Technology selection and process development deals with selection of the most
suitable technology for producing products and product design and development
is used to develop new products.
20. (b) Optimize the use of resources for best strategic use
The main objectives behind allocating resources to different alternatives (which
are also called strategic alternatives) include minimizing wastage in the facilities
and employing resources to the best possible use.
22
21. (a) 5 years
Payback period = Net investment / Expected annual income
= 10,00,000/2,00,000 = 5 years
22. (b) 4.8 years
Payback period = Net investment / Expected annual income
= 12,00,000/2,50,000 = 4.8 years
23. (c) 5.3 years
Payback period = Net investment / Expected annual income = 8,00,000/1,50,000
= 5.3 years
24. (b) Project B
Of all the investments, Project B is the best option. Though Rs.12, 00,000 are
invested in this project, the payback period is the shortest due to greater expected
annual income.
25. (c) It includes cash flows that are beyond the payback period.
Payback period is the time taken to recover the investment made. This method
ignores cash flow beyond the payback period and does not take into account the
time value of money.
Options i and iii are true regarding net present value, while options ii and iv refer
to payback period method.
Unit 17
Forecasting Demand
Structure
1. Introduction
2. Objectives
3. Forecasting in Operations
4. Forecasting Components
5. Demand Forecasting Process
6. Forecasting Methods
7. Selecting a Forecasting Method
8. Measures of Forecasting Accuracy
9. Monitoring and Controlling Forecasts
10. Summary
11. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the importance of
conducting financial and economic analysis in operations. We have learnt that
financial and economic analyses helps compare and analyze the costs and benefits
involved in various investments made by a company. In this unit, we will discuss
forecasting in operations.
Forecasting predicts the future value of a variable and helps managers in taking
effective decisions and planning their activities accordingly. Demand forecasting is
vital for the planning and control functions of an organization. Demand is the quantity
of a product or service that buyers are able and willing to buy during a particular time
period in a specific market environment. The primary step in planning involves
estimating the future demand for products and the resources required to produce them
to satisfy such demand.
Overestimating or underestimating future demand has a negative impact on the overall
performance of the organization. Overestimation leads to a huge inventory of finished
goods and results in locking up a large amount of working capital while
underestimation leads to an increase in the supply lead-time and results in loss of
orders and customers. Though it is difficult to make accurate forecasts, it is essential
for an organization to achieve good returns on its investments. Forecasts are never
100% accurate, but tracking the results and their accuracy will improve the accuracy
of future forecasts. In this unit, we shall discuss forecasting, the various methods of
forecasting, the reasons for their selection, and the measures of forecast accuracy.
This unit will introduce you to forecasting in operations, and explain the forecasting
components. We will discuss the demand forecasting process, and then study the
various forecasting methods. We shall then move on to discuss the steps involved in
the demand forecasting process, and understand how to measure the forecasting
accuracy. Finally, we would discuss how to monitor and control forecasts.
24
2. Objectives
define forecasting in operations.
discuss the various forecasting methods.
select a forecasting method.
identify the measures of forecasting accuracy.
explain how to monitor and control forecasts.
3. Forecasting in Operations
Forecasting predicts the future demand for products or services and is used in process
design, capacity and facilities planning, aggregate planning, scheduling, inventory
management, etc. Though the predictions may be inaccurate, they provide vital
information for strategic, tactical and operational planning, and decision-making.
Operations managers forecast future events including both long-term estimates for
aggregate demand and short-term demand estimates for each product or service.
Short-term demand estimates for individual products are detailed and are used to plan
and schedule the production operations while long-term estimates are used for making
location, layout, and capacity decisions. Individual forecasts are made on the basis of
aggregate forecasts which are used to plan and control operation subsystems. Accurate
forecasts help in inventory management, production planning, work assignment, and
overall management of costs associated with various stages of production process.
4. Forecasting Components
There are different factors or components that a firm has to consider while making a
forecast. Every forecast can be influenced by any of the six different components viz.
base demand, seasonal component, trends, cyclical component, promotions, and
irregular component.
Base demand: Base demand is the average sales over a given period of time and this
is applicable if the remaining components do not influence the demand.
Seasonal component: Seasonal component is the repeated increase and decrease in
demand during a particular period, say season and off-season.
Trend component: Trend component is the long term pattern of movement of
demand over time, which could be positive, negative or neutral. A positive trend
implies increasing demand while a negative trend implies decreasing demand. An
example of a positive trend is the demand for housing loans that is on the rise over the
past few years.
Cyclic component: Cyclical component refers to repetitive changes in the demand
patterns. This is different from the seasonal component in that the frequency is over
longer periods, say more than one year. Trade cycle is an example, where the demand
for certain goods is high during the boom period and low during the slump.
Promotional component: The promotional component refers to the promotional
activities taken up by marketers to increase the sales of their products. This
component has to be included whenever the firm expects to carryout a promotional
campaign. This is usually found in the consumer goods industry.
Irregular component: The irregular component refers to all those variations in
demand that cannot be attributed to any of the above five factors. This factor is
difficult to predict because of its random nature. Firms strive to minimize the irregular
component so as to develop a fairly accurate demand forecast.
Forecasting Demand
25
Check Your Progress
1. Which of the following is not a consequence of underestimation of demand?
a. Increase in supply lead time
b. Increase in loss of orders
c. Increase in customer switching
d. Increased locking up of working capital as inventory
2. Which of the following demand estimates are very detailed and used to plan and
schedule production operations?
a. Short-term demand
b. Medium-term demand
c. Long-term demand
d. All of the above
3. Forecasting demand has a direct impact on which of the following two functions
of management.
a. Planning and organizing
b. Directing and control
c. Organizing and staffing
d. Planning and controlling
4. For forecasting purposes, firms need to take into consideration various factors or
components. Which of the following is associated with average sales over a given
period of time?
a. Trend component
b. Seasonal component
c. Cyclical component
d. Base demand
5. The demand for luxury products may be linked with the business cycle, as sales
usually increase during the boom phase and slow-down during recession. What
component of forecasting is described here?
a. Trend component
b. Seasonal component
c. Cyclical component
d. Base demand
6. When LG increased the advertising budget by 40%, the sales of its televisions
doubled. On this basis, LG prepared an aggressive demand forecast for the next
year. What component of demand did LG consider as part of its forecast?
a. Cyclical component
b. Promotional component
c. Trend component
d. Irregular component
26
7. Which of the following is an example of the trend component of forecast?
a. The demand for gold has reduced as the price of gold has increased
b. The promotional expenditure of Airtels GSM service was hiked based on
demand forecast
c. The demand for camera mobile phones in India has increased steeply since 2001
d. The demand for wrist watches has been fluctuating for quite some time
5. Demand Forecasting Process
The process of demand forecasting involves five stages. They include understanding
the objective of forecasting, integrating demand planning & forecasting, identifying
the influencing factors, identifying the consumer segments, and determining the
appropriate forecasting technique.
Understanding the objective of forecasting: Organizations make use of forecasting
for decision-making in many managerial functions like developing production
schedules, marketing planning, etc. Hence, it is important to understand the objectives
of forecasting and the decisions that need to be implemented.
Integrate demand planning & forecasting: Integration of demand planning &
forecasting has to be done right from the initial stages of forecasting. As forecast is
the basis of all the planning activities like aggregate planning, production planning,
promotion planning, etc., it is essential to integrate these aspects with the forecast.
Identify the influencing factors: In this stage, the firm has to identify all the
influencing components of a forecast. Forecasting components like seasonal
components, trends, etc, discussed earlier, have to be identified.
Understand and identify the consumer segments: Different consumer segments
make up a market. Hence, the marketer has to understand the market and identify
different consumer segments based on their needs and requirements.
Determine the appropriate forecasting technique: In the final stage, the most
appropriate forecasting technique has to be selected. This depends on different aspects
like stage of the product life cycle, geographical region, customer groups, etc.
6. Forecasting Methods
Forecasting methods/ techniques are classified under three categories: qualitative
methods, time-series methods, and causal methods.
6.1. Qualitative Methods
Qualitative methods are based on judgments (regarding factors influencing demand)
and opinions (about probability of the factors affecting the demand) and not on any
mathematical models. These methods range from scientifically conducted opinion
surveys to intuitive predictions about future events.
Delphi method: The Delphi method is a coordinated and interactive method of
forecasting future events on the basis of independent opinions and predictions. These
opinions and predictions are made by an expert panel and reviewed by a competent
mediator. The method is mostly used for long-term forecasting. It involves the
following steps:
Selecting a group of experts, depending on the type of expertise required.
Obtaining ideas and forecasts from all participants through a questionnaire.
Summarizing the results and redistributing them along with appropriate new
questions. Any member whose response deviates from the opinion of the majority is
requested to reconsider or provide justification for the deviation.
Forecasting Demand
27
Summarizing the responses again, and developing new questions on the basis of the
responses. This cycle is repeated till the results are in a range that is narrow enough to
be used as a forecast.
Nominal group technique: The nominal group technique is a structured problem
solving and decision making method developed by Andrew Van de Ven. Following
are the steps involved in the technique:
Generation of ideas: In this stage, group members write down their ideas regarding
the question/problem posed by a mediator.
Round robin collection of ideas: The ideas of the group are collected and recorded on
a flip chart or a blackboard that is visible to all members. No discussion is permitted
during this stage.
Discussion: Each idea is discussed. To avoid any wastage of time, similar or duplicate
ideas are clubbed together and discussed. The ideas are discussed in terms of their
perceived importance, clarity, and logic. Members are allowed to make brief,
impersonal comments on a voluntary basis on each idea.
Preliminary Voting: Members are asked to cast their preliminary vote to select the
best idea. If there is no consensus regarding the best idea, the ideas concerned are
discussed further so that their meaning and logic are clarified.
Final voting: Members are asked to cast their final vote. The result of the final vote is
counted and the most preferred idea, solution, or forecast is identified.
Check Your Progress
8. Which of the following methods is judgmental and subjective in nature and based
on the estimates and opinions of individuals?
a. Time series methods
b. Delphi method
c. Exponential smoothing
d. Regression analysis
9. Identify the correct sequence of steps taken as part of the demand forecasting
process.
a. Identify influencing factors understand objectives identify customer segments
select forecasting technique
b. Identify influencing factors identify customer segments understand objectives
c. Identify customer segments understand objectives identify influencing factors
d. Understand objectives identify influencing factors identify customer segments
10. All the statements given below are true regarding the Delphi method, except:
a. It is a coordinated and interactive method of forecasting future events on the basis
of independent opinions and predictions.
b. It is used for short-term forecasting.
c. The opinions and predictions are made by an expert panel and reviewed by a
competent mediator.
d. The ideas and forecasts from all the participants are obtained through a
questionnaire.
28
11. Given below is the sequence of activities that take place in the Delphi method.
Identify the correct sequence from the options given below.
i. Obtaining ideas and forecasts from all participants through a questionnaire.
ii. Summarizing the results and redistributing them along with appropriate new
questions.
iii. Selecting a group of experts, depending on the type of expertise required.
iv. Summarizing the responses again and developing new questions on the basis of
the responses.
The correct sequence is:
a. i-ii-iii-iv
b. i-iii-ii-iv
c. ii-iv-i-iii
d. iii-i-ii-iv
12. ___________ refers to a structured problem solving and decision making method
that involves the following steps generation of ideas, round robin collection of
ideas, discussion, preliminary voting and final voting.
a. Delphi method
b. Nominal group technique
c. Linear regression technique
d. Exponential smoothing method
13. In the nominal group technique, the group members write down their ideas
regarding the question/problem posed by a mediator and then all the ideas are
collected and recorded on a flip chart or a blackboard that is visible to all the
members. Which of the following steps takes place after this?
a. A group of experts is selected depending on the type of expertise required.
b. Each idea is discussed in terms of their perceived importance, clarity, and logic.
c. Members are asked to cast their preliminary vote to select the best idea.
d. The results are summarized and redistributed along with appropriate new
questions.
6.2. Time-Series Methods
Time-series forecasting methods assume that past data is a good indicator of the
future. This assumption is mostly true and relevant data is always available. Hence,
operations managers use a time series model to forecast the demand for their goods or
services. Based on the complexity involved, time series methods can be divided into
static forecasting methods and adaptive forecasting methods.
Static Forecasting Methods
Also known as basic time series forecasting techniques, these methods assume that the
estimates of seasonal component and trends do not vary every year. These estimates
are determined from the available historical data and are projected to get the future
demand estimate. A forecast is obtained using the static forecasting method with the
help of the following steps.
Deseasonalize or decompose the time series: This step involves identifying the
seasonal variations in the time series and removing them using the seasonal index.
Forecasting Demand
29
Estimate the trend and seasonal components: Once the time series is decomposed, the
trend and seasonal components have to be calculated. The least square method is one
such method.
Make the forecast: Here the trend level is calculated for all the time periods
considered. It is then multiplied with either seasonal index, to get the seasonal effects,.
or/and cyclic index to include the cyclical effects in the forecast.
Adaptive Forecasting Methods
These methods are considered as advanced form of time series analysis. Adaptive
forecasting methods do not assume that the estimates of seasonal and trend component
remain same over years. The seasonal and trend components are adjusted after very
demand period (i.e. after every year if the demand forecasting is made every year).
Some of the popularly used adaptive forecasting methods are simple moving average,
weighted moving average and exponential smoothing.
Simple moving average (SMA): In this technique, demand is forecast on the basis of
the average demand calculated from actual demand in the past. This method is
effective when a product does not experience fluctuations in demand over a period of
time and the past demand for the product was not seasonal. This method is useful for
removing any random fluctuations in demand to get accurate forecasts.
F
t
=
n
D D D D
n t t t t
......
3 2 1
Where, F
t
= forecast for the period t
n = number of preceding periods taken for averaging
D
t-1
, D
t-2
and so on = actual demand in the immediately preceding time periods
The length of the time period has to be considered while using the SMA method. If
the moving average period is greater, the forecast will be less exposed to random
variations. A larger time period is taken when the demand fluctuations are minimal
while a small time period is taken when the demand fluctuations are high or when
there is a need to identify short-term fluctuations.
Activity: The following table shows the demand for product X for the last six
months from January to February. Calculate the demand for the product for the
month of July, using the simple moving average.
Months January February March April May June
Demand
(units)
85 90 75 80 88 82
Answer:
30
Weighted moving average (WMA): Due to some trend or seasonality in demand, the
forecaster using a moving average may not want all the n periods to be equally
weighted. There is no set rule for calculating weights. Weights are assigned for a
particular piece of data based on experience and trial and error methods. Each element
is weighted by a factor and the sum of the weights should be equal to one.
WMA
t+1
=
n
1 t
t t
A C Where WMA
t+1
= Weighted Moving Average at the end of the
time period t
A
t
= Actual demand in time period t
C
t
= Percentage weight given to time period t
0 C
t
1 and C
1
+ C
2
+ C
3
+ + C
t
= 1
Illustration 1
The following table shows the demand for product X for the last six months from July
to December. Calculate the demand for the product for January the following year,
using the simple moving average.
Months July August September October November December
Demand
(units)
70 75 65 72 78 76
Solution:
Select the time period for which the moving average of the demand for the product X
are calculated. For a three-month average, the forecast for the fourth period will be the
average of first three periods. Therefore, forecast for the month of October will be the
average of demand during July, August, and September.
For example, October = F
4
=
3
65 75 70
= 70
Month Demand 3 Months Average
July 70 -
August 75 -
September 65 -
October 72 70 (F
4
)
November 78 70.67 (F
5
)
December 76 71.67 (F
6
)
January 75.33 (F
7
)
So, the estimated demand for the month of January is approximately 75 units.
Illustration 2
A company wants to make a sales forecast based on the WMA method. The
forecasters of the company, based on their past experience and judgment, have
assigned weights for the sales data taken from the last six months to predict the future
demand. Following are the weights assigned for the sales data: 30% to the actual sales
Forecasting Demand
31
for the most recent month; 25% for the actual sales of two months ago; 20% to the
actual sales three months ago; 15% to the actual sales four months ago; 10% to the
actual sales five months ago; 5% to the actual sales six months ago. If the actual sales
for the last six months are given as (starting from the most recent month) 140, 144,
148, 145, 146, and 142, forecast the sales for the seventh month.
Solution:
WMA
6
= 140(0.30) + 144(0.25) + 148(0.20) + 145(0.15) + 146(0.10) + 142(0.05) =
42+36+29.6+21.75+14.6+7.1 = 151 units (approx).
Therefore, the sales forecast for the seventh month is 151 units.
Activity: Following are the weights assigned for the sales data for the past five
months: 25% to the actual sales for the most recent month; 20% for the actual sales
of two months ago; 15% to the actual sales three months ago; 10% to the actual
sales four months ago; 5% to the actual sales five months ago. If the actual sales
for the last five months are given as (starting from the most recent month) 210,
217, 220, 205, and 215, calculate the sales forecast of the company for the sixth
month using the WMA method.
Answer:
Exponential smoothing: Though SMA and WMA are simple and effective, they
suffer from a few drawbacks like the need to collect a large amount of historical data.
In contrast, the exponential smoothing method is based on the assumption that the
most recent data is a better indicator of future trends than past data. It is useful when
used on data characterized by seasonal tendencies. This model has different variants
based on periodic trends or variations. The advantages of the exponential smoothing
method are:
Availability of standard software packages
Relatively little data storage and computational requirements
Accuracy of forecasts
Ease in understanding the results
The maximum weightage is given to the demand for the most recent time period and
the weights assigned to the preceding periods decrease exponentially. For making the
forecast, the data requires the most recent forecasts, the actual demand for that time
period, and a smoothing constant ( ). The value of lies between 0 and 1.
First-order exponential smoothing: In this method, the demand forecast for the next
period is given by
F
t
=
1 t 1 t
F 1 D
Where, F
t-1
= Forecast for period t-1
D
t-1
= Actual demand for period t-1
= Smoothing constant, 0 1
32
The following equations are developed based on past actual demand and forecasted
demand data. For the three immediately preceding periods, the forecasts can be
calculated as follows:
F
t
=
1 t 1 t
F 1 D (i)
F
t-1
=
2 t 2 t
F 1 D (ii)
F
t-2
=
3 t 3 t
F 1 D (iii)
Substituting the value of F
t-1
from equation (ii) into equation (i), we get,
F
t
=
2 t 2 t 1 t
F ) 1 ( D 1 D (iv)
Again, substituting the value of F
t-2
in equation (iv), we get,
F
t
=
3 t 3 t 2 t 1 t
F ) 1 ( D ) 1 ( D 1 D (v)
Simplifying equation (v), we have,
F
t
=
3 t
3
3 t
2
2 t 1 t
F 1 D 1 D 1 D
From this equation, we can see that the weight assigned to the most recent observation
is the value of the smoothing constant ( ), and that the weights assigned to past
observations decrease exponentially as we go back in the time period.
Illustration 3
A firm achieved actual sales of 1500 units in June when the forecast was 1200 units.
Calculate the sales for July using a smoothing constant of 0.5.
Solution:
F
July
=
June June
F 1 D
Substituting the values in the above equation, we have,
F
July
= 0.5 1500 + (1-0.5) 1200 = 750 + 600 = 1350
Thus, the forecast for the month of July is 1350 units.
Activity: A firm achieved actual sales of 150 units in August when the forecast was
130 units. Calculate the sales for September by using a smoothing constant of 0.2.
Answer:
Selecting a smoothing coefficient ( ): The smoothing constant shows the effects of
past demand on future demand forecasts. It takes any value between 0 and 1.
The selection of is critical as a high results in assigning more weightage for the
most recent demand and a low results in a relatively lower weightage for it. A high
is more appropriate for new products for which demand is dynamic or unstable. If
demand is stable and believed to represent the future, a low can be selected to
smooth out the effect.
Forecasting Demand
33
Trend adjusted exponential smoothing (double smoothing): SMA and single
exponential smoothing have the shortcoming of lagging behind actual data, which
shows a steady trend, either upward or downward. Trend indicates a continuous
increase or decrease in the average of the series over a period of time. The presence of
a trend in a time series leads to forecasts that are above or below the actual demand. In
trend adjusted exponential smoothing, both the average and the trend are smoothed.
For this, two smoothing constants and are used. The following equations are used
for calculating both the average and the trend:
A
t
=
1 t 1 t t
T A 1 D
T
t
=
1 t 1 t t
T 1 A A
F
t+1
= A
t
+ T
t
Where, D
t
= Demand in period t
A
t
= Exponential smoothed average for period t
T
t
= Exponential smoothed trend for period t
T
t-1
= Trend estimate for period t-1
A
t-1
= Actual demand for period t-1
F
t+1
= Forecast for period t+1
= Smoothing constant (0 1)
= Smoothing constant (0 1)
Estimates for the last periods average and trend, which are required for the first
forecast, are obtained from historical data or by making an educated guess, in case no
historical data is available. The procedure for finding the value of is the same as
finding the value of .
Illustration 4
For a dealer in bikes, sales for the last six months averaged 50 units. The average
increase in bike sales was 6 units per month. In the sixth month, 49 units were sold.
Forecast sales for the next two months, using the trend adjusted exponential
smoothing method. Take smoothing constants as = 0.3 and = 0.25.
Solution:
From the information given, A
0
= 50, T
0
= 6, and D
1
= 49
A
t
=
1 t 1 t t
T A 1 D
T
t
=
1 t 1 t t
T 1 A A
F
t+1
= A
t
+ T
t
A
6
= 0.3(49) + (1 0.3) (50 + 6) = 14.7 + 39.2 = 53.9
T
6
= 0.25 (53.9 50) + (1-0.25) (6) = 0.975 + 4.5 = 5.475
F
7
= 53.9 + 5.475 = 59.375 = 59 (approx)
Forecast for the eighth month would be
A
7
= 0.3(59) + (1 0.3) (53.9+5.475) = 17.7 + 41.5625 = 59.2625
T
7
= 0.25 (59.2625 53.9) + (1-0.25) (5.475) = 1.340625 + 4.10625 = 5.446875
(approx)
F
8
= 59.2625 + 5.446875 = 64.709375= 65 units (approx).
34
Check Your Progress
14. Which of the following demand forecasting techniques is divided into static and
adaptive methods?
a. Qualitative methods
b. Time series methods
c. Causal methods
d. All of the above
15. Trend and seasonal components play an important role in demand forecasting. In
which of the following forecasting methods are estimates of trend and seasonal
components assumed to not vary from year to year?
a. Exponential smoothing
b. Static forecasting method
c. Regression analysis
d. Simple moving average
16. Identify the statistical techniques that use historical data collected over a period of
time to predict future demand.
a. Time-series methods
b. Qualitative methods
c. Nonparametric methods
d. Causal methods
17. The sum of weights used in weighted moving average method should be equal to
_________.
a. 1
b. 10
c. 100
d. Zero
18. How are weights in the weighted moving average method calculated?
a. Simple moving average method
b. Future forecast
c. Trial & error
d. Exponential smoothing
19. Which of the following forecasting methods are used when the demand for a
product is influenced by seasonal tendencies?
a. Delphi method
b. Simple moving average method
c. Exponential smoothing
d. All of the above
20. Which of the following is not a benefit that an operations manager gains when
using the exponential smoothing method?
a. Easy availability of standard software packages
b. Less computational requirements
c. Larger data storage space
d. Greater accuracy in forecasts
Forecasting Demand
35
21. Maximum weightage is given in the exponential smoothing method for demand
values in which of the following time periods?
a. Latest time period
b. Earliest time period
c. Average of latest and oldest time periods
d. Sum of latest and oldest time periods
22. What is the formula for calculating the weighted moving average?
a. WMA
t
=
n
1 t
t t
A C
b. WMA
t+1
=
n
1 t
t t
A C
c. WMA
t+1
=
1 n
1 t
t t
A C
d. WMA
t-1
=
1 - n
1 t
t t
A C
23. Why is the constant used in exponential smoothing method?
i. To show effects of past demand
ii. To smooth out the effects of any noise
iii. To predict future trends in demand
a. Only i
b. Only ii
c. i and ii
d. i, ii, and iii
Exercise
A. The demand for generator sets for twelve consecutive months from January to
December is given as 78, 80, 85, 82, 84, 85, 87, 88, 86, 89, 86, 87. Calculate the
approximate demand for January of the next year using the simple moving
averages method. Assume the time period to be a six month moving average.
Activity: For a dealer in refrigerators, sales for the last five months averaged 80
units. The average increase in refrigerator sales was 10 units per month. In the fifth
month, 71 units were sold. Forecast sales for the next two months, using the trend
adjusted exponential smoothing method. Take smoothing constants as = 0.1 and
= 0.05.
Answer:
36
6.3. Causal Quantitative Models
The demand for a product or service depends on various factors or variables like price,
quality, availability of substitute and/or complementary products/services, income
level of customers, number of competitors, etc. Organizations must identify the
variables that affect the demand for a product or service. A causal method evaluates
the relationship between different variables and their influence on each other. These
include linear regression and multiple regression analysis.
Linear regression: Regression refers to the functional relationship between two or
more correlated variables. Linear regression analysis establishes a relationship
between a dependent variable, for which the future forecast is needed, and a group of
other variables, known as independent variables, which influence the dependent
variable. For example, the sale of televisions is dependent on the advertising budget
and the number of retailers. Here, the sale of televisions is a dependent variable and
the advertising budget and number of retailers are independent variables. In linear
regression, the relationship between the dependent variable and one independent
variable is defined by a straight line.
Y = a + bX
Where Y = Value of the dependent variable
X = Value of the independent variable
a = Y intercept (constant value)
b = Slope of the line
Here, a is the Y-intercept and b is the slope of the line which represents the
variation in Y for a unit change in X. The value of a defines the point at which the
regression line crosses the Y-axis and the value of b defines the trend of the
dependent value. If b is positive, then the trend line increases positively and if it is
negative, the trend line decreases negatively.
Least square method: The least square method is used to generate a regression
model by assigning data to a single line. In this method, past demand data is used to
form a linear model by regressing the data points to a single line. After forming the
linear equation, future demand (Y) can be predicted by substituting the value of X.
The following equations are used to calculate the value of constants b and a in the
regression model:
2 2
X X n
Y X XY n
b
n
X
b
n
Y
a or X b Y
Where n is the sample size.
Illustration 5
Using regression analysis, find the cost of advertising for achieving sales of 100 units
of a product. Sales and advertising costs of previous months are given in the table:
Sales 9 25 11 20 35 20
Cost 6 5 10 7 14 8
Forecasting Demand
37
Solution:
By using the least square method, we can calculate the regression equation.
X (Sales) Y (Cost) XY X
2
Y
2
9 6 54 81 36
25 5 125 625 25
11 10 110 121 100
20 7 140 400 49
35 14 490 1225 196
20 8 160 400 64
120 50 1079 2852 470
Here, n = 6
X =
n
X
=
6
120
= 20, Y =
n
Y
=
6
50
= 8.33
2 2
X X n
Y X XY n
b = b =
2
X n
2
X
Y X n XY
Substituting the values in the equation, we get b = 0.17. Substituting the value of b in
the equation, a = X b Y , we get a = 4.93. Substituting a and b in the straight line
equation, we can obtain the value of the dependent variable on the basis of the
independent variable.
Y = 4.93 + 0.17X
Given X = 100 units
Y = 4.93 + (0.17100) = 4.93 + 17 = 21.93 or 22
So, to achieve a sales level of 100 units, the organization needs to spend 22 units of
capital on advertising.
Activity: Using regression analysis, find the cost on advertising for achieving sales
of 100 units. Sales and advertising costs are given in the table:
Sales 11 27 17 25 38 23
Cost 10 8 13 9 16 11
Answer:
38
Check Your Progress
24. Demand for a commodity is most likely to depend upon which of the following?
i. The price of the commodity
ii. The prices of the available complementary goods
iii. The customer tastes and preferences
iv. Price of substitutes
a. i and ii
b. ii and iii
c. i, ii, and iii
25. Demand for a product is influenced by many factors. Which of the following is
not a factor that influences product demand?
a. Price of the product
b. Price of the substitutes
c. Income levels of the consumers
d. Extent of accuracy of demand forecasts
26. In the equation Y = a + bX, what is a termed as?
a. Value of the dependent variable
b. Value of the independent variable
c. Slope of the line
d. Y intercept or constant value
27. What is the relation between the slope of the line and the trend line in regression
analysis?
a. If the slope is positive, then the trend line increases positively
b. If the slope is positive, then the trend line decreases negatively
c. There is no relationship between the slope and the trend line
d. If the slope is negative, then the trend line increases positively
28. Which of the following forecasting methods give 100% accurate forecasts?
a. Qualitative methods
b. Time series methods
c. Causal methods
7. Selecting a Forecasting Method
If a good forecasting method is selected, it maximizes accuracy and minimizes biases.
Therefore, the suitability of a forecasting method should be verified before it is
selected. The selection of a method depends on the availability of data, the amount of
data and its nature, the amount of variation expected, the forecast accuracy required,
and the costs and technical expertise involved in forecasting. In general, the selection
of a forecasting system depends on the time span, data availability, and cost and
accuracy.
Forecasting Demand
39
Time Span The time span is one of the key issues to be considered here. Time
series techniques such as moving averages and exponential smoothing are used for
making short-range decisions like purchasing, job scheduling, project assignment, and
machine scheduling. Medium-range decisions like capital and cash budgeting, sales
planning, production planning, and inventory budgeting are made by using regression
analysis. The Delphi technique, market research, etc. are used for making long-range
decisions like product planning, facility location, and expansion, and capital planning.
Data Availability Time series analysis like moving averages and exponential
smoothing methods are used if historical data is available in plenty. Qualitative
methods like the Delphi method or the nominal group technique are used if no data is
available or if it is too expensive to collect data. Causal methods like regression
analysis are used if a relationship exists between the different variables under review.
Cost and Accuracy Inaccurate forecasts result in high inventory holding costs and
operating costs. Accurate forecasting methods incur high implementation costs as they
require data that is difficult to obtain, and skilled manpower to conduct the study.
8. Measures of Forecasting Accuracy
Forecasts are future predictions and so are subject to error. As the demand for a
product depends on various factors and all of them cannot be represented in a
forecasting model, it is difficult to get accurate results from forecasting methods.
Forecasting error is the difference between the forecasted demand for a particular
period and the actual demand in that period. To find out how well the forecasts from a
forecasting model fit in with the actual demand pattern, the average error of the model
is calculated. Using forecast errors, managers can compare the effectiveness of
various forecasting models and can plan their functional activities in a way that
minimizes the effect of forecasting errors. Forecasting errors occur due to the
omission of relevant variables during forecasting, ignoring or misinterpreting seasonal
variations, etc. Following are the measures of forecast accuracy, also known as
measures of forecasting error.
Mean Absolute Deviation (MAD)
MAD is used to measure the dispersion or variation of observed values around the
expected values. It is the mean of errors made by the forecast over a period of time
without the direction of error being considered i.e., it does not determine whether the
forecast was an overestimate or underestimate.
MAD is calculated by adding up the differences between the forecast value and the
actual demand for each period of time, and dividing the sum by the number of periods.
MAD is therefore described as the sum of deviations divided by the number of data
points.
MAD =
n
1 t
t t
F A
n
1
Where At = Actual demand in the period t
Ft = Forecasted demand for the period t
n = Number of periods considered
t t
F A = Absolute value of deviation
The lower the value of MAD, the more accurate the forecasts are.
40
Mean Square Error (MSE)
MSE is a measure of forecast accuracy in which the mean of the squares of deviations
of forecast values from actual result is calculated.
MSE =
n
1 t
2
t t
F A
n
1
.
From the equation, it can be seen that large errors are penalized more than the small
ones because of squaring.
Mean Forecast Error (MFE)
Demand is a function of several independent variables. These variables cause random
fluctuations in actual demand which affect the accuracy of the forecasts. To negate or
smoothen the impact of these fluctuations, the accuracy of a forecasting model is
calculated over several time periods. In such cases, MFE is a useful tool to find the
accuracy of the forecasting methods. The calculation of MFE is similar to that of
MAD except that absolute values are taken in MAD while real values are taken in
MFE.
MFE =
n
1 t
t t
F A
n
1
.
An accurate forecast model does not consistently overestimate or underestimate the
demand. The closer the value of MFE to zero, the more accurate the result is.
Mean Absolute Percentage Error (MAPE)
MAD, MSE, and MFE provide information on the extent of error in the forecast
model but not the relative errors. MAPE indicates the relative errors.
MAPE =
n
1 t
t
t t
A
F A
n
100
.
Tracking Signal
A tracking signal (TS) is a measure of accuracy that assesses the accuracy with which
forecasting methods are able to predict demand. It is the ratio between the running
sum of forecast errors (RSFE) and MAD. RSFE is the cumulative forecast error.
TS =
n
t
MAD
Demand Forecast Demand Actual
1
=
MAD
RSFE
TS is calculated each time the forecast model is updated with new data. It indicates
how much the forecast has been varying above or below the actual data for n periods
in terms of MAD. A positive TS indicates that forecasts are lower than the actual
demand while a negative value indicates that the forecasting method is overestimating
i.e., the forecast values are higher than the actual values. TS will be very close to zero
if the forecasting model makes accurate predictions and will deviate significantly from
zero if the forecasting model makes inaccurate predictions. The performance of a
forecasting model is monitored over time. If TS crosses a range of predetermined
limits, it would indicate that the model is no longer appropriate.
Forecasting Demand
41
Illustration 6
Calculation of measures of forecasting accuracy from the demand forecast data and
the actual demand data given in the first two columns of the table:
F A (A F)
F A
2
F A
100
A
F A
100
A
F A
90 80 -10 10 100 -12.5 12.5
80 75 -5 5 25 -6.67 6.67
70 70 0 0 0 0 0
80 90 10 10 100 11.11 11.11
95 97 2 2 4 2.06 2.06
85 86 1 1 1 1.16 1.16
Total -2 28 230 -4.84 33.5
MAD =
n
1 t
t t
F A
n
1
From the table,
n
1 t
t t
F A = 28
Therefore, MAD =
6
1
28 = 4.67
MSE =
n
1 t
2
t t
F A
n
1
From the table,
n
1 t
2
t t
F A = 230
Therefore, MSE =
6
1
230 = 38.33
MFE =
n
1 t
t t
F A
n
1
From the table,
n
1 t
t t
F A = -2
42
Therefore, MFE =
6
1
(-2) = -0.33
MAPE =
n
1 t
t
t t
A
F A
n
100
Therefore, MAPE = 33.5/6 = 5.583
TS =
MAD
RSFE
From the table, RSFE = (Actual Demand Forecast Demand) = (A F) = -2.
From the above calculation, we have found that MAD = 4.67
Therefore, TS =
67 . 4
2
= -0.428
Activity: From the information given in the table, calculate the measures of
forecasting accuracy.
Demand Forecast Actual Demand
110 105
100 95
85 87
90 95
93 95
96 99
Answer:
Check Your Progress
29. The numerical difference between forecast demand and actual demand is called
___________.
a. Standard deviation
b. Forecast error
c. Forecast variance
d. Forecast noise
Forecasting Demand
43
30. Which of the following is not considered by operations managers before selecting
a method for forecasting the future demand?
a. Cost and accuracy
b. Data availability
c. Projected time span
d. Plant capacity
31. Which of the following measures provide information on the extent of forecast
error in relative terms?
a. Mean absolute deviation
b. Mean square error
c. Mean forecast error
d. Mean absolute percentage error
32. Short-range decisions vary from purchasing, job scheduling, and project
assignment to machine scheduling. Which of the following forecasting methods
can be used for such decisions?
b. Linear regression analysis
c. Multiple regression analysis
d. Delphi method
33. Identify the forecasting method that can be used when data collection proves very
expensive.
a. Moving averages method
b. Delphi method
c. Regression analysis
d. Exponential smoothing
34. Identify the relationship between cost of forecasting and accuracy of forecasting.
a. Cost is directly proportional to extent of accuracy
b. Cost is indirectly proportional to extent of accuracy
c. Accuracy is independent of costs
d. Cost is inversely proportional to extent of accuracy
Exercises
(Questions B to F)
Use the data given in the table below to answer the following five questions related to
forecast errors.
Demand Forecast Actual Demand
500 510
510 510
520 515
540 550
550 545
44
B. Calculate the Mean Absolute Deviation (MAD).
C. The Mean Square Error (MSE) for the given data is ______________.
D. Calculate the mean forecast error.
E. Mean Absolute Percentage Error (MAPE) for the given data is __________.
F. Calculate the Tracking Signal (TS).
9. Monitoring and Controlling Forecasts Methods
Accurate forecasts are improbable because of the frequently fluctuating sales and
demand patterns. Forecasts should represent and follow variations in the patterns
being studied. The continuous monitoring of forecast models reduces the cost of
forecast errors. An accurate forecast made with the help of an appropriate model
allows an organization and its departments to plan its activities better. As all the
departments work on the basis of the same forecast, their efforts become mutually
supportive. The reasons for the failure of the forecasting systems should be identified
and avoided. An appropriate forecasting model should be used and the results of the
selected model should be regularly monitored. The appropriateness of the model
depends on the nature of the data available. As the nature of data changes constantly,
the forecasts should be periodically reviewed and revised. The performance of the
forecasting model can be monitored in many ways. One method involves comparing
the actual data with the forecasted values. Another method is the use of TS to check
whether the forecasting model is overestimating or underestimating the forecasted
value.
Example: Lego Toys
The LEGO Group is a Denmark-based family-owned company founded in 1932,
which is famous for its Lego brand of toys. As the company grew from a small
company to a big one, it realized that the legacy systems that it was using had
become outdated. As it began to expand on a global scale, its supply and demand
planning also needed to grow simultaneously. The company decided to use the i2
supply chain management solutions software along with the i2 Demand Planner
software, both developed by Texas-based i2 Technologies, Inc. The i2 solutions
software helps FMCG companies to optimize and monitor inventory and at the
same time to reduce costs and risks through integrated sourcing, negotiation, and
procurement. It also helps in improving customer service levels and in reducing the
fulfillment costs through multi-division and multi-channel order management.
After implementing the i2 solutions software for three months, the company began
to use the i2 Demand Planner software. It followed a top-down and a bottom-up
approach by using 45 users on the system. The Demand Planner was used as a
global forecasting tool and as a key account planning and collaboration tool with its
major customers. Both the systems were run on centralized servers and supported
the companys global operations. Before using the software, the company had
different processes for each of its 25 sales companies. After using it, these 25 sales
companies merged into eight sales regions. All the regions adopted common
forecasting processes, practices, and tools. It helped in employing an integrated
approach that supports existing processes, and in creating an account planning
system for supporting Collaborative Planning, Forecasting, and Replenishment
(CPFR).
Contd
Forecasting Demand
45
Contd
The use of i2 solutions has resulted in improved technical quality, increased the
forecasting efficiency and accuracy, and enhanced customer service and
satisfaction levels. As the i2solutions were flexible and scalable, the company was
able to adjust its planning systems to meet the requirements of the constantly
changing business environment. The companys globalized processes also enabled
it to share and adopt best practices company-wide. The global forecast
consolidation time was reduced from 3-4 weeks to 1 day. The software solutions
also support the CPFR opportunity. By using the Demand Planner, the company
was able to quickly respond to the customer and the marketplace requirements.
Adapted from Building a More Accurate Demand Forecast at the LEGO Company,
<http://www.i2.com/assets/pdf/A37168DE-1B55-45B9-BFD67C8860BFDB06.pdf>.
10. Summary
Forecasting forms the basis for operations management. It predicts the future demand
for products or services.
Six different components viz. base demand, seasonal component, trends, cyclical
component, promotions, and irregular component are associated with forecasting.
The forecasting process involves five stages. They include understanding the
objective of forecasting, integrating demand planning & forecasting, identifying the
influencing factors, identifying the consumer segments, and determining the
appropriate forecasting technique.
Forecasting techniques are classified as qualitative methods, time-series methods, and
causal methods.
Qualitative methods are subjective, judgmental, and based on judgments and
opinions. The Delphi method and the nominal group technique are some of the
qualitative methods used by operations managers.
Time-series forecasting methods assume that past data is a good indicator of the
future. These models are used to forecast the demand for goods or services.
Time series methods can be broadly divided into static forecasting methods and
adaptive forecasting methods. Trend and seasonal components are assumed to change
for every demand period in adaptive forecasting methods while they are assumed to
remain constant over years in static forecasting methods.
Some common time-series methods under adaptive forecasting include simple
moving average, the weighted moving average, and exponential smoothing.
Causal methods evaluate the relationship between different variables and their
influence on each other. Forecasting methods like linear regression and multiple
regression analysis are used by operations managers.
Forecasts are future predictions and so are subject to error. Forecasting error is the
difference between the forecasted demand for a particular period and the actual
demand in that period.
The different measures of forecast accuracy, also known as forecasting error are:
Mean Absolute Deviation, Mean Square Error, Mean Forecast Error, Mean Absolute
Percentage error, and Tracking Signal.
An appropriate forecasting model should be used and the results of the selected model
should be regularly monitored.
46
11. Glossary
Adaptive forecasting methods: These methods do not assume that the estimates of
seasonal and trend component remain same over years. The seasonal and trend
components are adjusted after every demand period (i.e., after every year if the
demand forecasting is made every year).
Base demand: It is the average sales over a given period of time and this is applicable
if the remaining components do not influence the demand.
Causal method: It evaluates the relationship between different variables and their
influence on each other.
Cyclic component: It refers to repetitive changes in the demand patterns.
Delphi method: It is a coordinated and interactive method of forecasting future
events on the basis of independent opinions and predictions. These opinions and
predictions are made by an expert panel and reviewed by a competent mediator.
Demand forecasting process: It includes understanding the objective of forecasting,
integrating demand planning & forecasting, identifying the influencing factors,
identifying the consumer segments, and determining the appropriate forecasting
technique.
Demand: The quantity of a product or service that buyers are able and willing to buy
during a particular time period in a specific market environment.
Exponential smoothing method: It is based on the assumption that the most recent
data is a better indicator of future trends than past data. It is useful when used on data
characterized by seasonal tendencies. This model has different variants based on
periodic trends or variations.
Forecasting error: It is the difference between the forecasted demand for a particular
period and the actual demand in that period.
Forecasting: It predicts the future value of a variable and helps managers in taking
effective decisions and planning their activities accordingly. It predicts the future
demand for products or services and is used in process design, capacity and facilities
planning, aggregate planning, scheduling, inventory management, etc.
Irregular component: It refers to all those variations in demand that cannot be
attributed to the base demand, seasonal, trend, cyclic, and promotional factors.
Least square method: It is used to generate a regression model by assigning data to a
single line. In this method, past demand data is used to form a linear model by
regressing the data points to a single line.
Linear regression analysis: It establishes a relationship between a dependent
variable, for which the future forecast is needed, and a group of other variables,
known as independent variables, which influence the dependent variable.
Mean Absolute Deviation: It is used to measure the dispersion or variation of
observed values around the expected values.
Mean Absolute Percentage Error: It provides information on the relative errors in
the forecast model.
Mean Forecast Error: It is used to find the accuracy of the forecasting methods. It
helps in negating the impact of the random fluctuations caused by independent
variables.
Mean Square Error: It is a measure of forecast accuracy in which the mean of the
squares of deviations of forecast values from actual result is calculated.
Forecasting Demand
47
Nominal group technique: It is a structured problem solving and decision making
method developed by Andrew Van de Ven.
Promotional component: It refers to the promotional activities taken up by marketers
to increase the sales of their products.
Qualitative methods: These are based on judgments (regarding factors influencing
demand) and opinions (about probability of the factors affecting the demand) and not
on any mathematical models.
Regression: It refers to the functional relationship between two or more correlated
variables.
Seasonal component: It is the repeated increase and decrease in demand during a
particular period, say season and off-season.
Simple moving average: In this technique, demand is forecast on the basis of the
average demand calculated from actual demand in the past.
Static forecasting methods: These methods assume that the estimates of seasonal
component and trends do not vary every year. These estimates are determined from
the available historical data and are projected to get the future demand estimate.
Time-series forecasting methods: These methods assume that past data is a good
indicator of the future.
Tracking Signal: It is a measure of accuracy that assesses the accuracy with which
forecasting methods are able to predict demand.
Trend component: It is the long term pattern of movement of demand over time,
which could be positive, negative or neutral. A positive trend implies increasing
demand while a negative trend implies decreasing demand.
Weighted moving average: In this technique, moving average is calculated by
assigning weights. There is no set rule for calculating weights. Weights are assigned
for a particular piece of data based on experience and trial and error methods.
1. Forecasting predicts the future value of a variable and helps managers in taking
effective decisions and planning their activities accordingly. Explain the need for
forecasting in operations.
2. Forecasting in operations management involves the use of quantitative and
qualitative tools for estimating and predicting future demand for products and
services. What are the different methods of forecasting? Explain in detail.
3. Selecting a good forecasting method maximizes accuracy and minimizes biases.
What are the factors to be considered for selecting a forecasting system?
4. As demand for a product depends on various factors and all of them cannot be
represented in a forecasting model, it is difficult to get accurate results from
forecasting methods. Explain the various measures of forecasting accuracy.
5. An appropriate forecasting model should be used and the results of the model
should be regularly monitored. Why is it necessary to monitor and control
forecasts? Also explain how an organization can monitor and control forecasts.
6. Components of forecasting play a major role in estimating the forecast and the
accuracy of the forecast depends on the estimation of these components in a
major way. Examine the various forecasting components and importance in the
forecasting process.
48
7. Explain the following:
Delphi method
Static forecasting methods
Adaptive forecasting methods
Linear regression
6. Forecasting Theory
<http://www.me.utexas.edu/~jensen/ORMM/omie/operation/unit/forecast/index.h
tml>
7. Nominal Group Technique
<http://crs.uvm.edu/gopher/nerl/group/a/meet/Exercise7/b.html>
8. Time Series Analysis
<http://www.statsoft.com/textbook/sttimser.html>
9. Time Series Analysis
<http://www.itl.nist.gov/div898/handbook/pmc/section4/pmc4.htm>
10. Forecasting Techniques
<http://home.ubalt.edu/ntsbarsh/stat-data/Forecast.htm#rrstatthink>
11. Time Series
<http://www.stats.gla.ac.uk/steps/glossary/time_series.html>
12. Linear Regression
<http://www.stat.yale.edu/Courses/1997-98/101/linreg.htm>
13. Linear Regression
<http://www.graphpad.com/curvefit/linear_regression.htm>
14. Least Squares
<http://www.efunda.com/math/leastsquares/leastsquares.cfm>
15. Least Squares
<http://www.physics.csbsju.edu/stats/least_squares.html>
Forecasting Demand
49
16. Mean Absolute Deviation
<http://mathworld.wolfram.com/MeanDeviation.html>
17. Mean Square Error
<http://www.fmi.uni-sofia.bg/vesta/Virtual_Labs/freq/freq5.html>
18. Demand Forecasting
<http://mgtclass.mgt.unm.edu/MIDS/MIDS/Kraye/Mgt%20488/HK%27s%20Ch
pt%2004%20demand%20forecasting.ppt>
1. (d) Increased locking up of working capital as inventory
Working capital is locked up as inventory, only when there is excess production.
Excess production happens when demand is overestimated. However, when
demand is underestimated, production will not be sufficient to meet the demand.
Hence, there are greater chances of locking- up of working capital in the form of
inventory as a consequence of overestimation of demand rather than
underestimation.
2. (a) Short-term demand
Short-term demand estimates for individual products are generally very detailed,
and are used to plan and schedule production operations. Long-term and medium-
term demand forecasts are used for making location, layout and capacity
decisions.
3. (d) Planning and controlling
Forecasting demand is most important to the planning and control functions of
management. Forecasting is a step in the planning process where plans are
developed based on forecasts. Under the control function, actual results are
compared with that of planned standards (based on forecasts) and deviations are
identified and corrected.
4. (d) Base demand
Base demand is the average of sales over a given time period. This figure can be
taken as the right forecast if the demand for a product is not impacted by
seasonal, trend, cyclic, or promotional factors.
5. (c) Cyclical component
Cyclic component refers to changes in demand patterns, which exist for more
than a year. These changes could either show an upward or downward movement.
A good example is the demand for luxury products that is linked with the
business cycle. Sales usually increase during the boom phase and slow-down
during recession.
6. (b) Promotional component
The sales of LG televisions doubled when LG increased its advertising budget.
Here, LG gave more weightage to the promotional component to arrive at an
aggressive estimate.
7. (c) The demand for camera mobile phones in India has increased steeply
since 2001
The demand for camera mobile phones has shown a positive trend over a period
of time. The long-term pattern is clearly visible in this example. The prices of
gold increased and decreased, leading to rise and fall in demand. Hence, it is
cyclical. The Airtel example highlights the promotional component, and the
demand for wrist watches displays the irregular component.
50
8. (b) Delphi Method
Qualitative methods are judgmental and subjective in nature and are based on the
estimates and opinions of individuals like experts in case of Delphi method and
consumers in case of market research method.
9. (d) Understand objectives identify influencing factors identify customer
segments select forecasting technique
The forecasting process starts with understanding its objectives. Then, all the
major influencing factors are identified. Next, all possible customer segments in
the market are marked out and their impact on the forecast has to be understood.
Finally, a suitable forecasting technique has to be selected.
10. (b) It is used for short-term forecasting.
The Delphi method is a coordinated and interactive method of forecasting future
events on the basis of independent opinions and predictions. These opinions and
predictions are made by an expert panel and reviewed by a competent mediator.
The method is mostly used for long-term forecasting.
11. (d) iii-i-ii-iv
The Delphi method is a coordinated and interactive method of forecasting future
events on the basis of independent opinions and predictions. The steps involved
in the method are (a) selecting a group of experts, depending on the type of
expertise required; (b) obtaining ideas and forecasts from all participants through
a questionnaire; (c) summarizing the results and redistributing them along with
appropriate new questions; and (d) summarizing the responses again and
developing new questions on the basis of the responses.
12. (b) Nominal group technique
The nominal group technique is a structured problem solving and decision
making method developed by Andrew Van de Ven. The various steps involved in
the technique are generation of ideas, round robin collection of ideas,
discussion, preliminary voting, and final voting.
13. (b) Each idea is discussed in terms of their perceived importance, clarity, and
logic.
The nominal group technique involves the following steps (a) generation of
ideas; (b) round robin collection of ideas; (c) discussion; (d) preliminary voting;
and (e) final voting. Options (a) and (d) are steps involved in the Delphi method.
14. (b) Time series methods
Time series analysis can be categorized into two broad categories, based on the
complexity involved: static and adaptive. Static methods assume that estimates of
trend and seasonal components do not vary from year to year. Adaptive
forecasting is an advanced form of time series analysis, where trend and seasonal
components are adjusted after each demand observation.
15. (b) Static forecasting method
Static forecasting methods assume that estimates of trend and seasonal
components do not vary from year to year. In this method, estimates of trend and
seasonal components are determined based on historical data, which is projected
to obtain future demand data.
16. (a) Time-series methods
Time-series methods uses past (historical) data to predict future demand.
17. (a) 1
Each element in the weighted moving average method is weighted by a factor and
the sum of the weights should be equal to one.
Forecasting Demand
51
18. (c) Trial & error
Certain weights are assigned to each element and managers use past experience
(not future forecast) as well as the trial and error method to calculate these
weights. The simple moving average method and exponential smoothing are other
types of time series forecasting methods like the weighted forecasting method.
19. (c) Exponential smoothing
The exponential smoothing method is based on the assumption that the most
recent data is a better indicator of future trends than past data. The method is
useful when demand for products exhibit seasonal tendencies. The simple moving
average method is effective only when a product does not experience fluctuation
in demand over a period of time and past demand for the product was not
seasonal. Delphi method is a qualitative forecasting method
20. (c) Larger data storage space
The advantages of the exponential smoothing method are: availability of standard
software packages; relatively little data storage and computational requirements;
accuracy of forecasts and easy understanding of results.
21. (a) Latest time period
In the exponential smoothing method, the demand for the most recent time period
is given maximum weightage. The weights assigned to the preceding periods
decrease exponentially.
22. (b) WMA
t+1
=
n
1 t
t t
A C
The formula for calculating the weighted moving average is
WMA
t+1
=
n
1 t
t t
A C
Where,
WMA
t+1
= Weighted moving average at the end of the time period t, A
t
= Actual
demand in time period t, C
t
= Percentage weight given to time period t, 0 C
t
1
and C
1
+ C
2
+ C
3
+... + C
t
= 1
23. (c) i and ii
Smoothing constant shows the effects of past demand on future demand
forecasts and helps smoothen out the effects of any noise. But, is not used to
predict future trends in demand.
Demand for a product is influenced by conditions like the price of the product,
price of substitutes, price and availability of complementary products, income of
consumers, their tastes and preferences, and their reactions to changes in price.
25. (d) Extent of accuracy of demand forecasts
Demand is influenced by conditions like the price of a product, and the price of
its substitute and complementary products; the incomes of customers, their
expectations regarding price changes, and their tastes and preferences; the number
of customers and their travel costs to the point of purchase (PoP). Accurate
forecasts of demand help organizations to suitably increase or reduce production.
Therefore accurate forecasts, as such, do not influence the demand for the
product. They instead help the management in decision-making relating to
product demand.
52
26. (d) Y intercept or constant value
In linear regression, the relationship between the dependent variable and a single
independent variable is defined by a straight line.
Y = a + bX where, Y = Value of the dependent variable, X = Value of the
independent variable, a = Y intercept (Constant value), and b = Slope of the line,
a is the Y-intercept and its value defines the point at which the regression line
crosses the Y-axis.
27. (a) If the slope is positive, then the trend line increases positively
If the slope is positive, then the trend line increases positively. If the slope is
negative, then the trend line decreases negatively.
28. (d) None of the above
No forecasting method, either qualitative, time series or causal, gives 100%
accurate forecasts. They can only be highly accurate and 100% accuracy is not
possible.
29. (b) Forecast error
A forecasting error is the difference between the forecasted demand for a
particular period and the actual demand in that period.
30. (d) Plant capacity
Plant capacity is not a factor that is considered to forecast demand. Operations
managers may increase or decrease the running capacity of the plant depending
on the demand. Hence, it cannot be considered a factor that influences demand.
Rather plant capacity is influenced by the demand.
31. (d) Mean absolute percentage error
Mean absolute percentage error (MAPE) provides information on the extent of
forecast error in relative terms while the other measures provide information in
absolute terms.
32. (a) Exponential smoothing
For short-range decisions like purchasing, job scheduling, project assignment and
machine scheduling, time series techniques like moving averages (SMA or
WMA) and exponential smoothing are the most preferred forecasting methods.
Regression analysis is used in medium range forecasting as well as long term
forecasting. Linear regression analysis is useful in long term forecasting of major
occurrences and aggregate planning.
33. (b) Delphi method
Delphi method is used when no data is available or if it is too expensive to collect
data. The other three methods primarily require data to forecast demand.
34. (a) Cost is directly proportional to extent of accuracy
Accuracy of forecasts depends on data availability. Forecasts can be more
accurate when more data is available. Also, it is costly to collect huge volumes of
data. Hence, to avoid these costs, some organizations use readily available data at
low costs and end up with inaccurate forecasts. Thus, accurate forecasts come at a
dearer price.
Forecasting Demand
53
A. 87
In the six-month simple moving average technique, the forecast for the seventh
month will be the average of the preceding six months. Thus, the forecast for the
month of July is the average demand of generator sets during Jan, Feb, March,
April, May, and June. Similarly, the forecast for January 2007 would be the
average of demand during July, Aug, Sep, Oct, Nov, and Dec months.
Forecast for January 2007 = (87 + 88 + 86 +89 + 86 + 87) / 6 = 523/6 = 87.1666
(approx 87)
January 78
February 80
March 85
April 82
May 84
June 85
July 87 82.33
August 88 83.83
September 86
October 89
November 86
December 87 86.83
87.17
B. 6
Demand Forecast (F) Actual Demand (A) (A - F) |A - F|
500 510 10 10
510 510 0 0
520 515 -5 5
540 550 10 10
550 545 -5 5
Sum 10 30
Mean absolute deviation =
n
t 1
t
F
t
A
n
1
MAD
= 30/5
= 6
54
C. 50
Demand Forecast (F) Actual Demand (A) (A - F) (A - F)
2
500 510 10 100
510 510 0 0
520 515 -5 25
540 550 10 100
550 545 -5 25
Sum 10 250
Mean Square Error =
n
1 t
2
t t
) F (A
n
1
MSE
= 250/5
= 50
D. 2
Demand Forecast (F) Actual Demand (A) (A - F)
500 510 10
510 510 0
520 515 -5
540 550 10
550 545 -5
Sum 10
n
1 t
t t
) F (A
n
1
MFE
= 10/5
= 2
E. 1.14
Demand
Forecast (F)
Actual
Demand (A)
(A - F) |A - F| (|A-D|/2) x 100
500 510 10 10 1.96
510 510 0 0 0
520 515 -5 5 0.97
540 550 10 10 1.82
550 545 -5 5 0.92
Sum 10 30 5.67
Forecasting Demand
55
n
1 t t
t t
A
F A
n
100
MAPE
MAPE = 5.67/5 = 1.134
F. 1.67
Demand Forecast Actual Demand Deviation (A-F)
500 510 10
510 510 0
520 515 -5
540 550 10
550 545 -5
Sum 10
n
i 1
MAD
demand Forecast Demand Actual
TS
TS = 10/6
= 1.67
Unit 18
Allocating Resources to Strategic Alternatives
Structure
1. Introduction
2. Objectives
3. Allocation Decisions in Operations Strategy
4. Linear Programming in Operations Management
5. Formulation of Linear Programming Problems
6. Solution of Linear Programming Problems
7. The Transportation Problem in Linear Programming
8. Summary
9. Glossary
1. Introduction
In the last section of the previous unit, we have discussed how to monitor and control
forecasts. We have learnt that an accurate forecast made with the help of an
appropriate model allows an organization and its departments to plan its activities
better. In this unit, we will discuss how to allocate resources to strategic alternatives.
Organizations focus on achieving their objectives of revenue maximization, capacity
utilization, cost minimization, etc. by making effective use of the resources available
to them. Resources are effectively utilized when they are allocated to strategic
alternatives that result in maximum benefits. In operations, the term resources means
manpower, machinery and equipment, capital, materials (raw, semi-finished, and
finished), spares, components, floor space, and others that are required for production.
Allocating these resources to strategic alternatives is a complex task for an
organization as it operates under various constraints like limited availability of
resources and time and the need to fulfill social obligations.
This unit will discuss allocation decisions in operations strategy. We will discuss
linear programming in operations management. We shall then move on to discuss how
to formulate linear programming problems, and how to find solution to such
problems. Finally, we would discuss transportation problems in linear programming.
2. Objectives
discuss the allocation decisions in operations strategy.
use linear programming in operations management.
compute linear programming problems.
determine the solution of linear programming problems.
assess the transportation problem in linear programming.
57
3. Allocation Decisions in Operations Strategy
Constrained optimization models are mathematical models that enable operations
managers to compute the amount of resources to be allocated to each of the strategic
alternatives. A model represents the key features of an object, system, or a problem,
uncluttered by the finer details.
3.1. Components of Constrained Optimization Models
Constrained optimization models consist of three major components: decision
variables, objective functions, and constraints.
Decision variables Decision variables are the physical quantities that can be
controlled. The optimal values of these variables will be determined after the problem
has been solved through a constrained optimization model.
Objective functions The objective function states the criteria on which the
alternatives are to be evaluated. It is a mathematical function of the decision variables
and states what is to be maximized (profit, sales revenue) or minimized (cost, distance
to travel).
Constraints Constraints are practical limitations that restrict the choice of the
decision variables of a problem. These constraints are mathematically represented as:
less than (<), greater than (>), less than equal to ( ), equal to (=), or greater than equal
to ( ). A constraint imposes an upper limit on the function of decision variables like
utilization of the available raw materials or machinery. A constraint provides the
lower limit on some function of decision variables. For example, the constraints may
specify that the number of units to be produced should exceed the demand of the
product. An = constraint states that the number of products to be manufactured must
be equal to a certain quantity. For example, a firm produces three products X, Y, and
Z, generating a profit of Rs. 10, Rs. 12, and Rs. 16 respectively from them. The
operations manager of the firm wants to identify the right mix of products to be
produced that will maximize the firms profits. Assume that the firm has the raw
material to produce only 12 units of Y and the time to produce only 5 units of Z. The
objective is to maximize profits by considering all the constraints involved in the
problem. Decision variables are the number of products to be produced of each
product X, Y, and Z. Therefore, the objective function is Maximize Z = 10X + 12Y +
16Z, which is subject to the constraints Y 12 and Z 5.
3.2. Merits and Demerits of Constrained Optimization Models
Following are the merits and demerits of the models:
Merits
An optimization model reduces the number of feasible solutions to a convenient
number.
These models provide an optimal solution for the organization as a whole.
Optimization models help a decision-maker perform a what-if analysis (sensitivity
analysis).
Optimization models also help a decision-maker solve problems mathematically.
Demerits
The solution obtained from the model may not always be the optimal solution for the
real problem as these models do not consider non-quantifiable criteria.
The models may sometimes provide a solution that cannot be put into practice.
58
Check Your Progress
1. Constrained optimization models consist of three major components. Which of
the following is not a component of these models?
a. Decision variables
b. Nature of demand
c. Objective functions
d. Constraints
2. Constrained optimization models are useful techniques enabling operations
managers to compute the amount of resources to be allocated to each strategic
alternative. Which of the following is not a benefit of using a constrained
optimization model?
a. Feasible solutions are reduced to manageable numbers
b. Provides optimal solution for the whole organization
c. Enables decision-makers to perform what-if analysis
d. Provides optimal solutions that are always practical
3. If the objective function is a maximizing function, which of the following can be
considered for it?
a. Profits
b. Inventory
c. Advertising expenditure
d. Production costs
4. Linear Programming in Operations Management
Linear programming is a mathematical, constrained optimization model used to
maximize or minimize the linear functions of a large number of variables, subject to
certain constraints. The technique is used to allocate resources to strategic alternatives
to ensure that they are utilized optimally. The technique specifies how to use limited
resources to meet a particular objective of maximizing profits or minimizing costs,
when the resources have alternative uses. As the output per unit of resource and the
return per unit of output are known, the resource combination that optimizes the
organizations objectives can be determined. Linear programming is widely used in
various industrial and military operations.
Example: Computers for Agriculture
Computers have made agricultural planning easier and led to reduction in economic
losses. In the Chang Qing county in China, the most important occupations are crop
farming and animal husbandry. The county officials used linear programming to
help farmers in choosing their crops and other forms of agricultural production to
increase net profit without causing adverse effects on the environment. The
problem involved more than 3000 variables and 100 constraints. This increased the
crop profits by 12% and the animal husbandry profits by 54%. It also improved the
ecology of the region and helped in diversifying the economy.
Adapted from Qingzhen, Zhao, Wang Changyu, and Zhang Zhimin, The application of
Operations Research in the Optimization of Agricultural Production. Operations Research,
Vol. 39, No. 2 (1991). pp. 194-205,<http://www.hsor.org/case_studies.cfm?
name=farming_china>
59
4.1. Assumptions of Linear Programming
The following are the assumptions made in linear programming models:
Proportionality In linear programming problems, it is assumed that the contribution
of individual decision variables in the objective function is proportional to their numeric
value. Assume that variable X
j
represents the number of units produced of product j and
C
j
is the raw material quantity utilized in producing a unit of the product. Producing 10
units of Product j consumes 10 times the raw material quantity C
j
. Hence, the raw
material consumption per unit product produced remains constant. This means that
economies of scale do not play a role in linear programming problems.
Additivity The objective function and constraints include several decision variables.
It is assumed that the total value of the objective function and each constraint is equal
to the sum of the individual contributions from each decision variable. This means
that the model does not consider any synergistic or anti-synergistic effects among the
decision variables while calculating the total value for the objective function.
Divisibility Decision variables can be non-negative and real numeric values within
the range specified by the constraints. The problems that involve fractional values for
the decision variables should also be solved in the same way in which problems with
decision variables as integers are solved. To avoid fractional values in the final
solution, operations managers use integer programming, a technique similar to linear
programming, that allows only integer values in the solution.
Certainty It is assumed that all the constants C
j
, A
ij
and B
i
have certain values and
the solution is optimal for the problem only when the coefficients of variables have
certain or definite values.
4.2. Characteristics of Linear Programming
Operations managers should be able to identify the problems for which the linear
programming model can be applied. These models can be applied to problems with
following characteristics:
There is a well-defined single objective.
There are alternative courses of action to solve the problem.
The decision variables are continuous and they can accept any non-negative or
fractional values within the specified range.
All factors that affect the objective function should be written in the form of
constraints.
The objective and the constraints are linear functions.
Refer Table 4.1 for an example demonstrating how an operations manager can
determine whether the linear programming technique is applicable to a particular
problem. After ensuring that the linear programming can be applied to the problem,
the next step is to formulate the problem.
Table 4.1: Recognizing Linear Programming Problem
As a part of its strategic planning process, the Gulf Coast Company must determine
the mix of its products to be manufactured next year. The company produces two
principal product lines for the commercial construction industry: a line of powerful
portable circular saws and a line of precision table saws. The product lines share
the same production capacity and are sold through the same sales channels.
Although some product variety does exist within each product line, the average
profit is Rs. 5 for each circular saw and Rs. 7 for each table saw. The production
capacity is constrained by the capacities of two facilities: fabrication and assembly.
Contd
60
Contd
A maximum of 13 hours of fabrication capacity is available per month. Each
circular saw requires 2 hours and each table saw requires 3 hours of fabrication
respectively. There is a maximum of 12 hours of assembly capacity available per
month. Each circular saw requires 3 hours and each table saw requires 2 hours of
assembling respectively. How many circular saws and table saws should be
produced monthly next year to maximize profit?
1. Is there a single managerial objective?
Yes, the objective is to maximize the profit.
2. Are there alternative courses of managerial actions?
Yes, the management can decide to produce only circular saws or only table
saws or any mix of circular and table saws.
3. Is the achievement of the objective constrained by resources?
Yes, profits are constrained by the maximum number of fabrication and
assembly hours available per month.
Check Your Progress
4. Identify the mathematical technique used to determine the optimal utilization of
resources in an organization.
b. Regression analysis
c. Linear programming
d. Decision tree analysis
5. While constructing a linear programming problem, certain assumptions are made.
Which of these is not such an assumption?
a. Proportionality
b. Optimality
c. Divisibility
d. Additivity
6. The concept of linear programming does not consider any synergetic effects
among decision variables while calculating their total value for the objective
function or the constraints they are associated with. This is part of which
assumption of linear programming?
a. Proportionality
b. Additivity
c. Divisibility
d. Certainty
7. Identify from the following, the characteristics of a linear programming problem.
i. There is a well-defined single objective.
ii. The decision variables are continuous and they can accept any non-negative or
fractional values within the specified range.
61
iii. All factors that affect the objective function should be written in the form of
constraints.
iv. The objective and the constraints are linear functions.
5. Formulation of Linear Programming Problems
Formulating a linear programming problem is the most vital and difficult aspect of
solving a real problem. Though there is no fixed pattern for formulating such
problems, the following procedure can be followed:
1. Identify the Decision Variables The decision-maker should identify the
variables that are under his/her control. These variables, which can be changed in
order to optimize the objective function, are called decision variables and they
should be defined completely and precisely.
2. Define the Objective Function The objective of the problem and the criteria
for evaluating alternative solutions should be well defined. The objective is
generally written as a linear function of the decision variables, each multiplied
by an appropriate coefficient.
3. Identify and Express Relevant Constraints After defining the decision
variables and the objective function, the operations manager should identify the
constraints that affect the objective function. This process of formulation is
generally iterative. Refer Table 4.2 for the steps involved in formulating the
linear programming model for the problem given in Table 4.1.
The general form of a linear programming problem is
Maximize
n n 2 2 1 1
x C ... x C x C Z
Subject to the constraints
A
11
x
1
+A
12
x
2
+ ... +A
1n
x
n
b
1
A
21
x
2
+A
22
x
2
+...+A
2n
x
n
b
2
A
m1
x
1
+A
m2
x
2
+...A
mn
x
n
b
m
x
1
, x
2
, ...x
n
0.
Where
x
1
, x
2
, x
3
, ...x
n
= a set of variables whose numerical values are to be determined
C
ij
, A
ij
, and b
i
= numeric coefficients that are specified in the problem.
It can be observed that Z is a linear function of variables x
i
, i.e, when the value of a
variable x
i
increases by unity, the value of Z increases by C
i
.
The linear programming model can also be used to minimize the objective function. In
such case, the constraints are written with a sign . The constraints can also be
written as linear equalities. Thus, the resulting set of decision variables (values for the
n variables, x
1
, x
2
, x
3
...x
n
) optimizes (either maximizes or minimizes) the objective
function, subject to m constraints and the non-negativity conditions of x
j
variables.
62
Table 4.2: Formulating a Linear Programming Problem
The problem illustrated in Table 4.1 can be formulated as a linear programming
problem by adopting the following steps:
Step 1: Identify the decision variables - The variables that can be altered to
optimize the profit of the Gulf Coast Company are the number of circular saws and
table saws that are to be manufactured.
Let x
1
and x
2
represent the number of circular saws and table saws manufactured
per month respectively.
Step 2: Define the objective function - The objective of the problem is to maximize
profits. Each circular saw contributes Rs. 5 and each table saw contributes Rs. 7
toward profits. Hence, the objective function may be defined as;
Maximize Z = 5 x
1
+ 7 x
2
Step 3: Identify the relevant constraints: The goal of maximizing profit is
constrained by the number of fabrication hours, and the number of assembly hours.
These constraints can be expressed as;
2x
1
+ 3x
2
(Each circular saw requires 2 hours of fabrication and each table saw requires 3
hours of fabrication, but the total fabrication hours available are only 13).
Similarly, 3x
1
+ 2x
2
12.
(Each circular saw requires 3 hours for assembling and each table saw requires 2
hours for assembling. But the total assembly hours available are only 12).
The other constraint is a non-negativity constraint. Since a negative number of
saws cannot be manufactured, x
1
and x
2
0.
Thus, the linear programming problem is finally formulated as:
Maximize Z = 5x
1
+ 7x
2
Subject to
2x
1
+ 3x
2
13
3x
1
+ 2x
2
12
x
1
, x
2
0.
Check Your Progress
8. Identify the correct sequence of steps to formulate a linear programming problem.
i. Identify the objective function
ii. Identify decision variables
iii. Identify constraints
a. ii, i, and iii
b. i, ii, and iii
c. iii, ii, and i
d. ii, iii, and i
63
Exercises
(Questions A to E)
Atul Tele-Products manufactures two telephone models using two different raw
material grades. One (x) is of superior quality and the other (y) inferior (second
grade). The profit per unit for the model using superior quality raw material is Rs.200
and that of the other is Rs150. The maximum demand for both telephones is 600 units.
Production should not exceed demand and total machine time available for both types
of telephones together is 650 hours. Besides, one superior quality telephone can be
produced in two hours while one unit of inferior quality telephone can be produced
every hour. Answer the following five questions using the information given above.
A. If Atul Tele-Products wants to maximize profits, what should be the objective
function?
B. What is the constraint on machine hours?
C. What is the constraint on demand?
D. If the number of superior quality telephones produced in a month is 200 and
inferior quality telephones is 200, then what is the maximum profit (in rupees)
that the company gets?
E. What is the appropriate production combination for the two models to gain
maximum profits?
6. Solution of Linear Programming Problems
After formulating a linear programming problem, the following methods can be used
to solve them:
6.1. Graphical Method
The graphical method explains the process of obtaining a solution to a linear
programming problem in a simple way. Following is the procedure:
Formulate the linear programming problem by identifying the decision variables, the
objective function and the constraints.
Convert the inequality constraints to their equalities and plot them on a graph (in
linear form).
Using the inequalities in each constraint, determine the feasible region.
Write down the corner points of the solution area. Substitute the values in the
objective function. The optimum solution is obtained at any of these points.
Example: Maximize Z = 700x
1
+ 400x
2
Subject to
2x
1
+ x
2
3,000
x
1
+ 2x
2
4,000
x
1
+ x
2
2500
x
1
, x
2
0
Find the optimum solution for the given problem using the graphical method.
64
Solution: Refer Figure 4.1 for the optimum solution to the given problem. The
feasible solution area is OABC and the optimum solution is at the point (2000/3,
5000/3). The number of circular saws to be manufactured per month = 2000/3 = 667
and the number of table saws to be manufactured = 5000/3 = 1667. After representing
the problem graphically, the operations manager should ensure that all the points in
the feasible region satisfy all the linear programming constraints. The point at which
the solution is optimum can also be found by moving the objective linear equation on
the feasible region of the same graph. Starting at the origin or from any point, the
objective function is moved parallel to itself in a direction away from the origin until
the last point in the feasible region is reached. This is the point at which the value of
the objective function is optimum.
The graphical method is applicable only to those problems in which a maximum of
two decision variables are involved. Solving a graphical problem is tedious as the
decision-maker has to identify the coordinates of all the extreme points in the feasible
region, and then evaluate the objective function at each of them. Therefore, the
simplex method is preferred to the graphical method.
Figure 4.1: Optimum Solution (Graphical method)
6.2. Simplex Method
The method overcomes the limitations of the graphical method and can be applied to
problems with more than two decision variables. The algorithm for the simplex
method is iterative in nature and determines the optimum solution for a problem in a
systematic manner. The following points should be considered before solving a
simplex problem:
The value of the constraint in the right-hand side of each of the constraints should be
non-negative. If not, it should be converted into a non-negative value.
Each decision variable of the problem should be non-negative.
Slack variables are introduced in each constraint equation as an idle source to convert
inequalities to equalities.
65
Example: Maximize Z = 8x + 6y subject to the constraints,
4x + 2y 60
2x + 4y 48
x, y 0
Solution: The objective of the problem is to maximize the function Z = 8x + 6y
The constraints are:
4x + 2y 60
2x + 4y 48
x, y 0
Adding slack variables S
1
, and S
2
to the problem,
Maximize Z = 8x + 6y + S
1
+ S
2
Subject to
4x + 2y + S
1
= 60
2x + 4y + S
2
= 48
x, y, S
1
, S
2
0.
Refer to the initial simplex table. The highest element in the Index or (C
j
Z
j
) row is
8. Therefore, the x column becomes the key column and x is called the entering
variable. The ratios are obtained by dividing the solution variables by the
corresponding elements of the key column. The row with the minimum ratio is called
the key row and the intersection element of the key row and the key column becomes
the key element. Here, S
1
row is the key row and 4 is the key element. The variable
S
1
is called the departing variable.
Initial Simplex Table:
C
j
8 6 0 0 Ratio
C
B
Basic
Variables
Solution
Variables
x y S
1
S
2
0 S
1
60 4* 2 1 0 60/4 = 15
0 S
2
48 2 4 0 1 48/2 =24
Z
j
0 0 0 0
(C
j
- Z
j
) 8 6 0 0
* Key Element
Now, the new simplex table is developed using the following procedure. All the
values in the key row are divided by the key element to obtain the new values and the
departing variable S
1
is replaced by the entering variable x.
Thus the values in the key row are:
15 1 0.5 0.25 0
66
The new values for each remaining row (other than the key row) can be computed by
using the formula:
New row value =
= Old row value
element Key
) column key the in value ing Correspond row key the in value ing Correspond (
Thus the new values of S
2
row can be calculated as:
New Values:
New value for 48 = 48 [(260)/4] = 18
New value for 2 = 2 [(42)/4] = 0
New value for 4 = 4 [(22)/4] = 3
New value for 0 = 0 [(12)/4] = -0.5
New value for 1 = 1 [(02)/4] = 1
Simplex Table 2:
C
j
8 6 0 0 Ratio
C
B
Basic
Variables
Solution
Variables
x y S
1
S
2
8 x 15 1 0.5 0.25 0 15/0.5 = 30
0 S
2
18 0 3* -0.5 1 18/3 = 6
Z
j
8 4 2 0
(C
j
- Z
j
) 0 2 -2 0
* Key Element
Refer to simplex table 2. From the table, the largest positive value in the (C
j
Z
j
) row
is 2 and it lies in the y column. So, y becomes the entering variable and the y
column becomes the key column. The ratios obtained by dividing the solution
variables with the values in the key column are 30 and 6. Here, 6 is the minimum
ratio. Therefore, the S
2
row becomes the key row and the variable S
2
becomes the
departing variable. The key element is 3. The departing variable is replaced by the
entering variable y and the revised key row is obtained by dividing all the values in
the key row by the key element.
Thus the values in the key row are:
6 0 1 -0.17 0.33
New Values:
New value for 15 = 15 [(180.5)/3] = 12
New value for 1 = 1 [(00.5)/3] = 1
New value for 0.5 = 0.5 [(30.5)/3] = 0
New value for 0.25 = 0.25 [(-0.50.5)/3] = 0.33
New value for 0 = 0 [(10.5)/3] = - 0.17
67
Simplex Table 3:
C
j
8 6 0 0
C
B
Basic
Variables
Solution
Variables
x y S
1
S
2
8 X 12 1 0 0.33 -0.17
6 Y 6 0 1 -0.17 0.33
Z
j
8 6 1.62 0.62
(C
j
- Z
j
) 0 0 -1.62 -0.62
Refer to simplex table 3. Since there is no positive value in the (C
j
Z
j
) row of the table,
the simplex table cannot be developed further. Therefore, the optimum solution is
x = 12, y = 6, and
The maximum value of the profit at this optimum solution is
Z
max
= 8x + 6y = 8(12) + 6(6) = 96 + 36 = Rs. 132
Example: Linear Programming at Nabisco
Nabisco, a bakery, used mathematical programming to plan the production of its
items. The companys biscuit division carried out two operations: baking and
secondary operations. In the baking process, the raw materials were fed into an
oven to get the finished products. The secondary operations included sorting,
packaging, and labeling the finished products. It is a difficult task to schedule
operations in a bakery. Each oven produced many but not all the products and the
efficiency of each oven varied. The secondary facilities at one site were shared by
the ovens operating at the same time. The planning of production had to be done in
such a way as to reduce the manufacturing and the transportation costs. The
company developed a mathematical model in 1983, which addressed the following
questions: the place to produce each product, the quantity of each product to be
assigned to each oven, the place from where the product had to be shipped to each
customer, the location of the new plants to develop new products, the type of
facilities to be placed in these plants, etc. This linear programming problem was
solved with the help of an IBM 3033 computer in less than 60 CPU seconds. The
problem involved 150 products, 218 facilities, 10 plants, and 127 customer zones.
It also involved more than 44,000 decision variable and about 20,000 constraints.
Adapted from Brown, G.G., G. W. Graves and M. D. Honczarenko, Design and Operation of a
Multicommodity Production/Distribution System Using Primal Goal Decomposition,
Management Science, Vol. 33, No. 11 (1987) pp. 1469-1480, and
<http://www.hsor.org/case_studies.cfm?name=nabisco>
Activity:
Maximize Z = 10x + 12y, subject to
x + y 5
x 2
y 4
x, y 0
Contd
68
Contd
Answer:
Activity:
2. Minimize Z = 80X
1
+ 100X
2
, subject to
80X
1
+ 60X
2
1500
20X
1
+ 90X
2
1200
X
1
, X
2
0
Answer:
Check Your Progress
9. Where does the optimum solution lie on the graph in the graphical method of
solving a linear programming problem?
a. On the X axis
b. On the Y axis
c. In the feasible region
d. Outside the feasible region
10. In the simplex method of solving a linear programming problem, the lesser than
or equal to inequality is converted into equality by ___________ to the left hand
side of the inequality.
a. Adding a slack variable
b. Subtracting a slack variable
c. Adding a function
d. Subtracting a function
11. Given below are the steps involved in the graphic method.
i. Write down the corner points of the solution area, and substitute the values in the
objective function.
ii. Using the inequalities in each constraint, determine the feasible region.
iii. Identify the decision variables, the objective function, and the constraints.
iv. Convert the inequality constraints to the equalities and plot them on a graph.
69
Identify the correct sequence of the above given steps.
a. i-ii-iii-iv
b. iii-iv-ii-i
c. ii-iv-iii-i
d. ii-i-iv-iii
12. Which of the following is not true regarding the points to be considered before
solving a simplex problem?
i. The value of the constraint on the right-hand side of each of the constraints
should be negative.
ii. Each decision variable of the problem should be non-negative.
iii. Slack variables are introduced in each constraint equation as an idle source to
convert equalities to inequalities.
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
Exercises
(Questions F to I)
The diagram represents the solution for a linear programming problem where ABCS
is the feasible region. Use the diagram to answer the following four questions.
F. Identify the constraint represented by the line passing through the coordinates
(40, 0) and (0,60).
G. Identify the corner points of the feasible region from the above diagram.
H. What is the equation of the line passing through (80,0)?
I. Find the minimum value of the objective function where minimize Z = 20x + 35y.
C
B
A
20
Y
O (0,0)
20
60
80
40
80 X
60
40
S
120
100 120
100
D
70
7. The Transportation Problem in Linear Programming
The transportation problem is a special case of linear programming. In the general
form, it has a number of destinations. A certain quantity of commodity is produced at
each origin and it is to be transported to destinations, each of which has certain
requirements. The objective of the problem is to meet the requirements of the
destination with supply from the sources and to ensure that the transportation costs are
minimal. This method can be applied to situations which involve the physical
movement of goods from plants to warehouses, warehouses to wholesalers,
wholesalers to retailers, and from retailers to customers. These models can also be
applied to production scheduling and inventory control. Such models are preferred as
they reduce the computational effort involved in the simplex method. A transportation
problem can be either balanced or unbalanced. It is said to be balanced if the quantity
of goods produced is equal to the total requirement of all the warehouses. Otherwise it
is considered as unbalanced. In an unbalanced problem, a dummy warehouse is added
if the production capacity is more than the requirement; if the production capacity is
less than the requirement a dummy origin is added with the desired quantity to make it
a balanced one. The transportation problem can be formulated as a linear
programming problem as shown:
X
ij
is the quantity transported from plant P
i
to a warehouse W
j
. C
ij
is the unit
transportation cost from P
i
to W
j
. As the objective of a transportation problem is to
minimize the total transportation cost, the objective function can be given as Minimize
ij
X
ij
C Z
Subject to the supply constraints, 2...m 1, i and S X
i
n
1 j
ij
Demand constraints, 2...n 1, j and D X
j
m
1 i
ij
Where
X
ij
= the number of units shipped from origin i to destination j
C
ij
= cost of shipping a unit from origin i to destination j
S
i
= supply available at i
th
origin
D
j
= quantity demanded at j
th
destination
And, X
ij
0, for all i and j
Following is the procedure used for solving a transportation problem:
1. Define the objective function that is to be minimized.
2. Develop a transportation table with rows representing the origins and column
representing the destinations.
3. Determine the initial feasible solution to the problem.
4. Examine whether the initial solution is feasible or not. A solution is feasible if the
number of occupied cells in the solution is (m + n 1) where m is the number of
origins and n is the number of destinations.
5. Test the solution obtained for optimality by computing the opportunity costs
associated with the unoccupied cells.
6. If the solution is not optimum, modify the allocation such that the transportation
cost can be reduced further.
71
Developing an Initial Feasible Solution
Following are the methods used for developing an initial feasible solution:
North-West Corner Method
In this method, the allocation of products starts at the north-west corner (or the top left
corner) of the transportation table. The procedure is given below:
1. Assign the maximum possible quantity of products to the top left corner cell of
the transportation problem.
2. After the allocation, adjust the supply and demand numbers.
3. If the supply in the first row is exhausted, move down to the corresponding cell in
the second row and assign the possible quantity of products to that cell. If the
demand in the column is first satisfied, move horizontally to the next cell in the
second column and assign the quantity of products.
4. Continue the same procedure till the entire requirements are met.
5. Check for feasibility of the solution.
Example: Given below is a table showing the distances between a factory and its
warehouses and the demand at each warehouse. Find a solution for transporting the
goods at the minimum cost for the given transportation problems using the North-
West Corner method.
Factory/
Warehouse
W
1
W
2
W
3
W
4
W
5
Supply
F
1
17 7 8 14 11 150
F
2
9 11 12 7 9 250
F
3
13 6 15 10 10 300
Demand 100 120 140 160 180
Solution: Following are the steps involved in solving the given problem using the
North-West Corner method:
a) Assign the maximum number of goods that can be transported from F
1
to W
1
,
in the cell (F
1
, W
1
); i.e. 100.
b) Move to the cell (F
1
, W
2
) and assign the remaining goods being supplied by F
1
to
W
2
; i.e. 50.
c) Move to the cell (F
2
, W
2
) and assign the possible number of goods; i.e. 70.
d) Move to the cell (F
2
, W
3
e) Move to the cell (F
2
, W
4
) and assign the remaining goods being supplied by F
2
to
W
4
; i.e. 40.
f) Move to the cell (F
3
, W
4
g) The remaining goods are assigned to the cell (F
3
, W
5
); i.e. 180.
Factory/
Warehouse
W
1
W
2
W
3
W
4
W
5
F
1
100 (17) 50 (7) (8) (14) (11)
F
2
(9) 70 (11) 140 (12) 40 (7) (9)
F
3
(13) (6) (15) 120 (10) 180 (10)
72
The solution obtained is feasible as the number of occupied cells is 7, which is equal
to the value of (m + n 1). Transportation cost =
= (17100) + (7 50) + (11 70) + (12 140) + (7 40) + (10 120) + (10 180) =
Rs. 7780.
Least Cost Method
In this method, allocations are made on the basis of unit transportation costs. The
following is the procedure:
1. Select the cell with the least unit transportation cost and allocate as many units as
possible to that cell.
2. If the minimum cost exists in several cells, select a cell arbitrarily and assign the
possible number of goods. Then consider the remaining cells of the same unit
transportation cost.
3. Select a cell with the next higher unit transportation cost and continue the process
till all requirements are met.
warehouses and demand at each warehouse. Find a solution for transporting the goods
at the minimum cost for the given transportation problems using the least cost method.
Factory/Warehouse W
1
W
2
W
3
W
4
Supply
F
1
2 3 11 7 6
F
2
1 0 6 1 1
F
3
5 8 15 9 10
Demand 7 5 3 2
least cost method:
a) Consider the cell which has the least unit cost of transportation; i.e. the cell (F
2
,
W
2
) with a cost of Rs. 0.
b) The possible number of goods that can be assigned to the cell (F
2
, W
2
) is 1.
c) Move to that cell where the next higher unit cost of transportation exists and
assign the possible number of goods.
d) Continue the process until all the goods have been assigned.
Factory/Warehouse W
1
W
2
W
3
W
4
F
1
6 (2) (3) (11) (7)
F
2
(1) 1 (0) (6) (1)
F
3
1 (5) 4 (8) 3 (15) 2 (9)
to the value of (m + n 1). Transportation cost = (2 6) + (5 1) + (0 1) + (8 4)
+ (15 3) + (9 2) = Rs. 112.
73
Vogels Approximation Method
Vogels Approximation Method is the most preferred method of the three methods as
it results in an optimal or a near optimal solution. The following is the procedure:
1. Calculate a penalty for each row and column of the transportation table. The
penalty for a row/column is the difference between the least cost and the next
least cost of that row/column.
2. Identify the row or column with the largest penalty value; and assign the possible
quantity of products to the cell with the least unit cost in that row or column. In
case of a tie, select the row or column that has minimum cost.
3. Adjust the supply and requirement values after the allocation has been made.
4. Delete that row or column where the supply or requirement is zero.
5. Calculate the values of penalty to all the rows and column for the reduced
transportation problem and repeat the procedure till the entire requirement has
been met.
warehouses and the demand at each warehouse. Find the solution for transporting the
goods at the minimum cost for the given transportation problems using the Vogels
approximation method.
Factory/Warehouse W
1
W
2
W
3
W
4
W
5
Supply
F
1
20 28 32 55 70 50
F
2
48 36 40 44 25 100
F
3
35 55 22 45 48 150
Demand 100 70 50 40 40 300
least cost method:
a) Compute the penalty for each row and column of the transportation problems.
The penalty for the first row is (28 20) = 8. Similarly, the values of penalty for
the second and the third row are 11 and 13 respectively. Similarly, the values of
penalty for the first, second, third, fourth, and fifth columns are 15, 8, 10, 1, and
23 respectively.
b) Identify the row or column with the largest penalty value, i.e., the fifth column
with a penalty value of 23.
c) The cell with the least cost is chosen and the possible number of goods is
assigned to that cell. Therefore, assign 40 to the cell (F
2
, W
5
).
d) If the remaining row supply or column demand is zero, remove that row/column.
e) The process is repeated for the reduced transportation problem till the entire
supply at the factories is assigned to satisfy the demand at different warehouses.
Factory/Warehouse W
1
W
2
W
3
W
4
W
5
F
1
50(20) (28) (32) (55) (70)
F
2
(48) 60 (36) (40) (44) 40 (25)
F
3
50 (35) 10 (55) 50 (22) 40 (45) (48)
74
to the value of (m + n 1).
Transportation cost = (20 50) + (36 60) + (25 40) + (35 50) + (55 10) + (22
50) + (45 40) = Rs. 9,360.
Stepping Stone Method
After computing the initial solution by using any of the three methods explained, the
solution needs to be tested to see whether it is optimum or not by using the stepping
stone method. In this method, the decision-maker calculates the net cost change
obtained by introducing a unit of quantity in any of the unoccupied cells and checks
for the possibility of improving the solution. This method describes the unused cells
as water and used cells as stones, and the transportation refers to walking on a path
of stones half submerged in the water. The following is the procedure:
1. Determine the initial basic solution by using any of the three methods: North-
West method, Least Cost method or the Vogel Approximation method. Check the
feasibility of the solution.
2. Select an unoccupied cell and trace a closed path starting from that cell using the
most direct route through at least three occupied cells by making only horizontal
or vertical moves.
3. Starting from the selected cell, assign + and signs alternatively to the corner
cells of the closed path.
4. Calculate the net cost change of the selected cell by adding the unit cost values
(with the signs assigned) along the closed path.
5. If the net cost change is positive for all the unoccupied cells, we can conclude
that the optimum solution has been arrived at.
6. If the net cost change of an unoccupied cell is negative, the quantity of products
to be assigned to that cell is equal to the minimum quantity of those cells with the
minus sign in the closed path.
7. Repeat the procedure till the optimum solution has been reached.
Example: The initial feasible solution of a transportation problem is given below.
Using the stepping stone method, test whether the solution is optimum. Calculate the
optimum solution if the given solution is not the optimum one.
Factory/Warehouse W1 W2 W3 W4
F1 (9) (13) 25(1) 25(6)
F2 (12) 60(3) (7) 10(9)
F3 30(6) (14) (10) 50(17)
Solution:
a) For the unoccupied cell (F
1
, W
1
);
The closed path is (F
1
, W
1
) (F
1
, W
4
) (F
3
, W
4
) (F
3
, W
1
).
Net cost change = + 9 6 + 17 6 = 14 (+ve).
Therefore, nothing can be assigned to this cell.
b) For the unoccupied cell (F
1
, W
2
);
The closed path is, (F
1
, W
2
) (F
1
, W
4
) (F
2
, W
4
) (F
2
, W
2
).
75
c) For the unoccupied cell (F
2
, W
1
) ;
2
, W
1
) (F
2
, W
4
) (F
3
, W
4
) (F
3
, W
1
).
Net cost change = + 12 9 +17 6 = 14 (+ve).
d) For the unoccupied cell (F
2
, W
3
);
2
, W
3
) (F
2
, W
4
) (F
1
, W
4
) (F
1
, W
3
).
e) For the unoccupied cell (F
3
, W
2
);
3
, W
2
) (F
3
, W
4
) (F
2
, W
4
) (F
2
, W
2
).
f) For the unoccupied cell (F
3
, W
3
);
3
, W
3
) (F
3
, W
4
) (F
1
, W
4
) (F
1
, W
3
).
Net cost change = + 10 17 +6 1 = - 2 (-ve).
So, some quantity of products should be assigned to this cell. Let us allocate 25 units
to this cell taking it from cell (F
1
, W
3
). In the same way, reduce 25 units in cell (F
3
,
W
4
) and add 25 units to cell (F
1
, W
3
). So the transportation table is changed to:
Factory/Warehouse W1 W2 W3 W4 Supply
F1 (9) (13) (1) 50(6) 50
F2 (12) 60(3) (7) 10(9) 70
F3 30(6) (14) 25 (10) 25(17) 80
Demand 30 60 25 85 200
g) For the unoccupied cell (F
1
, W
3
);
1
, W
3
) (F
1
, W
4
) (F
3
, W
4
) (F
3
, W
3
).
Therefore, this is the optimum solution for the given transportation problem.
Activity: A container manufacturer is considering locating two warehouses capable
of absorbing 800 units (total) per week from the firms plants. The unit
transportation costs are shown below:
Plant
Location
Warehouse
W1 W2 Supply
L1 100 120 400
L2 120 150 400
Demand 300 500
Contd
76
Contd
Calculate the total transportation cost for an optimal allocation using the following
methods:
North-West Corner method
Least Cost method
Vogels Approximation method
Also using the stepping stone method, verify if the solution obtained through the
Vogels approximation method is feasible or not.
Answer:
Activity: The initial feasible solution of a transportation problem is given below.
Using the stepping stone method, test whether the solution is optimum. Calculate
the optimum solution if the given solution is not the optimum one.
Factory/Warehouse W1 W2 W3 W4
F1 (15) 10(18) 20(22) (16)
F2 (15) (19) 5(20) 35(14)
F3 20(13) 10(16) (23) (17)
Answer:
Activity: A company has to consider locating 6 warehouses capable of absorbing
700 units per week from the firms plants. The unit transportation costs are given
below:
Plant Location W1 W2 W3 W4 W5 W6 Supply
F1 35 41 28 60 20 12 320
F2 14 21 28 30 15 24 180
F3 45 18 17 29 26 19 200
Demand 125 125 100 100 175 75
Contd
77
Contd
Calculate the total transportation cost for an optimal allocation using the following
methods:
North-West Corner method
Least Cost method
Vogels Approximation method
Answer:
Check Your Progress
13. Identify the typical objective function of a transportation problem.
a. To minimize the sum of all quantities transported
b. To minimize the sum of all production costs
c. To minimize the sum of all transportation costs
d. All of the above
14. Given below are the steps involved in solving a transportation problem.
i. If the solution is not optimum, modify the allocation such that the transportation
ii. Define the objective function that is to be minimized.
iii. Determine the initial feasible solution to the problem.
iv. Examine whether the initial solution is feasible or not.
v. Develop a transportation table with rows representing the origins and columns
representing the destinations.
vi. Test the solution obtained for optimality by computing the opportunity costs
associated with the unoccupied cells.
Identify the correct sequence of the above given steps from the following options.
a. iv-i-v-vi-iii-ii
b. iii-iv-ii-vi-i-v
c. ii-v-iii-iv-vi-i
d. vi-ii-i-iv-iii-v
15. In the ___________ method of obtaining initial feasible solution, allocations are
made on the basis of unit transportation costs.
a. Least cost method
b. Vogels approximation method
c. North-West corner method
d. Both (b) and (c)
78
16. Which among the following is not a method used in developing an initial feasible
solution for a transportation problem?
a. North-West corner method
b. Least cost method
c. Vogels approximation method
d. Stepping stone method
17. Of all the methods used to determine the initial feasible solution in transportation
problems, which is said to be most effective?
a. North-West corner method
b. Lest cost method
c. Vogels approximation method
d. Both (a) & (b)
18. In the _______ method, the decision maker calculates the net cost change
obtained by introducing a unit of quantity in any of the unoccupied cells and
checks for the possibility of improving the solution. This is done to test the
solution obtained to see whether it is optimum or not.
a. Least cost method
b. Stepping stone method
c. North-West corner method
d. Vogels approximation method
8. Summary
The availability of resources are limited in nature. Therefore, operations managers
should carefully assign these resources to strategic alternatives.
To attain objectives of profit maximization or cost minimization, operations managers
use constrained optimization models like linear programming.
The first step in solving a problem using the linear programming model is to
formulate the model.
The linear programming problems can be solved by using the graphical method or the
simplex method.
The transportation model is a special case of linear programming and is applied to
optimize the distribution system.
In the transportation model, the initial feasible solution can be developed by using any
of the three methods of North-West Corner method, Least cost method, and Vogels
Approximation method.
To verify whether the solution obtained by these three methods is optimal or not, the
stepping stone method is used.
9. Glossary
Constrained optimization models: Mathematical models that enable operations
managers to compute the amount of resources to be allocated to each of the strategic
alternatives.
Constraints: The practical limitations that restrict the choice of the decision variables
of a problem. These constraints are mathematically represented as: less than (<),
greater than (>), less than equal to ( ), equal to (=), or greater than equal to ( ).
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Decision variables: The physical quantities that can be controlled.
Least cost method: Allocations are made on the basis of unit transportation costs.
Linear programming: A mathematical, constrained optimization model used to
maximize or minimize the linear functions of a large number of variables, subject to
certain constraints. The technique is used to allocate resources to strategic alternatives
to ensure that they are utilized optimally.
North-West Corner method: The allocation of products starts at the north-west
corner (or the top left corner) of the transportation table.
Objective functions: The criteria on which the alternatives are to be evaluated.
Resources: In operations, the term resources means manpower, machinery and
equipment, capital, materials (raw, semi-finished, and finished), spares, components,
floor space, and others that are required for production.
Stepping stone method: This method is used to test whether the solution obtained by
using North-West corner method, least cost method, or Vogels approximation
method is optimum or not.
1. Resources are effectively utilized by allocating them to strategic alternatives.
Why is it important to allocate resources to strategic alternatives?
2. Constrained optimization models enable operations managers to compute the
amount of resources to be allocated to each of the strategic alternatives. Explain
the various components of the constrained optimization models. What are the
advantages and disadvantages of using the models?
3. Linear programming is a constrained optimization model used to maximize or
minimize the linear functions of a large number of variables, subject to certain
constraints. Explain the linear programming model.
4. Formulating a linear programming problem is the most vital and difficult aspect
of solving a real problem. Explain the process of formulating a linear
programming problem.
5. After formulating a linear programming problem, the solution to the problem has
to be found. What are the different methods of solving a linear programming
problem?
6. A transportation problem is used to meet the requirements of a destination with
supply from the sources and to ensure that the transportation costs are minimal.
Explain the transportation problem of linear programming in detail.
7. After defining the objective function and developing a transportation table, the
next step is to develop an initial feasible solution. Explain the various methods of
developing an initial feasible solution in the transportation method of linear
programming.
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6. Constrained Optimization Models
<http://www.maaw.info/ConstrainoptTechs.htm#What%20is%20constrained%20
optimization>
7. Linear Programming
<http://home.ubalt.edu/ntsbarsh/opre640a/partVIII.htm#rplp>
<http://www.cs.nyu.edu/overton/g22_lp/encyc/article_web.html>
<http://mathworld.wolfram.com/SimplexMethod.html>
<http://www2.isye.gatech.edu/~spyros/LP/node1.html>
<http://www.egwald.com/operationsresearch/lpgraphical.php>
<http://www.me.utexas.edu/~jensen/ORMM/models/unit/linear/index.html>
13. Simplex Algorithm
<http://www2.isye.gatech.edu/~spyros/LP/node22.html#SECTION00050000000
000000000>
14. Simplex Method
<http://home.ubalt.edu/ntsbarsh/opre640a/partIV.htm#rsimplexmethod>
15. Transportation Problem
<http://orms.pef.czu.cz/text/transProblem.html>
<http://www.me.utexas.edu/~jensen/models/network/net8.html>
<http://mat.gsia.cmu.edu/classes/QUANT/notes/node87.html#SECTION0012330
00000000000000>
18. North West Corner Method
<http://tep.ecsu.edu/dised/vcfac/mworthington/CH11/NW.HTM>
1. (b) Nature of demand
There are three elements of constrained optimization models: decision variables,
objective functions and constraints.
2. (d) Provides optimal solutions that are always practical
One of the main drawbacks of these models is that the solution obtained may not
always be the optimal one for the real problem. This is because these models do
not take into account non-quantifiable criteria. Sometimes, models may provide a
solution that cannot be put into practice.
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3. (a) Profits
Profits can be maximized while inventory, advertising expenditure and
production costs have to be minimized. Hence, profits can be considered for a
maximizing function.
4. (c) Linear programming
Linear programming is used to allocate resources to strategic alternatives to
ensure that they are utilized optimally. Exponential smoothing and regression
analysis are methods to forecast demand for a product. Decision tree analysis is
another operations technique helpful in decision-making like linear programming.
5. (b) Optimality
The assumptions that are made while constructing a linear programming problem
are proportionality, additivity, divisibility, and certainty. Using these, problems
are solved for achieving optimality, i.e., achieving an optimum solution. Hence,
optimality is not an assumption but a result.
6. (b) Additivity
The objective function and constraints include several decision variables. Here, it
is assumed that the total value of the objective function and each constraint is
equal to the sum of individual contributions from each decision variable. It means
that the model does not consider any synergistic or anti-synergistic effects among
decision variables while calculating the total value for the objective function.
Operations managers should be able to identify the problems for which the linear
programming model can be applied. These models can be applied to problems
with following characteristics (a) There is a well-defined single objective; (b)
There are alternative courses of action to solve the problem; (c) The decision
variables are continuous and they can accept any non-negative or fractional
values within the specified range; (d) All factors that affect the objective function
should be written in the form of constraints; and (e) The objective and the
constraints are linear functions.
8. (a) ii, i, and iii
The first and foremost step in formulating a linear programming problem is to
identify the decision variables. Next is to identify the objective function, and
finally comes identifying constraints present in the problem.
9. (c) In the feasible region
A feasible region is obtained when constraints are plotted on the graph. The
optimum solution always lies in the feasible region.
10. (a) Adding a slack variable
A slack variable is always added to the left-hand side of the lesser than or equal
to inequality (constraint) to convert it to an equation.
11. (d) iii-iv-ii-i
The graphical method explains the process of obtaining a solution to a linear
programming problem in a simple way. It consists of the following steps -- (a)
Formulate the linear programming problem by identifying the decision variables,
the objective function and the constraints; (b) Convert the inequality constraints
to their equalities and plot them on a graph (in linear form); (c) Using the
inequalities in each constraint, determine the feasible region; and (d) Write down
the corner points of the solution area. Substitute the values in the objective
function. The optimum solution is obtained at any of these points.
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The following points should be considered before solving a simplex problem (a)
The value of the constraint in the right-hand side of each of the constraints should
be non-negative. If not, it should be converted into a non-negative value; (b) Each
decision variable of the problem should be non-negative; and (c) Slack variables
are introduced in each constraint equation as an idle source to convert inequalities
to equalities.
13. (c) To minimize the sum of all transportation costs
The objective of any transportation problem is to minimize the transportation costs.
14. (c) ii-v-iii-iv-vi-i
Following is the procedure used for solving a transportation problem (a) Define
the objective function that is to be minimized; (b) Develop a transportation table
with rows representing the origins and columns representing the destinations; (c)
Determine the initial feasible solution to the problem; (d) Examine whether the
initial solution is feasible or not; (e) Test the solution obtained for optimality by
computing the opportunity costs associated with the unoccupied cells; and (f) If
the solution is not optimum, modify the allocation such that the transportation
15. (a) Least cost method
The initial feasible solution to the transportation problem can be obtained using
the North-West corner method, the least cost method, and the Vogels
approximation method. In the least cost method of obtaining initial feasible
solution, allocations are made on the basis of unit transportation costs.
16. (d) Stepping stone method
While methods mentioned in options (a), (b), and (c) can be used to develop the
initial feasible solution, the stepping stone method is used to test the solution for
optimality.
17. (c) Vogels approximation method
Vogels Approximation Method is most effective and preferred over other
methods as it usually results in an optimal or a near-optimal solution.
18. (b) Stepping stone method
After computing the initial solution, the solution needs to be tested to see whether
it is optimum or not by using the stepping stone method. In this method, the
decision-maker calculates the net cost change obtained by introducing a unit of
quantity in any of the unoccupied cells and checks for the possibility of
improving the solution.
A. (b) Maximize Z = 200x + 150y
As profits have to be maximized, profits from each telephone model have to be
considered. Hence, the objective function would be maximize Z = 200x + 150y,
where 200 and 150 represent profit per unit of each model in rupees.
B. (a) 2x + y 650
Total machine hours are 650. The superior quality telephone takes two hours (2x)
while the other takes one hour (y) to be produced. Hence, the total number of
telephones produced using available machine hours has to be less than or equal to
650 hours. Thus, 2x + y 650
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C. (d) x + y 600
The total demand is 600 units and production should not exceed demand. Hence,
x + y 600.
D. (b) Rs. 70000
Substitute the number of telephones manufactured in the objective function.
Z = 200x + 150y
= 200(200) + 150(200)
= 40000 + 30000
= 70000
E. (d) x = 200, y = 200
Options (a) and (b) are not feasible as they violate the constraint on total machine
hours (650 hours). Substituting the number of telephones manufactured in the
objective function Z = 200x + 150y for options (c) and (d), option (d) gives a
maximum profit of Rs.70000.
F. (c) 3x + 2y = 120
The coordinates of the line are (40, 0) and (0, 60). When these coordinates are
substituted in each of the above options, we get LHS = RHS only in option (c).
Hence, the constraint is 3x + 2y = 120.
G. (d) (0,60), (40,0), (80,0), (80,60)
ABCS is the feasible region.
Coordinates of A (0,60), Coordinates of B (40,0), Coordinates of C (80,0),
and Coordinates of S (80,60).
H. (a) x = 80
The line passes through the coordinates (80,0) At that point, the value of x=80
and y=0. Thus, x = 80 would be the equation of the line.
I. (c) 800
The coordinates are (0,60), (40,0), (80,0), (80,60)
At A(0,60), Z = 20(0) + 35(60) = 2100
At B(40,0), Z = 20(40) + 35(0) = 800
At C(80,0), Z = 20(80) + 35(0) = 1600
At S(80,60), Z = 20(80) + 35(60) = 3700
Unit 19
Design of Production Processes
Structure
1. Introduction
2. Objectives
3. Process Planning and Design
4. Major Factors affecting Process Design Decisions
5. Types of Process Designs
6. Process Planning Aids
7. Selecting the Type of Process Design
8. Summary
9. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the transportation problem
in linear programming. We have learnt that the technique is a special case of linear
programming that can be used to allocate resources to strategic alternatives to ensure
that they are utilized optimally. In this unit, we will discuss how to design production
processes.
Operations managers need to streamline their operations in order to compete in the
highly competitive business environment. And apart from managing operations, they
also have to manage the structure of the organization which includes number of
plants, size of plants, their location, plant capacity, choice of equipment and process
technology, production control, work force management, etc. Designing the
production processes plays an important part in the structure of operations. In this
unit, we will discuss the methodologies involved in planning and designing the
production processes.
This unit will introduce you to process planning and design. We will discuss the major
factors affecting process design decisions, and study the various types of process
designs. We shall then move on to discuss process planning aids. Finally, we would
discuss how to select the type of process design.
2. Objectives
explain process planning and design.
discuss the major factors affecting process design decisions.
identify the various types of process designs.
assess the process planning aids.
select the type of process design.
85
3. Process Planning and Design
The complete delineation and description of the stages in the production process and
the linkages between the stages that enable the production system to produce products
or services is referred to as process planning and design. The products should meet
quality standards and total costs should be within the budgeted limits. Process
planning forms the basis for designing factory buildings and facility layouts and for
selecting production equipment. It also has an impact on quality control, job design,
and capacity in different facilities of the organization. Changes in market conditions,
production capacity, and the availability of technologically superior equipment call for
re-planning of the production processes. The selection of the process design depends
on the operations strategy of the organization. The operations strategy is reflected in
the production plan of the organization, which includes the planning and designing of
the production processes. The product/service design also has an impact on the
process design. An effective process design accommodates the product/service design.
Both the process design and the product/service design should be compatible with
each other. For process planning and design to be effective, it is necessary for
operations managers to have a thorough knowledge of operations strategies, product/
service designs, technologies of the production system, and market conditions.
4. Major Factors affecting Process Design Decisions
Operations managers have to consider factors like the nature of demand, the degree of
vertical integration, flexibility, degree of automation, and quality level and degree of
customer contact while making process design decisions.
4.1. Nature of demand
Organizations have to produce products or services based on customer needs and
preferences. They have to schedule their production so as to be able to meet the
estimated future demand levels. Methods for estimating future demand consider
factors like seasonality, growth trends, and other demand patterns that affect future
demand levels.
Influence of demand patterns The demand for a product rises or falls over a period
of time and is influenced by factors like seasonal fluctuations that affect the design of
the production process of the product. For example, the demand for products like air
conditioners, refrigerators, etc. varies from season to season.
Influence of price level The price-volume or the demand curve influences the
process design. As customers are price-sensitive, they have a tendency to buy more of
a product at a low price and less at a high price.
4.2. Degree of vertical integration
Vertical integration is the extent to which the production and the distribution chain is
brought under the ownership of the organization. The degree of vertical integration
determines the extent to which a product and its components are produced internally.
Vertical integration is of two types: forward and backward. Forward integration is the
expansion of ownership of production to the distribution chain, towards the market.
And when it is expanded backward or toward the sources of supplies, it is referred to
as backward integration. Vertical integration provides flexibility in manufacturing
which results in increased profits due to centralized overheads, pooling of R&D and
design efforts, and economies of scale. It reduces the over-dependency on the
purchasing function. Vertical integration may not, however, always be desirable as the
decision to produce the components instead of buying them could leave organizations
stuck with outdated technology. Operations managers should evaluate the pros and
cons of vertical integration before deciding on its implementation.
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Example: Pokarnas Vertical Integration
Hyderabad-based Pokarna Granites Limited was established in 1991 as a partnership
firm. The company was initially involved in quarrying Black Galaxy granite in India.
Soon after its establishment, it acquired quarries in Andhra Pradesh, Karnataka, and
Tamil Nadu. It expanded into the business of quarrying materials of different colors
like Absolute Black, Black Pearl, Ruby Red, Sapphire Blue, Forest Green, Silver
Pearl, etc. It also entered into the fabrication business by purchasing fabricating
plants. The company took the high quality raw material from its own quarries or
identified independent quarries, fabricated it at its plants, and exported it to other
countries. It also processed granite into slabs and tiles by using state-of-the-art
machinery purchased from around the world. Apart from the slabs from India, the
company processed granite sourced from Norway, the Middle East, Turkey, and other
countries. The company attributed its success to vertical integration, the use of the
latest technologies, quality control, skilled management, and human resources. With
the help of these strategies, it became a 100% export oriented unit and successfully
entered the markets of Europe, the US, Japan, and the Far East. To bring in the image
of a diversified company, the company changed its name to Pokarna Limited. The
company currently owns quarries, fabricating plants, and shipping trucks. It offers a
variety of products like slabs, rough blocks, tiles, and fabricated products like
vanities, kitchen tops, tabletops, and other counter tops for projects.
Adapted from Michael Reis, Vertical integration in India, August 01, 2003,
<http://www.stoneworld.com/CDA/Archives/c07d81db106f7010VgnVCM100000f932a8c0>
and www.pokarna.com
Activity: Sahasra is an agricultural food product company. The company takes the
crop yield from the suppliers, purifies it, and packages it to sell it to the consumers
through distributors. The company has realized that over the past few years,
suppliers of other food product companies have been going in for forward
integration. They have been acquiring food product companies and also their
distributors. Sahasras management is considering ways to fight competition from
the suppliers, who have now become manufacturers and also distributors of food
products. It has decided to integrate its operations with its suppliers and
distributors. Should the company go in for both backward as well as forward
integration? How should the company go about it? What factors should it take into
consideration before deciding on integrating the operations?
Answer:
4.3. Flexibility
A flexible organization is one that responds quickly to the changing customer
preferences or market conditions. Organizations have to be flexible in order to
increase or maintain their market share. Flexibility can be broadly classified into:
Product/service flexibility The ability of the production system to shift quickly
from producing one product to another is referred to as product/service flexibility.
This is necessary for organizations which produce different custom-designed products/
services in small lots using general-purpose equipment and multi-skilled employees.
87
Volume flexibility The ability to increase or decrease production volumes rapidly in
response to external changes is referred to as volume flexibility. This is necessary for
organizations that produce products the demand for which fluctuates and for which it
is uneconomical to maintain a high level of inventory.
4.4. Degree of automation
Operations managers in the past avoided automation due to the high costs involved in
automating the processes and the difficulty in integrating them with other production
processes. Of late, they have realized that automation can be used as a strategic
weapon for competing with others. Though automation is expensive, it can reduce
labor and related costs. Operations managers should decide on the degree of
automation required for their production processes.
4.5. Quality level and degree of customer contact
The quality levels of a product or service decide its competitiveness in the market and
affect the production process design at all stages of production. The desired level of
quality has direct implications for the degree of automation and the extent of customer
interaction and contact required for the production process.
Check Your Progress
1. In the emerging business scenario, it has become essential for operations
managers to manage the structure of their organizations, not merely their
operations. What does the term structure include?
a. Number of plants and their individual capacities
b. Choices in equipment and process technology
c. Production control and workforce management
d. All of the above
2. Which of the following forms the basis for designing factory buildings and
facility layouts?
a. Operations strategy
b. Production planning
c. Process planning
d. Product design
3. Keeping other things constant, when the price of a commodity decreases, the
demand for the commodity __________.
a. Does not change
b. Increases continuously
c. Increases to a certain level
d. Decreases
4. To attain its objective of profit maximization, L&T decided to acquire a mine in
Australia thereby owning sources of raw material supplies. What is this process
of expanding ownership called?
a. Horizontal integration
b. Forward integration
c. Backward integration
d. Diagonal integration
88
5. Organizations must be flexible to increase or maintain their market share. The
ability of the production system to shift quickly from producing one product to
another is called _____________.
a. Product flexibility
b. Demand flexibility
c. Volume flexibility
d. Customer flexibility
6. When Hindustan Smelters Ltd. decided to manufacture lead ingots, the
management decided to develop a process plan for the same. Which of the
following factors should the operations manager at Hindustan Smelters Ltd. keep
in mind while making process design decisions?
a. Nature of demand
b. Degree of vertical integration
c. Employee skill level requirements
d. Quality level and degree of customer contact
7. Demand for Pepsi cola is seasonal. It has a very high demand during summer and
minimal demand during winter season. Which of the following assumptions is
false with respect to the seasonality of demand of Pepsi cola?
a. As demand is seasonal, Pepsi cola should not be produced in winter season.
b. Pepsi cola should be produced throughout the year but with varying outputs.
c. Finished goods inventory must be stocked to meet high demand during summer.
d. All the above statements are false.
8. Identify which of the following is not an advantage of vertical integration.
a. It reduces the over-dependency on the purchasing function.
b. It helps decentralize the overheads.
c. It helps in pooling the R&D and design efforts.
d. It helps in achieving economies of scale
9. Assume that Eastside, a readymade garment retailer, acquired a textile mill to
produce different fabrics. What kind of integration strategy has the retailer
adopted?
a. Forward integration
b. Backward integration
c. Horizontal integration
d. Lateral integration
5. Types of Process Designs
Process designs are classified into product-focused, process-focused and group
technology.
5.1. Product-focused
Product-focused production systems are used in production departments that are
organized according to the type of product or service being produced. This kind of
system is also called the Line Flow Production System. In this system, products or
services tend to follow a linear path or a similar production sequence without
backtracking or sidetracking. These systems require higher initial investments because
of the use of specialized and expensive fixed position processing equipment in the
production process. These systems produce a single or few varieties of products.
89
Therefore, the variable costs remain low. Product-focused systems are used to produce
bulk volumes and as the volume of output increases, the total cost of production
decreases. The system is designed for the following three forms of production:
Discrete unit manufacturing This refers to the production of distinct products like
radio or television sets. These products can be made in batches and the system can be
shifted to produce other products in similar batches.
Process manufacturing This involves the movement of materials between
operations such as screening, crushing, storing, mixing, milling, blending, cooking,
fermenting, evaporating, and distilling. It is widely applied in the cement, paper,
chemical, steel, and brewing industries.
Delivery of services In this, services are administered to customers while they move
in a queue or in a linear route. Waiters in restaurants use this system.
5.2. Process-focused
In process-focused production systems, all the operations are grouped according to the
type of process. This kind of system is also called an intermittent production system as
production of products is carried out intermittently i.e. on a start and stop basis. It is
also referred to as a job shop as the products move from one department to another in
batches or jobs based on customers orders. These systems produce small quantities or
batches of different items on relatively general-purpose machinery. The diversity of
customer orders is a primary criterion for adopting a process-focused production
system. Processing equipment and personnel are located according to the functions
and products flow through the facilities on irregular paths. The system allows
sidetracking and backtracking in the product flow route.
Organizations use a mix of the above two approaches in order to cut production costs.
Activity: Glad International is a company manufacturing 12 different consumer
goods. The company currently adopts a product-focused production system, in which
the production departments are organized based on the type of products the company
produces. The company now wants to use a process-focused production system as
well. If you were the operations manager of the company, what kind of suggestions
would you make regarding the change that the management wants to undertake? Do
you think the company can have the product focused and process focused production
systems? Also give the management information regarding the different types of
process designs and the conditions to be considered before selecting one.
Answer:
5.3. Group Technology
In a group technology layout, dissimilar machines are grouped into work centers to
work on products similar in shape and processing requirements. The layout is similar
to both product and process layouts as each cell is dedicated to a limited range of
products and is designed to perform a specific set of processes. This layout is also
90
referred to as the parts classification and coding system. In group technology, each
part manufactured is given a code which has several digits, each digit representing the
physical characteristic of the part.
Benefits of Using Coding System in Group Technology:
It is easy to route the parts in production as coding gives a clear picture of the
steps involved in producing a part.
Coding results in standardization of part designs.
Parts with similar characteristics can be grouped into families as similar products
are generally produced in similar ways, i.e., similar parts are made on the same
machines using similar tools.
Cellular manufacturing: Cellular manufacturing is a type of group technology in
which the total production area is divided into cells, each cell consisting of a group of
similar machines. In cellular manufacturing, parts spend less time in waiting before
they are processed. Hence, the in-process inventory levels get reduced. The benefit of
cellular manufacturing is that the changeover times between batches of parts are
greatly reduced as similar parts go to a particular cell. The costs of training workers
can be reduced significantly, compared to a non-cellular group technology, the route
of production through cells is more direct. This simplifies production planning and
control (PPC), reduces the material handling costs, and also permits quicker shipment
of products.
Activity: Kailash works for an electric tools company known for its quality
management practices. Though it is satisfied overall with its performance, the
company, feels that there are areas in which it could do even better. It wants to
improve the quality of its products, reduce costs, and improve delivery. It aims to
deliver what the customers needs in less lead-time. The company currently follows
the batch system of manufacturing. To implement its goals, the companys
management wants to go in for cellular manufacturing. Kailash has been asked by
the management to research on cellular manufacturing and find ways in which the
company can go about it. Assist Kailash in the process.
Answer:
Check Your Progress
10. ABC Corp. to match the diversity in customer orders wants to produce products
in small batches. Which type of process design would be economically feasible
for ABC?
a. Assembly line
b. Continuous processing
c. Discrete unit processing
d. Job shop process
91
11. There are various types of process designs that are generally used by
organizations. In which type of process design, products or services tend to flow
along linear paths without backtracking or sidetracking?
a. Product-focused systems
b. Process-focused systems
c. Group technology
d. All the above
12. Steel and Chemical industries generally implement which type of process design?
a. Discreet unit manufacturing
b. Process manufacturing
c. Job shop process
d. Both a & c
13. Which of the following process design systems entail high initial investment?
a. Product-focused systems
b. Process-focused systems
c. Group technology
d. All of the above
14. What are the characteristics of process focused systems?
i. Operations are grouped according to the type of processes
ii. Production is performed on products on a start and stop basis
iii. Products move from department to department in batches
iv. Products are produced irrespective of diversity in customer orders
a. i and ii
b. iii and iv
c. i, ii, and iii
d. ii, iii, and iv
15. Which of the following is not an advantage of cellular manufacturing?
a. Lesser machine changeover time
b. Lower cost of training
c. Reduction in material handling costs
d. Increase in the in-process inventory
16. Which of the following is not true about a product-focused system?
a. Presence of initial fixed costs
b. Presence of low variable costs
c. The total cost of production increases as the output volume increases
d. Low variations in products
17. In what way is a typical product-focused system distinct when compared to a
process focused system?
a. Lower fixed costs and higher variable costs
b. Higher fixed costs and lower variable costs
c. Higher fixed costs and higher variable costs
d. Lower fixed costs and lower variable costs
92
6. Process Planning Aids
Process planning is used for designing and implementing a work system that will
produce the required quantity of goods and services. Assembly charts and process
charts are used to redesign, update, and evaluate production processes.
Assembly Charts Assembly charts are used to obtain a general understanding of the
entire process involved in producing products, which entails the assembling of a
number of parts. They demonstrate the movement of components and sub-assemblies
in the production process.
Process Charts Process charts are similar to assembly charts, except that they
include information like a description of the various steps involved, their frequency of
occurrence, the time each step takes, the distance traveled, etc. Non-productive
activities like storage, delay and transport are also included.
7. Selecting the Type of Process Design
While selecting a production processing system, operations managers should consider
the following factors:
Variety and Volume
The selection of a process design depends upon the product range i.e. the variety and
volume of demand for each product model.
Investment
A product-focused production system requires huge investment. The system consists
of inflexible equipment that is specialized for the product, and necessitates specific
training of employees for producing the product. The choice of the production system
is influenced by the capital investment required.
Economic Analysis
Each type of process design requires different amounts of funds for its
implementation, as fixed and variable costs differ from one production system to
another. The higher the investments in fixed assets, the higher will be the fixed costs
whereas the variable costs differ with the volume of products produced during a
period. A process-focused system requires comparatively lower initial investment in
fixed assets whereas the variable costs increase steeply with an increase in the volume
of production. In cellular manufacturing, the fixed and the variable costs lie between
both the product and process focused systems. Managers can select the process design
based on the targeted production volume of the product if they have funds available.
Example: Vertical Integration
Ohio-based lift truck manufacturer Crown Equipment Corporation was able to
provide shorter cycle times and become more adaptive to the needs of its customers
using vertical integration. Founded in 1945, the company began producing
temperature controls for coal furnaces and in 1957, it shifted its focus to
manufacturing lift trucks. To develop better products and processes, the company
adopted the vertical integration strategy. To ensure that high quality equipment was
placed into the trucks, the company invested in top of the line machinery. It also
employed a number of mills, lathes, and machining centers from Texas-based
company, Mori Seiki. The company had an innovative workforce to determine
the most appropriate way to machine the parts. Through vertical integration,
the company also secured the advantage of producing the parts it needed internally.
Contd
93
Contd
If a customer was in immediate need of a product, the company had to just
rearrange its schedule to meet the need. Through vertical integration, the company
was able to offer flexible products and a higher level of service. This would not
have been possible if it had relied upon external suppliers. Using this business
strategy, Crown also faced certain challenges in finding skilled workers. The
integration level required highly talented personnel. To combat the labor shortage
in the manufacturing industry, the company took advantage of technology. It
automated its operations whenever it was possible. Multitasking machines like the
ZT line helped the company reduce labor for machining a range of parts. Being a
vertically integrated company, Crown did not demand shorter turnaround times
from the suppliers. The company invested in technology and then worked on the
processes by itself. To effectively manage its operations, the company implemented
Mori Seikis Caps-Net software, which facilitated the inflow of information to and
from the factory floor. This allowed constant monitoring of machine status and
operational history. The company used the software to identify previously
undetected inefficiencies.
Adapted from, Better Production Vertical Integration Reduces Cycle Times, June 2005,
http://www.mmsonline.com/articles/0605bp1.html
Check Your Progress
18. Identify the statement(s) that does not hold true regarding assembly charts.
a. They are used to obtain a general understanding of the entire process involved in
producing products.
b. They demonstrate the movement of components and sub-assemblies in the
production process.
c. They include information like a description of the various steps involved, their
frequency of occurrence, the time each step takes, the distance traveled, etc.
d. Both (a) and (b)
19. Which of the following factors should the operations manager consider while
selecting a production processing system?
a. The product range, i.e., the variety and volume of demand for each product model
b. The capital investment required
c. Economic viability of the process design
d. All of the above
8. Summary
Process planning forms the basis for designing factory buildings and facility layouts.
Various factors like the nature of demand, the degree of vertical integration,
flexibility, etc., affect the process design decisions.
Process designs can be classified as product-focused, process-focused, and group
technology.
Cellular manufacturing is a type of group technology in which the total production
area is divided into cells, each cell consisting of a group of similar machines.
Process planning is used for designing and implementing a work system that will
produce the required quantity of goods and services.
94
While selecting a production processing system, operations managers should consider
various factors like variety and volume of demand for each product model, economic
analysis of the process design etc.
9. Glossary
Assembly Charts: These are used to obtain a general understanding of the entire
process involved in producing products, which entails the assembling of a number of
parts.
Cellular manufacturing: A type of group technology in which the total production
area is divided into cells, each cell consisting of a group of similar machines.
Discrete unit manufacturing: This refers to the production of distinct products that
can be made in batches and the system can be shifted to produce other products in
similar batches.
Forward and backward integration: Forward integration is the expansion of
ownership of production to the distribution chain, towards the market. And when it is
expanded backward or toward the sources of supplies, it is referred to as backward
integration.
Process Charts: These include information like a description of the various steps
involved, their frequency of occurrence, the time each step takes, the distance
traveled, etc. Non-productive activities like storage, delay and transport are also
included.
Process manufacturing: This involves the movement of materials between
operations such as screening, crushing, storing, mixing, milling, blending, cooking,
fermenting, evaporating, and distilling.
Process-focused production system: In this, all the operations are grouped according
to the type of process. It is also called an intermittent production system as production
of products is carried out intermittently, i.e., on a start and stop basis. It is also referred
to as a job shop as the products move from one department to another in batches or
jobs based on customers orders.
Product/service flexibility: The ability of the production system to shift quickly from
producing one product to another.
Product-focused production system: It is used in production departments that are
organized according to the type of product or service being produced. This kind of
system is also called the line flow production system. In this system, products or
services tend to follow a linear path or a similar production sequence without
backtracking or sidetracking.
Vertical integration: It is the extent to which the production and the distribution
chain is brought under the ownership of the organization
Volume flexibility: The ability to increase or decrease production volumes rapidly in
response to external changes.
1. Designing the production processes plays an important part of the structure of the
operations. What do you understand by process planning and design? Explain its
importance.
2. Operations managers have to consider various factors while making process
design decisions. What are the various factors affecting the decisions regarding
process designs?
3. An organization has to decide on the type of process design which should be used
to produce products or services. What are the different types of process designs?
Explain in detail.
95
4. Process planning is used for designing and implementing a work system that will
produce the required quantity of goods and services. What are the various
planning aids that operations managers use to evaluate the production processes?
5. While selecting a production processing system, the operations managers should
consider various factors. Explain in detail the factors to be considered for
selection of the process design.
6. Vertical Integration
<http://www.quickmba.com/strategy/vertical-integration/>
<http://en.wikipedia.org/wiki/Vertical_integration>
<http://econ-www.mit.edu/files/1191>
9. Lean Manufacturing
<http://en.wikipedia.org/wiki/Lean_manufacturing>
10. Lean Manufacturing
<http://www.wisegeek.com/what-is-lean-manufacturing.htm>
11. Cellular Manufacturing
<http://www.rockfordconsulting.com/cell.htm>
<http://www.siliconfareast.com/cellular-manufacturing.htm>
<http://en.wikipedia.org/wiki/Cellular_manufacturing>
<http://www.informs-cs.org/wsc98papers/131.PDF>
The term structure has a broad meaning and includes issues like the number of
plants, size of plants and their location, plant capacity, choice of equipment and
process technology, production control, workforce management, etc.
96
2. (c) Process planning
Process planning forms the basis for designing factory buildings and facility
layouts, and selecting production equipment. It also has a bearing on quality
control, job design and capacity in different facilities of the organization.
3. (c) Increases to a certain level
As the price of a commodity decreases, demand increases as consumers buy more
of the commodity. However, this is observed only until a certain point. Beyond
this there will not be a proportionate increase in demand when prices are decreased.
4. (c) Backward integration
Backward integration refers to gaining ownership over the source of raw material
supplies and other materials required for production. Forward integration refers to
gaining ownership of front-end activities (distribution networks through which
products are distributed to the customers).
5. (a) Product flexibility
Product flexibility is the ability of the production system to shift quickly from
producing one product to another. Some business strategies call for the
production of many custom-designed products/services, in small lots.
Product/service flexibility is required in such cases.
6. (c) Employee skill level requirements
Operations managers generally make process-design decisions after taking into
consideration several factors like nature of demand, degree of vertical integration,
flexibility, degree of automation, quality level, and degree of customer contact.
However, employee skill level requirements are dependent on the type of process
plan decided and are considered only after developing the process plans.
7. (a) As demand is seasonal, Pepsi cola should not be produced in winter season.
Seasonality of demand is not directly linked to the production because companies
focus on meeting annual demand. A company may bring down production
capacity in the lean season and increase it to peak capacity during high demand.
Also, production can be beefed up just before the season begins and inventory can
be stocked to meet the excess demand.
8. (b) It helps decentralize the overheads.
Vertical integration relieves an organization from excessive dependence on the
purchasing function and provides flexibility in manufacturing. This can result in
an increase in profits due to centralized overheads, pooling of R&D and design
efforts, and economies of scale.
9. (b) Backward integration
The raw material for a readymade garment retailer is fabrics. Hence, when Eastside
acquired a textile mill, it gained ownership of a supplier leading to greater control
over fabric production and supply. This is a backward integration strategy.
10. (c) Discrete unit processing
Discrete unit manufacturing refers to the production of distinct products like radio
or television sets. These products can be made in batches, and the system can be
shifted to produce other products in similar batches. However, assembly lines and
continuous processing do not help in changing jobs. Job shop process is used to
produce highly customized products where one job can be carried out at one point
of time on one machine. The flexibility is minimal here. Hence, ABC must use
discrete unit processing.
97
11. (a) Product-focused systems
In this type of process design, products or services tend to flow along linear paths
without backtracking or sidetracking. Items follow a similar production sequence,
which can be anything from a pipeline (for oil) to an assembly line (for
televisions or radios).
12. (b) Process manufacturing
Process manufacturing involves the movement of materials between different
operations such as screening, crushing, storing, mixing, milling, blending,
cooking, fermenting, evaporating and distilling. It is widely applied in the
cement, plastic, paper, chemical, steel and brewing industries.
13. (a) Product-focused systems
Product-focused systems require higher initial investments because of the use of
specialized and expensive fixed position processing equipment in the production
process.
In process-focused production systems, all operations are grouped according to
the type of process. The system is also referred to as an intermittent production
system because production is performed on products intermittently (that is on a
start and stop basis). In this system, the products move from department to
department in batches (jobs) that are usually determined by customers orders.
The diversity of customer orders is a primary criterion for adopting a process-
focused production system.
15. (d) Increase in the in-process inventory
In cellular manufacturing, parts spend less time in waiting before they are
processed. Hence, the in-process inventory levels get reduced.
16. (c) The total cost of production increases as the output volume increases
The product-focused systems require initial investments in the form of expensive
machinery and this result in high initial fixed costs. But, as the product-focused
systems produce a single or few varieties of products, the variable costs remain
low. Product-focused systems are used to produce bulk volumes and as the
volume of output increases, the total cost of production decreases.
17. (b) Higher fixed costs and lower variable costs
Product focused systems need high initial costs (fixed costs); however operating
variable costs remain low due to limited scope for product variety.
18. (c) They include information like a description of the various steps involved,
their frequency of occurrence, the time each step takes, the distance traveled,
etc.
Assembly charts are used to obtain a general understanding of the entire process
involved in producing products, which entails the assembling of a number of
parts. Process charts include information like a description of the various steps
involved, their frequency of occurrence, the time each step takes, the distance
traveled, etc.
While selecting a production processing system, operations managers should
consider various factors like variety and volume of demand for each product
model; the capital investment required; and the economic viability of the process
design.
Course Components
Block
V
DESIGN OF FACILITIES AND OPERATIONS
PLANNING
UNIT 20
Facility Location and Layout 1-32
UNIT 21
Aggregate Planning and Capacity Planning 33-53
UNIT 22
Fundamentals of Inventory Control 54-70
UNIT 23
Purchase Management 71-82
UNIT 24
Materials Management 83-103
Expert Committee
Hyderabad Hyderabad


Hyderabad


Prof. Vivek Gupta
Hyderabad

Hyderabad

Ms. Smita Singh
IU, Sikkim

Mr. Ch Syamala Devi
IU, Meghalaya

Hyderabad

IU, Mizoram
Aizawal

IU, Dehradun

Mr. Manoj Kumar De
IU, Tripura
Agartala






Block V
Design of Facilities and Operations Planning
The fifth block of the course on Project & Operations Management deals with
the design of facilities and operations planning. The block contains five units.
The first unit explains the importance of facility location and layout. The
second unit focuses on the concepts of aggregate planning and capacity
planning. The third unit examines the basics of inventory control. The fourth
unit examines the purchase management function, while the fifth unit
discusses the materials management function.
The first unit, Facility Location and Layout, discusses the importance of
location and the factors affecting the location decisions. The unit focuses on
the general steps in location selection, decision process, and the evaluation
methods. The unit also deals with facility layout, the basic layout formats, and
how to develop a process layout, a product layout, and a cellular
manufacturing layout. The unit also provides an idea of the Japanese
approaches and trends in manufacturing layouts, and the service facility
layouts.
The second unit, Aggregate Planning and Capacity Planning, deals with
planning activities and the aggregate planning process. The unit also explains
the strategies for developing aggregate plans, and the aggregate planning
techniques. It discusses the master production schedule, and the
implementation of aggregate plans and master schedules. Finally, the unit
examines the concept of capacity planning.
The third unit, Fundamentals of Inventory Control, provides an idea about the
purpose of inventories and the need for controlling them. The unit explains
inventory costs and systems. It discusses the economic order quantity model.
It also examines the inventory classification models.
The fourth unit, Purchase Management, explains the importance of
purchasing, and the ways to organize to purchasing function. The unit
discusses the responsibilities of a purchase manager, and the purchasing
process. It deals with the duties of buyers, and make-or-buy analysis. The unit
also examines the ethical issues involved in buying.
The fifth unit, Materials Management, discusses the necessity of materials
management. The unit explains the functions of materials management. It
discusses the materials management technology. The unit also examines the
various techniques used in materials management.
Unit 20
Facility Location and Layout
Structure
1. Introduction
2. Objectives
3. Importance of Location
4. Factors Affecting the Location Decisions
5. General Steps in Location Selection and Location Decision Process
6. Location Evaluation Methods
7. Facility Layout
8. Basic Layout Formats
9. Developing a Process layout
10. Developing a Product Layout
11. Developing a Cellular Manufacturing Layout
12. Japanese Approaches and Trends in Manufacturing Layouts
13. Service Facility Layouts
14. Summary
15. Glossary
1. Introduction
In the last unit of the previous block, we have discussed how to design production
processes. We have learnt that designing the production processes plays an important
part in the structure of operations. In this unit, we will discuss about facility location
and layout.
Facility location refers to the place where the firms set up their operations.
Manufacturing and service firms evaluate different plant and service locations by
conducting a facility location analysis and finally choose an optimum location to start
their operations. After deciding on the facility location, firms decide on the internal
structure of the firm called the layout. Both facility location and layout play an
important role in enhancing the efficiency of the firm. Firms can then revise or
redesign the layout in the future depending on its strategies (expansion, etc.). In this
unit, we will discuss the role played by facility location and layout in improving the
material flow and the overall efficiency of firms.
This unit will introduce you to the importance of location, and explain the factors
affecting the location decisions. We will discuss the general steps in location
selection, decision process, and the evaluation methods. We shall then move on to
discuss facility layout, the basic layout formats, and how to develop a process layout,
a product layout, and a cellular manufacturing layout. Finally, we would discuss the
Japanese approaches and trends in manufacturing layouts, and the service facility
layouts.
2
2. Objectives
explain the importance of location.
identify the factors affecting location decisions.
recall the general steps in location selection and the location decision process.
define the location evaluation methods.
discuss facility layout and the basic layout formats.
determine how to develop process and produce layouts.
explain the process of developing a cellular manufacturing layout.
compare the Japanese approaches and trends in manufacturing layouts.
discuss service facility layouts.
3. Importance of Location
The selection of a facility location is a strategic decision for any organization and is
very important for the following reasons. Facility location will fix the production
technology and cost structure, it depends on the size and nature of the business, it
affects the companys ability to serve its customers quickly and conveniently. If the
facility location is such that it reduces transportation costs of raw materials and goods,
lowers labor costs, and has good access to the markets, it helps the firm to score over
its competitors. Therefore, facility locations require careful attention of finance,
personnel, marketing and operations managers who run the facilities.
4. Factors Affecting the Location Decisions
Location decisions are influenced by a number of factors given below:
Market Proximity Transportation costs can be reduced by locating facilities close to
the market, this also helps in providing better service to customers.
Integration with other Parts of the Organization Organizations that already have
plants would want their new facility to be located near the existing ones so that the
work can be integrated with other plants.
Availability of Labor and Skills Firms should locate their operations where labor and
skills are more easily available.
Site Cost The cost of the site should match the benefits that it is going to provide.
Availability of Amenities Firms generally prefer locations with good external
amenities like housing, shops, community services, communications systems, etc.
Availability of Transportation Facilities Firms prefer locations where they have
good modes of transportation air, rail, road, water.
Availability of Inputs Apart from good transportation, firms can reduce costs by
locating their plant near that of the suppliers.
Availability of Services While selecting a location, firms should consider availability
of services like electricity, water, gas, drainage, and waste disposal.
Suitability of Land and Climate Firms should consider the climatic conditions such
as humidity, temperature, atmosphere, and geology of the location for setting up the
facility.
Regional Regulations Firms should ensure that the proposed location adheres to the
local laws and regulations.
3
Room for Expansion Firms should ensure that the selected location has enough area
for future expansion of the firms operations.
Safety Requirements Firms should ensure that units like nuclear power stations and
explosive factories are located in remote areas to minimize any damage they may
cause.
Political, Cultural, and Economic Situation Firms should be aware of the political,
cultural, and economic environment in the location.
Regional Taxes, Special Grants and Import/Export Barriers Firms can enjoy the
benefits of special grants like tax holidays, infrastructure support, low-interest loans,
etc. given by the government for establishing facilities in special export zones, export
promotion zones, technology parks, and industrial estates. In addition, companies are
provided land at low costs. The land provided is not prime real estate as SEZs are
located away from cities or towns.
Activity: Krushi International is a US-based firm set up by an NRI citizen. The
company is engaged in manufacturing hardware devices and developing software.
The companys management wants to set up a plant in Tamil Nadu in India. The
company has sent a team to study the feasibility of setting up the plant in the state.
The team has come up with suggestions on a number of locations within the state
for setting up the plant. What do you think are the factors to be considered before
setting up a plant? Help the management to arrive at a proper decision.
Answer:
Check Your Progress
1. Which of the following reasons persuade companies to set up facilities in export
promotion zones, technology parks and industrial estates?
i. Tax holidays and exemption from import-export barriers
ii. Availability of infrastructure
iii. Low loan interest rates
iv. Low cost of manpower
a. i and iv
b. ii, iii, iv
c. i, ii, iii
d. ii and iv
2. Cotton yarn manufacturing units are generally concentrated in select areas of the
country as yarn production requires certain ideal levels of humidity. What factor
influences selection of plant location in this case?
a. Site cost
b. Conducive politico-economic situation
c. Suitability of climate
d. Availability of amenities
4
3. In which of the following situations is there no need for selecting a facility
location?
a. When a business has just started
b. When expansion of the existing plant is possible
c. When a business wants to establish new branches/plants
d. When government regulations mandate that the business has to shift its location
4. Firms conduct facility location analysis where they evaluate different locations
and finally choose an optimum location to start operations. Arrange the following
activities related to facility location planning in a logical sequence.
i. Design layout
ii. Select location
iii. Search for a location
iv. Revise layout
a. i, ii, iii, iv
b. ii, iii, i, iv
c. iii, ii, i, iv
d. iv, iii, ii, i
5. Rahul wanted to set up a small scale printing press to print books for individuals
interested in publishing their work for a small audience. Which is the right
location for Rahul to establish a printing press to cater to this kind of market?
a. Near paper mills
b. In a town/city
c. In a village where cost of labor is cheap
d. Near the manufacturer of printing machines
6. There are many factors affecting the selection of a facility location. Which of the
following factors would deter a firm from setting up operations in a particular
location?
a. Low labor costs
b. High transportation costs
c. Availability of public utility services
d. Benefit of tax holidays
7. The basic raw material for a cement manufacturing unit is limestone and the
major consumers are the government, real estate and individual consumers.
Which is the best possible location to build a cement plant?
a. Close to sea port
b. Close to cities where consumption is high
c. Close to the raw material source
d. Within special economic zones or export processing zones
8. Many auto-ancillary units have set up facilities close to facilities of auto majors
like Hyundai and Ford near Chennai. Which of the following factors would have
primarily led to this decision?
a. Site cost
b. Proximity to markets
c. Need for safety requirements
d. Availability of services like electricity, drainage, and waste disposal
5
9. Which of the following is not considered a benefit derived by companies setting
up operations in special export zones (SEZ)?
a. Good infrastructure support
b. Tax holidays
c. Low interest loans
d. Availability of prime real estate
5. General Steps in Location Selection and Location Decision Process
There are a number of factors that affect location decisions. The following are the
steps involved in the location decision process:
Define the location objectives and associated constraints These are defined on the
basis of requirements of the promoters, owners, employees, suppliers, and customers
of the firm.
Identify the Relevant Decision Criteria The criteria should include economic factors
like labor and material costs, and non-economic factors like impact of the plant on the
surrounding environment.
Relate the Objectives to the Criteria Using Appropriate Models The decision
criteria should be evaluated by using models like break-even analysis, linear
programming, and qualitative factor analysis.
Do Field Research to Relevant Data and Use the Models to Evaluate the Alternative
Locations Primary and secondary data should be collected to evaluate the alternative
locations using the given decision criteria.
Select the Location that Best Satisfies the Criteria The location that meets the
desired objectives, satisfies the criteria and provides benefits to the society should be
selected.
6. Location Evaluation Methods
Certain factors should be considered before a location is selected. Each possible
decision has advantages as well as disadvantages. The company should select a
location that suits the products it offers, the location of its customers and materials,
and other criteria that are specific to the company. Several models and techniques are
available that help managers take appropriate location decisions.
6.1. Cost-Profit-Volume or Break-Even Analysis
Break-even analysis is a graphical and algebraic representation of the relationships
among volume of output, costs, and revenues. Costs are of two types: fixed costs and
variable costs. Fixed costs are those which do not vary with the volume of output.
Examples are administration expenses, rents of buildings, lighting, etc. Variable costs
are costs which vary with the volume of output. Raw material cost, labor cost, etc. are
variable costs. The sum of the fixed and variable costs at a specific volume of output
would be the total cost at that volume of output. Break-even analysis is one of the
tools used for selection of a location. As each and every location will have a different
cost structure, and sales volume, break-even analysis helps managers to identify the
location where profits are high.
Example: Krishna Electricals Ltd. wanted to set up its new plant for manufacturing
heaters and the management identified that Hyderabad, Tirupathi, and Vijayawada as
potential areas for setting up the plant. The fixed costs per year and the variable costs
per unit at each of the three locations are given below.
6
Location Fixed cost /Yr Variable Cost / Unit
Hyderabad Rs. 3,00,000 425
Tirupathi Rs. 3,50,000 385
Vijayawada Rs. 4,00,000 365
The product is expected to be sold at Rs.1200 and the existing demand for heaters in
the market is 800 units per year. Calculate the likely profit at each of the locations and
determine the location that is the most profitable for the company.
Solution: Let us calculate the total costs (sum of the fixed and variable costs) at each
of the three locations when 800 units of goods are sold.
Total cost at Hyderabad = Rs. 300,000 + (425 800) = Rs. 640,000
Total cost at Tirupathi = Rs. 350,000 + (385 800) = Rs. 658,000
Total cost at Vijayawada = Rs. 400,000 + (365 800) = Rs. 692,000
Total revenue of the firm = 1200 800 = Rs. 960,000.
Therefore, the profits of the company if they were set up in the given locations would
be as follows:
Profit at Hyderabad = Rs. 960,000 Rs. 640,000 = Rs. 320,000
Profit at Tirupathi = Rs. 960,000 Rs. 658,000 = Rs. 302,000
Profit at Vijayawada = Rs. 960,000 Rs. 692,000 = Rs. 268,000
From these calculations it is clear that Hyderabad is the most profitable location to set
up the new plant for producing 800 units per year.
Activity: Shruti Refrigerators Ltd. wanted to set up its new plant for manufacturing
cold freezers. The management identified that Vijayawada, Cuddapah, and
Tirupathi were the potential areas for setting up the plant. The fixed costs per year
and the variable costs per unit at each of the three locations are given.
Location Fixed Cost /Yr Variable Cost / Unit
Vijayawada Rs. 4,00,000 625
Cuddapah Rs. 4,50,000 585
Tirupathi Rs. 5,00,000 565
The product is expected to be sold at Rs.5000 and the existing demand for cold
freezers in the market is 200 units per year. Calculate the likely profit at each of the
locations and determine the location that is the most profitable for the company.
Answer:
7
6.2. Point Rating Method
Companies select a site or location based on various objectives which are given certain
levels of importance. Weights are attached to these objectives in the form of points.
Potential sites are evaluated based on every factor and points are allocated accordingly
to each factor. A superior site is the one which adds up to more points. The disadvantage
with this method is that a factor giving a high score would triumph over a factor with a
low score. In this method, tangible cost factors are given more importance than
intangible cost factors. Points are assigned only to the intangible factors. However, an
evaluation is done to know whether the difference between the intangible factors is
worth between tangible factors of the competing locations. For example, A & B are two
potential sites being evaluated on the basis of cost. The manufacturer evaluated the sites
considering the intangible factors using the point rating method. The following table
shows that location A is a more site with more potential than location B.
Points Assigned to Alternative Locations
Factors rated Maximum
Possible
Points
Points assigned to
Location A Location B
Availability of fuel in future 700 500 600
Availability of labor 600 540 500
Water supply 300 260 240
Transportation facility 400 350 250
Topography of the site 200 180 190
Living conditions 500 400 410
Total 2700 2230 2190
6.3. The Transportation Method of Linear Programming
For a single source of supply, the cost of supply is calculated by adding the production
cost at the supply point and the shipping cost from that point to the potential location.
However, it becomes difficult to calculate the cost of supply if there is a network of
several supply chains supplying to a potential location. In this case, the total cost of
supplying to one location should be compared to that of another location. Such a
comparison can be made by evaluating the best match of capacity and demand for
each potential location and comparing the costs and profits. The transportation method
attempts at matching the capacity and demand of a firm and thereby minimizing the
total transportation costs of the firm. The plant will be set up at a location which
incurs the least total transportation cost.
6.4. Center of Gravity Method
The center of gravity method aims at minimizing the total shipping cost, i.e. cost
incurred for shipping from the distribution center to the different shipping points.
Factors like proximity to markets, cost of goods, transportation costs affect the
optimal location of the distribution center.
If the quantities that are to be shipped to the different destinations are equal, the
location at which the transportation cost will be minimum can be identified by taking
the arithmetic averages of the X and Y coordinates of the destination. If the quantities
are not equal, then weighted arithmetic means have to be calculated where the
quantities to be shipped act as the weights. The formulae for calculating the
coordinates of the optimal location (in case of different quantities being shipped to
destination points) are as given under.
8
i
i i
c
V
V X
X
i
i i
c
V
V Y
Y
Example: The X and Y coordinates of five destination points are given in the table
below along with the quantities to be shipped to each point. Use this information to
calculate the coordinates of the optimal location for the distribution center such that
the total transportation cost is minimum.
Destination Point X Y
Volume
(in thousand)
A 4 8 80
B 5 12 100
C 3 9 120
D 11 2 130
E 14 6 100
Solution: This is case where quantities shipped to destination points are unequal.
Hence weighted arithmetic means have to be calculated where the respective volumes
would be used as weights. Hence, the coordinates of each destination point have to be
multiplied with the respective volumes. This is as shown in the table below:
Destination Point X
i
Y
i
Volume (V
i
) V
i
X
i
V
i
Y
i
A 4 8 80 320 640
B 5 12 100 500 1200
C 3 9 120 360 1080
D 11 2 130 1430 260
E 14 6 100 1400 600
530 V
i
4010
i
X
i
V 3780
i
Y
i
V
Now the coordinates of the distribution center can be calculated using this data.
X coordinate of distribution center = 4010/530 = 7.57
Y coordinate of distribution center = 3780/530 = 7.13
Hence the coordinates of the optimal location of the distribution center are 7.57/ 7.13)
6.5. Analytical Delphi Method
Analytical Delphi method is useful in decisions involving multiple locations with
different objectives. This method involves the need of three panels forecasting
panel, strategic panel, and coordinating panel. The function of forecasting panel is to
forecast the future trends, in the physical and social environment, that have an impact
on the organization. Strategic panel helps develop long-term goals and objectives for
the organization, and the coordination panel oversees and manages the entire process.
After formation of the panels, the coordination panel carries out two inquiries with
forecasting panel and strategic panel through questionnaires. In the first Delphi
inquiry, information on future trends is elicited from the forecasting panel and is given
to the strategic panel. In the second Delphi inquiry, the strategic panel uses this
9
information to determine the goals, objectives and future directions of the
organization. Various alternatives are developed based on these goals by the strategic
panel. The best alternatives among them are selected through group consensus.
Check Your Progress
10. Which of the following is not a location evaluation method?
a. Point rating method
b. Center of gravity method
c. Analytical Delphi method
d. Historical analogy method
11. Which of the following techniques is not associated with taking suitable location
decisions?
a. Cost-profit-volume analysis
b. Factor analysis
d. CRAFT analysis
12. Companies can follow certain guidelines when trying to analyze possible
locations and identify an optimal one since it is expensive and time-consuming.
What is the correct sequence of guidelines a company can follow when evaluating
locations?
a. Define location objectives relate objectives to criteria Identify relevant
decision criteria evaluate alternative locations select the best location
b. Identify relevant decision criteria define location objectives relate objectives
to criteria evaluate alternative locations select the best location
c. Define location objectives identify relevant decision criteria relate objectives
to the criteria evaluate alternative locations select the best location
d. Define location objectives identify relevant decision criteria evaluate
alternative locations relate objectives to criteria select the best location
13. Though there is no standard procedure, certain guidelines can be used for making
a location decision. The first guideline is to define location objectives. Whose
views and requirements are not considered when defining them?
a. Owners and promoters
b. Employees
c. Customers
d. Competitors
14. Analytic Delphi Method helps managers take complex multi-location decisions.
Give the correct sequence of steps to be taken as part of such location decisions.
a. Form panels - Identify trends and opportunities - Determine directions and
strategic goals of the organization - Develop alternatives - Prioritize alternatives
b. Identify trends and opportunities - Determine directions and strategic goals of the
organization - Form panels - Develop alternatives - Prioritize alternatives
c. Identify trends and opportunities - Form panels - Determine directions and
strategic goals of organization - Prioritize alternatives - Develop alternatives
d. Form panels - Determine directions and strategic goals of the organization -
Prioritize alternatives - Develop alternatives - Identify trends and opportunities
10
Exercises
(Questions A to C)
The table below gives details about fixed costs and variable costs for three different
locations. Answer the following three questions using information given in the table.
Location Fixed cost /Yr Variable cost / Unit
Chandigarh Rs. 4,00,000 300
Gurgaon Rs. 4,50,000 285
Delhi Rs. 5,00,000 275
A. Which of the locations would have the highest total cost per year if annual output
of a firm located there is 1000 units?
B. Which of the locations would have the highest annual profit if the annual
production is 1000 units and selling price per unit is Rs.1000?
C. Which plant location would you select if you were the authority to make the final
decision?
D. The following table gives the volume of quantities to be shipped to four markets.
The X and Y coordinate values of the location that would help minimize
transportation costs are also given. Use the center of gravity method to find out
coordinates for the optimal location to set up a warehouse to service the four
markets with minimal transportation costs.
Distribution
Center
X Y VOLUME (000)
A 4 4 60
B 12 6 90
C 10 14 110
D 5 13 100
7. Facility Layout
Layout includes the initial layout of machines and other facilities. It also contains
improvements or revisions in the existing layout if there is any development in the
methods of production. The physical disposition of the facilities of a plant is referred
to as the plant layout. A plant layout is a floor plan to determine and arrange the
machinery and equipment in the manner that best allows the quick flow of material at
minimal cost and the least handling process from the stage of receipt of raw material
to the shipment of finished products. It provides a smooth work flow of material
through the factory, or a comfortable traffic pattern for both customers and workers in
the organization. Like location decisions, layout decisions have long-term
consequences in terms of cost and the companys ability to serve its customers. While
designing a layout, an organization should identify the objectives of its strategy that
have to be supported by the layout and many other factors that affect and are affected
by the layout.
11
Criteria for a Good Layout
Layout can be designed by using work study methods and industrial engineering
techniques. For a good layout, some of the criteria that have to be satisfied are:
Maximum Flexibility A good layout is one which can be modified to suit the
changing environment.
Maximum Coordination The departments and the functions should be arranged in a
manner which facilitates proper coordination.
Maximum Visibility The layout should have no hiding places lest goods can get
misled.
Maximum Accessibility The servicing and maintenance points should be readily
accessible.
Minimum Distance All the movements should be direct and unnecessary and
circuitous movements should be avoided.
Minimum Handling Handling of material and information should be minimized.
Minimum Discomfort Excessive sunlight, heat, noise, vibrations should be avoided.
Inherent Safety Safety should be given prime importance in each and every layout.
Efficient Process Flow Material or information should flow in only one direction.
Identification A proper work space should be provided to the workers.
8. Basic Layout Formats
Layouts are differentiated by the type of work flow they require. The types of layout
are:
Process Layout
Process layouts, also known as functional layouts or job-shop layouts, involve
grouping of all similar equipment or functions. These are designed to accommodate
variety in product designing and processing. These layouts mostly use general purpose
machines that can be changed over rapidly to new operations for different product
designs. Workers in process layouts must be highly skilled. These layouts have greater
flexibility in production, work can be transferred to another machine in case of
Cost Volume Relationships of Two Locations
V
0
Volume of sales
Revenue
TC
2
TC
1
FC
1
FC
2
12
breakdown of equipment, they allow expansion of different production line capacities
and they also allow proper utilization of the men and machines. However, production
requires more time as work-in-progress has to travel from one place to another in
search of machines, the layout requires more floor space and work gets accumulated.
Product Layout
Product layouts, also known as flow-shop layouts or straight-line layouts, involve the
arrangement of equipment or machines according to the progressive steps by which a
product is made. Raw materials are moved to the first machine and the finished
products come out from the last machine. These layouts are designed to accommodate
only a few mostly one or two standardized products and process designs. These
layouts allow mechanization of materials and reduce material handling costs. These
layouts require less floor area per unit of production, and facilitate better production
control and help avoid production bottlenecks. However, there are difficulties in
expanding the production line and supervising. Breakdown of one piece of equipment
leads to disruption in the entire production system
Grouping Technology Layout
Grouping technology layout, also known as cellular manufacturing layout, involves
grouping of dissimilar machines into cells where each cell functions like a product
layout within a larger job shop or process layout. These layouts help simplify machine
changeovers, reduce materials-handling costs, lead to quicker manufacturing and
quicker shipping, reduce the in-process inventory required, and automate production
easily. However, this layout reduces the flexibility of manufacturing.
Fixed Position Layout
A fixed position layout involves the movement of all machines and men to the
product, which remains stationary. In this layout, a major component of the product is
fixed in a particular location and all the requirements are brought to the location. It
involves low investment, and helps to avoid bulky material being transported.
Hybrid Layouts
Single layouts like process layouts, product layouts, or fixed position layouts, are
difficult to practice in their true sense. Therefore, a combination of several types of
layouts is used. This is called a hybrid layout or a combined layout.
9. Developing a Process Layout
For planning a process layout, managers can use models like mathematical models,
computer models, and physical models. Mathematical models help managers to
analyze and conceptualize the problem; computer models provide them with a quick
approximation of good layouts; and physical models help them visualize the layout.
Graphic and Schematic Analysis
The most common layout-planning tools are templates and two-dimensional cutouts
of equipment drawn to a scale. Templates are used for identifying the best layout
through trial and error by moving within a scaled model of walls and columns of a
facility. These templates are also used for developing product and fixed-position
layouts.
Computer Models CRAFT
Computerized Relative Allocation of Facilities Technique (CRAFT) is a computerized
layout program that identifies a layout through the quick evaluation of thousands of
alternative layouts. It has the capacity to handle plants with up to 40 work centers of
different shapes and sizes, and can account for mobile and immobile process centers.
13
Load Distance Model
A plant using a process layout produces diversified products in variable work flows.
Such a plant handles relatively large amounts of material. Huge movement costs are
incurred as there is a lot of movement of material in the process. The load distance
model is one of the important models used to minimize the flow of material. This
model considers the number of loads (standardized amount of material) moved
between each pair of process centers over a period of time and the distances between
them. These distances depend on the locations fixed by the initial layout. The initial
layout is then modified to reduce costs. This process is repeated until there is no scope
for further cost minimization.
Check Your Progress
15. What do you understand by the term facility layout?
a. A list of facilities provided by the organization to the consumers
b. The physical distribution of various departments for ease in production
c. The location of employees inside the organization
d. Layout of safety equipment in an organization
16. Identify the statements that does not hold true regarding layout.
a. It contains improvements or revisions in the existing layout if there is any
development in the methods of production.
b. Layout decisions have short-term consequences in terms of cost and the
companys ability to serve its customers.
c. It determines and arranges the machinery and equipment in the manner that best
allows the quick flow of material at minimal cost and the least handling process
from the stage of receipt of raw material to the shipment of finished products.
d. It provides a smooth work flow of material through the factory, or a comfortable
traffic pattern for both customers and workers in the organization.
17. Which of the following involves the use of layout planning tools like templates
and two-dimensional cut-outs of equipment drawn to scale?
a. Graphic and schematic analysis
b. Load distance model
c. Computer models
d. CRAFT model
18. Layouts are differentiated by the types of workflow they entail. Workflow in turn
is dictated by the nature of the product. Which of the following statements is true
about product layout?
a. Equipment is dedicated to the manufacture of a narrow product line
b. Equipment is flexible to produce a wide range of products
c. Material handling cost increases significantly
d. It is used for manufacturing customized products
19. Which of the following types of layout is used when the product manufactured is
bulky, heavy or fragile?
a. Product layout
b. Process layout
c. Fixed position layout
d. Group technology layout
14
20. Which of the following is not a type of facility layout?
a. Process layout
b. Product layout
c. Employee layout
d. Hybrid layout
21. It is also called the cellular manufacturing layout. Identify the layout from the
following.
a. Process layout
b. Grouping technology layout
d. Hybrid layout
22. Process layouts are also known as ______.
a. Functional layouts
b. Fixed position layout
c. Flow-shop layouts
d. Straight-line layouts
23. Under which type of layout are similar machines and equipment grouped to carry
out the production process.
a. Process layout
b. Product layout
d. Hybrid layout
24. What type of machine is used in a process layout?
a. Specially designed machines
b. General purpose machines
c. Machines that help manufacture standardized products
d. All of the above
25. Which of the following is an advantage of process layouts?
a. Increased production time
b. Increased work-in-progress
c. Increased accumulation of work
d. Increased utilization of men and material
26. Which type of layout is designed to produce standardized products?
a. Process layout
b. Product layout
d. Hybrid layout
27. Which of the following manufacturing processes requires using a fixed position
layout?
a. Petroleum distillation
b. Beer manufacturing
c. Ship-building
d. Cement manufacturing
15
28. Managers can use various models like mathematical models, computer models,
and physical models to develop a process layout. Which among the following
helps find the best process layout by evaluating thousands of alternative layouts
very quickly?
b. CRAFT model
c. Load distance model
d. Line balancing
29. Different types of products are manufactured using a process layout. As workflow
differs from product to product, managers focus on minimizing the movement of
materials as it can hike material movement costs. Which of the following models
aims at minimizing these costs?
b. CRAFT model
c. Load distance model
d. Line balancing
10. Developing a Product Layout
Design for developing a product layout is partly established when each part of the
product is designed and the different steps required to make it are determined. The
volume of production determines the most economical process, and the process
technology determines the sequence of steps which have to be performed in
production. Finally, the equipment and workstations are placed along a line in that
sequence. Workstations and equipment for the same product can be arranged in many
possible sequences. Line-balancing is a mathematical model used for determining
appropriate ways to group the tasks to be performed at each workstation.
Line Balancing
Line balancing is a part of the assembly line study that involves the selection of a
suitable combination of work tasks to be performed at each workstation so that the
work is performed in a feasible sequence. It ensures that each workstation gets
approximately an equal amount of time.
Steps in Assembly Line Balancing
The following steps are needed to balance an assembly line:
i. The sequential relationship among different tasks is specified by using a
precedence diagram.
The cycle time is determined by using the following formula:
day per output Required
day per time Production
time Cycle
ii. The theoretical minimum number of workstations required to satisfy the cycle
time is determined using the following formula:
C
T
t
N
Where N
t
= Theoretical number of workstations
T = Sum of task times
C = Cycle time
16
iii. A set of rules is identified to shortlist and select the tasks to be assigned to
workstations. A sample set of rules is given below.
a) Identification of feasible (remaining) tasks for the same station:
From the unassigned tasks, identify the task(s) which can be assigned next to the
same station, subject to two constraints:
The precedence rules should not be violated.
The individual time required for each of these feasible (remaining) tasks should be
less than the unassigned time for the station, where Unassigned time for a station =
Cycle time (Sum of the time required for all previous tasks that have been assigned
to the station)
Note:
When there is no feasible (remaining) task for the same station, move on to the next
station.
When there is exactly one feasible remaining task for the same station, assign it as the
next task for the same station.
When there are multiple feasible remaining tasks for the same station, use the
following tiebreaker rules to shortlist/select the next task for the same station.
b) Shortlist the tasks with most followers, among the feasible (remaining) tasks for
the same station:
Now, shortlist the task(s) which has (have) the most followers from the feasible
(remaining) tasks for the same station.
c) Select the task with the longest operation time:
From the short listed tasks with most followers, select the task which has the
longest operation time, and assign it as the next task for the same station.
Sometimes, there may be many such tasks. In this case, one of these tasks with
the longest operation time can be (arbitrarily) assigned as the next task for the
same station.
iv. This set of rules is applied iteratively till all the tasks are assigned. At the end of
this process, the actual number of work stations (N
a
) required may be greater
than or equal to the theoretical number of work stations (N
t
).
The efficiency of the balance is calculated by using the following formula.
C
a
N
T
Efficiency
Where, T = Sum of task times
N
a
= Actual number of workstations
C = Cycle time
v. The balance is accepted if the efficiency is satisfactory, otherwise balancing is
done using a different decision rule.
17
Example: The desired daily output for an assembly line is 300 units. The assembly
line operates for a period of 480 minutes a day. The process involves the tasks A, B,
C, D, E, F, G, H, I, J, and K. Balance the assembly line and calculate the cycle time
and efficiency of the assembly line.
Task Task Time (Seconds) Tasks that Must Precede
A 55 -
B 21 A
C 19 B
D 60 -
E 25 D
F 22 C
G 22 C
H 22 E
I 22 E
J 18 F,G,H,I
K 19 J
Total Time 305
Solution: Following is the precedence diagram of all the tasks. The time required (in
seconds) for completion of each of the tasks is given:
Given that the operation time per day is 480 min, i.e. (48060) sec. The sum of the
task times of the process, T = (55 + 21 + 19 +60 + 25 + 22 + 22 +22 + 22 + 18 + 19) =
305 sec.
day per Output
day per time Operation
time Cycle
300
60 480
= 96 sec.
The theoretical minimum number of workstations required,
96
305
C
T
N
t
= 3.18
Therefore, a minimum of 3 workstations are required to balance the assembly line.
We arrange tasks in order of the largest number of following tasks.
Task Number of Following Tasks
A 6
B or D 5
C or E 4
F, G, H, I 2
J 1
K 0
Apply the above rules for balancing the assembly line given in the problem:
To begin with, no tasks are assigned to any station. So, the unassigned time for Station
1 is 96 seconds. Subject to the precedence rules and the time constraints, A or D can
be considered as the feasible remaining tasks. Since A has the most followers, we
assign Task A to Station 1, as shown below.
Station Task Time
Unassigned
Time
Feasible
Remaining
Tasks (for the
Same Station)
Task with
Most
Followers
Task with
Longest
Operation
Time
Station 1 - 0 96 A, D A A
Station 1 A 55 41 None None None
Now, the unassigned time for Station 1 is 41 seconds and neither of the potential next
task (B or D) can be assigned next to this station, because of the time constraint. So
we move on to Station 2. Following the same rules described above, the entire table
can be filled as shown below.
Station Task Time
Unassigned
Time
Feasible
Remaining
Tasks (for the
Same Station)
Task with
Most
Followers
Task with
Longest
Operation
Time
Station 1 - 0 96 A, D A A
A 55 41 None None
Station 2
- 0 50.4 B, D B, D D
D 60 36 None None None
19
Station Task Time
Unassigned
Time
Feasible
Remaining
Tasks (for the
Same Station)
Task with
Most
Followers
Task with
Longest
Operation
Time
Station 3
- 0 96 B, E B B
B 21 75 C,E C,E E
E 25 50 C,H,I C C
C 19 31 F,G,H,I F,G,H,I F,G,H,I
F 22 9 None None None
Station 4
- 0 96 G,H,I G,H,I G,H,I
G 22 74 H,I,J H,I H,I
H 22 52 I,J I I
I 22 30 J J J
J 18 12 None None None
Station 5 - 0 96 K K K
K 19 77
All tasks have been assigned
# The last task (Task K) could not be assigned to Station 4, since the unassigned time (12
seconds) was less than the time required for Task K (19 sec). So, we need a fifth workstation to
perform Task K.
Therefore, actual number of workstations, N
a
= 5
Efficiency of the assembly line
C N
T
a
6 9 4
305
= 0.79
Mixed-Model Line Balancing
Mixed-model line balancing is used to meet the demand for a variety of products. It
involves multiple lot sizes, lot sequencing, different set-up times for each lot, differing
workstation sizes along the line, and task variations that make it very difficult to
design.
Activity: The desired daily output for an assembly line is 800 units. The assembly
line operates for a period of 420 minutes a day. The process involves the tasks A,
B, C, D, E, F, G, H, I, J, and K. Balance the assembly line and calculate the cycle
time and efficiency of the assembly line.
A 50 -
B 12 A
C 11 B
Contd
20
Contd
D 55 -
E 17 D
F 13 C
G 13 C
H 13 E
I 13 E
J 9 F,G,H,I
K 10 J
Answer:
Check Your Progress
30. Match the following models used to develop layouts with their respective
features.
i. CRAFT model
ii. Load distance model
iii. Line balancing
iv. Graphic & schematic analysis
p. Used for studying workflow in an assembly line
q. Evaluates thousands of alternative layouts in a short period
r. Analyses and minimizes material movements costs in a plant
s. Two dimensional drawings are used to determine the best layout
a. i/p, ii/q, iii/r, iv/s
b. i/q, ii/p, iii/r, iv/s
c. i/r, ii/q, iii/p, iv/s
d. i/q, ii/r, iii/p, iv/s
31. Which of the following is a mathematical model that involves the selection of a
suitable combination of work tasks to be performed at each workstation so that
the work is performed in a feasible sequence?
a. Line balancing
c. Center of Gravity Method
d. Analytical Delphi Method
21
32. Given below are the steps required to balance an assembly line.
i. The set of rules is applied iteratively till all the tasks are assigned.
ii. The balance is accepted if the efficiency is satisfactory, otherwise balancing is
done using a different decision rule.
iii. The theoretical minimum number of workstations required to satisfy the cycle
time is determined.
iv. The sequential relationship among different tasks is specified by using a
precedence diagram.
v. A set of rules is identified to shortlist and select the tasks to be assigned to
workstations.
a. v-i-ii-iii-iv
b. iii-v-i-ii-iv
c. iii-v-i-iv-ii
d. iv-iii-v-i-ii
33. Which of the following are the rules identified to shortlist and select the tasks to
be assigned to the workstations?
i. Identify the feasible (remaining) tasks for the same station.
ii. Shortlist the tasks with most followers, among the feasible (remaining) tasks for
the same station
iii. Select the task with the shortest operation time
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
34. ___________ is used to meet the demand for a variety of products. It involves
multiple lot sizes, lot sequencing, different set-up times for each lot, differing
workstation sizes along the line and task variations that make it very difficult to
design.
a. CRAFT model
c. Mixed-model line balancing
d. Graphic and schematic analysis
11. Developing a Cellular Manufacturing Layout
The following are the steps for developing a cellular manufacturing layout:
The parts that follow a common sequence of steps are grouped into a family.
The dominant flow patterns of parts-families are identified as a basis for location or
relocation.
The machines and processes are physically grouped into cells. The machinery parts
that cannot be grouped with any cell or family are placed in a remainder cell.
Problems involved in developing a cellular manufacturing layout are:
Developing and classifying a coding scheme for items of different shapes, sizes,
materials, etc.
Grouping parts in families to form cell groups on the basis of processing requirements
and routings
Creating the physical layout for positioning cells relative to each other.
22
12. Japanese Approaches and Trends in Manufacturing Layouts
The approach towards business management of Japanese firms is different from that of
US firms. These differences are reflected in their facility layout. The Japanese make
most use of the little space available as space is available at a premium. Materials travel
shorter distances and products go through the factory faster, resulting in high production
rates, quick processing of customer orders, and reduction in materials handling and
inventory costs. This also makes the factories more flexible to changes in customer
orders, production schedules, and production rates. Japanese layouts are designed for
flexibility and adaptability to different product models or to different production rates,
whereas US layouts are designed for high worker and machine utilization.
Check Your Progress
35. In which of the following countries were compact production layouts developed
due to space constraints?
a. USA
b. Japan
c. India
d. China
36. Given below are the steps involved in the development of a cellular
manufacturing layout.
i. The dominant flow patterns of parts-families are identified as a basis for location
or relocation.
ii. The parts that follow a common sequence of steps are grouped into a family.
iii. The machines and processes are physically grouped into cells.
a. i-iii-ii
b. ii-i-iii
c. i-ii-iii
d. iii-i-ii
37. Which of the following are the problems involved in developing a cellular
manufacturing layout?
a. Developing and classifying a coding scheme for items of different shapes, sizes,
materials, etc.
b. Grouping parts in families to form cell groups on the basis of processing
requirements and routings
c. Creating the physical layout for positioning cells relative to each other.
d. All of the above
38. Which of the following statements is true regarding the Japanese approaches and
trends in manufacturing layouts?
a. The approach of Japanese firms toward business management is similar to that of
the US firms.
b. The Japanese make most use of the little space available as space is available at a
premium.
c. Japanese layouts are designed for high worker and machine utilization, unlike US
layouts that are designed for flexibility and adaptability to different product
models or to different production rates.
d. Japanese factors are less flexible to changes in customer orders, production
schedules, and production rates.
23
13. Service Facility Layout
A service facility is different from a manufacturing facility as service facilities bring
together the customer and the organizations services. Based on the degrees of
customer contact, there are two extremely different types of service facility layouts.
At one extreme, the layout is designed around the customer receiving service
functions like that of banks. At the other extreme, the layout is designed around
technology, processing of physical materials, and production efficiency like that of
hospitals. Certain service facilities like restaurants strike a balance between these two
extremes. In a restaurant, attention is directed both at customer receiving and
servicing as well as on processing and preparation of food. In these layouts, the
internal work of the employees is given secondary importance.
Example: Plant Locations Strategies
In 1977, Japanese-based automobile manufacturer Nissan Motor Co. Ltd sent its
teams to the state of Tennessee to search of a potential location for setting up its
manufacturing plant in the US. At that time, there were 49 automotive suppliers in
the state. This number rose to 500 in 1999. The growth of the automotive industry
in Tennessee and the Southeast of the US can be attributed to the way the
automotive suppliers chose to locate and expand. They selected a site by matching
the needs of the company with the characteristics of the community.
Evaluation of an optimal location was done after considering various criteria which
were divided into three main categories. They were operating costs, structural
conditions, and quality-of-life attributes. Wage levels, utility costs, costs of raw
materials, taxes, and land costs were the operating costs which influenced the
location decisions. The productivity of the workers and the provision of public
services like infrastructure also had an effect on the operating costs of the firm.
Structural conditions included elements like market access, regulatory
environment, provision of public goods, degree of urbanization, and the
demographic set-up of the population. The quality-of-life attributes included
climate, crime rate, natural environment, amenities, educational opportunities, and
the overall appearance of the community. In addition to these factors, just-in-time
manufacturing played an important role in influencing the location decisions.
The automotive suppliers conducted the site selection process in three stages: initial
screening, community selection, and final selection. Each of the stages in the
selection process had different location determinants. In the initial screening stage,
a wide region and the individual states encompassing it were identified based on
factors like wage differentials, transportation capabilities, and critical flaws. In the
community selection stage, the focus was placed mainly on the geographic area
like the Southeast, or on individual states. During this stage, the firms started
making detailed calculations of differences in operating costs, quality-of-life
attributes across sites, availability of labor force, etc. The third and the final stage
in the location decision was site selection. This stage involved a detailed evaluation
and comparison of three to five sites based on costs, benefits, attributes, etc. All
these factors contributed to the site selection and ultimately led to the growth of the
automotive industry in these regions.
Adapted from Matthew N. Murray, Paula Dowell, and David T. Mayes, The Location Decision
of Automotive Suppliers in Tennessee and the Southeast, Center for Business and Economic
Research, August 1999, http://cber.utk.edu/pubs/mnm083.pdf
24
Check Your Progress
39. Different types of layout of service facilities exist based on degrees of customer
contact. In which of the following layouts is internal work of employees given
secondary importance?
a. Layouts focusing on customer receiving and servicing
b. Layouts focusing on technology
c. Layouts focusing on physical materials processing
d. Layouts focusing on production efficiency
40. Which of the following service providers uses both customer focus layouts and
process focus layouts as part of its service facility layout?
a. Banks
b. Hospitals
c. Restaurants
d. Call center
41. All the statements given below are true regarding a service facility layout, except:
a. It brings together the customer and the services of the organization.
b. A service facility layout is designed around the customer receiving service
functions.
c. A service facility is designed around technology, processing of physical
materials, and production efficiency.
d. In service facility layouts such as restaurants, attention is directed only at the
customer receiving and servicing function, and not at the processing and
preparation of food function.
14. Summary
Location decisions are strategic decisions that require huge financial investments and
they are irreversible in nature.
Models and techniques such as break-even analysis, factor rating technique, and the
transportation method of linear programming that includes center of gravity method
and analytical Delphi method help managers in taking location decisions.
The physical disposition of the facilities of a plant is referred to as the plant layout.
The basic types of layouts are: process layout, product layout, fixed-position layout,
cellular manufacturing layout, and hybrid layout.
In case of designing service layouts, there exist two types based on the degree of
customer contact. One is designed around the customer service and the other around
the technology.
15. Glossary
Analytical Delphi method: It is useful in decisions involving multiple locations with
different objectives. This method involves the need of three panels forecasting
panel, strategic panel, and coordinating panel. The forecasting panel forecasts the
future trends, in the physical and social environment, that have an impact on the
organization; the strategic panel helps develop long-term goals and objectives for the
organization; and the coordination panel oversees and manages the entire process.
25
Break-even analysis: It is a graphical and algebraic representation of the
relationships among volume of output, costs, and revenues.
Center of gravity method: It aims at minimizing the total shipping cost, i.e., cost
incurred for shipping from the distribution center to the different shipping points.
Computerized Relative Allocation of Facilities Technique (CRAFT): A
computerized layout program that identifies a layout through the quick evaluation of
thousands of alternative layouts. It has the capacity to handle plants with up to 40
work centers of different shapes and sizes, and can account for mobile and immobile
process centers.
Facility location: The place where the firms set up their operations.
Fixed costs: These do not vary with the volume of output. Examples are
administration expenses, rents of buildings, lighting, etc.
Fixed position layout: It involves the movement of all machines and men to the
product, which remains stationary. In this layout, a major component of the product is
fixed in a particular location and all the requirements are brought to the location.
Grouping technology layouts (cellular manufacturing layouts): These involve
grouping of dissimilar machines into cells where each cell functions like a product
layout within a larger job shop or process layout.
Hybrid layouts (or combined layouts): A combination of several types of layouts
such as process layouts, product layouts, or fixed position layouts is used.
Layout: It includes the initial layout of machines and other facilities. It also contains
improvements or revisions in the existing layout if there is any development in the
methods of production.
Line balancing: A part of the assembly line study that involves the selection of a
suitable combination of work tasks to be performed at each workstation so that the
work is performed in a feasible sequence.
Load distance model: It is used to minimize the flow of material. It considers the
number of loads (standardized amount of material) moved between each pair of
process centers over a period of time and the distances between them.
Mixed-model line balancing: It is used to meet the demand for a variety of products.
It involves multiple lot sizes, lot sequencing, different set-up times for each lot,
differing workstation sizes along the line, and task variations that make it very
difficult to design.
Plant layout: The physical disposition of the facilities of a plant. It is a floor plan to
determine and arrange the machinery and equipment in the manner that best allows
the quick flow of material at minimal cost and the least handling process from the
stage of receipt of raw material to the shipment of finished products.
Process layouts (functional or job-shop layouts): These involve grouping of all
similar equipment or functions. These are designed to accommodate variety in
product designing and processing.
Product layouts (flow-shop or straight-line layouts): These involve the
arrangement of equipment or machines according to the progressive steps by which a
product is made.
Total cost: The sum of the fixed and variable costs at a specific volume of output
would be the total cost at that volume of output.
Variable costs: These vary with the volume of output. Raw material cost, labor cost,
etc. are variable costs.
26
1. Manufacturing and service firms evaluate different locations and finally choose
an optimum location to start their operations. What do you understand by facility
location? Explain the importance of making location decisions.
2. Location decisions are long-range decisions and are affected by a number of
factors. Therefore developing a formal and generic location model is very
difficult. What are the factors affecting location decisions? Explain the location
decision process.
3. Several models and techniques are available to help managers take appropriate
location decisions. Explain the different methods through which an organization
can evaluate a location.
4. Facility layout is the physical disposition of the facilities of a plant and its various
parts for the purpose of achieving quickest and smoothest production. Explain the
criteria for selecting a good layout.
5. Layouts are differentiated by the type of work flow and the nature of the product.
What are the various types of layout formats? Describe these layouts and list out
the advantages and disadvantages of each.
6. Managers use mathematical models, computer models, and physical models in
order to develop layouts. Explain the planning and developing process of the
following layouts:
Process layout
Product layout
Cellular manufacturing layout
Japanese manufacturing layouts vs. US manufacturing layouts
Service facility layouts are different from manufacturing facility layouts.
6. Break-Even Analysis
<http://www.tutor2u.net/business/production/break_even.htm>
7. Plant Layout
<http://www.du.ac.in/coursematerial/ba/esb/Lesson_7.pdf>
8. Facility Layout Planning
<http://www.techasst.com/facility_layout.htm>
27
9. Break-Even Analysis
<http://homepages.cambrianc.on.ca/tutorial/thetutorialcentre/mathscience/math/br
eak_even_analysis.htm>
10. Facility Layout
<http://www.strategosinc.com/plant_layout_elements.htm>
11. Facility Layout and Design
<http://www.referenceforbusiness.com/small/Eq-Inc/Facility-Layout-and-
Design.html>
12. Japanese Manufacturing Techniques
<http://www.referenceforbusiness.com/encyclopedia/Int-Jun/Japanese-
Manufacturing-Techniques.html>
Following are the answers to the Check Your Progress Questions given in the Unit.
1. (c) i, ii, iii
Except alternative iv, all others are reasons for companies to set up facilities in
select zones. Low cost of manpower is a country-specific factor and does not
significantly differ within and outside exclusive zones.
2. (c) Suitability of climate
Cotton yarn manufacturing units require a certain level of humidity in the
atmosphere throughout the year which is present in only certain places. This is
because cotton is affected by high humidity levels. Hence, many companies are
set up in low humidity locations.
3. (b) When expansion of the existing plant is possible
A new location is necessary under all conditions except option b. The need for
selection of facility location also arises when there is no possibility of expanding
the existing plant and the firm is compelled to search for a new location.
4. (c) iii, ii, i, iv
A firm first looks out for a location and identifies two or more possible locations.
It then selects the best location from available choices. After selecting the
location, it designs a layout. Firms can then revise or redesign the layout in the
future depending on its strategies (expansion etc,).
5. (b) In a town/city
The location of the facility affects the companys ability to serve its customers
quickly and conveniently. Rahul must set up the printing press within reach of
target markets. In this case, a town or city is an ideal location as people who wish
to publish their work live largely in cities.
6. (b) High transportation costs
If selection of a location leads to high transportation costs, it would reduce
profitability of the firm. Low labor costs, availability of public utility services and
tax holidays are factors that would encourage firms to choose a particular location.
7. (c) Close to the raw material source
Cement plants are generally located near limestone quarries. This is because raw
material required is huge and transportation cost over long distances cannot offset
the benefits accrued from other options mentioned in the question.
28
8. (b) Proximity to markets
The major markets for auto-ancillary units are auto makers like Hyundai and
Ford. Proximity to these plants enables them to service clients more effectively.
9. (d) Availability of real estate
Government provides many benefits to industries that set up operations in special
export zones. In addition to tax holidays, infrastructure support and low interest
loans from banks, etc, companies are provided land at low costs. The land
provided is not prime real estate as SEZs are located away from cities or towns.
10. (d) Historical analogy method
The historical analogy method is a forecasting method. The other options point
rating method, center of gravity method, and analytical Delphi method are
standard methods to locate the optimal location for a firm.
11. (d) CRAFT analysis
CRAFT analysis is used for developing a process layout and not for determining
plant location.
12. (c) Define location objectives identify relevant decision criteria relate
objectives to the criteria evaluate alternative locations select the best
location
Though there is no standard procedure, the following steps serve as a guideline
for location decisions. The correct sequence includes: define location objectives
and associated constraints, identify relevant decision criteria, relate objectives to
the criteria using appropriate models, do field research to relevant data and use
models to evaluate alternative locations and select the location that best satisfies
the criteria.
13. (d) Competitors
Location objectives and associated constraints are defined on the basis of the
views and requirements of promoters, owners, employees, suppliers and
customers of the firm. Competitor views are not an important factor.
14. (a) Form panels - Identify trends and opportunities - Determine directions
and strategic goals of the organization - Develop alternatives - Prioritize
alternatives
Analytic Delphi Method helps managers take complex multi-location decisions.
This method requires the participation of a coordinating panel, forecasting panel
and strategic panel. The coordinating team selects two teams from within the
organization, the forecasting and strategic panels. These two panels participate in
two Delphi inquiries. In the first, the coordinating panel uses a questionnaire to
elicit information from the forecasting panel regarding future trends, threats and
opportunities. In most cases, the process is repeated several times till consensus is
reached. In the next step, information collected through the first Delphi inquiry is
given to the strategic panel. This information is used by the strategic panel in the
second Delphi inquiry to identify the organization's direction and goals. After
strategic goals have been identified, the strategic panel develops various
alternatives. Finally, all alternatives generated in the previous step are presented
to members of the strategic panel to obtain their subjective value judgments.
15. (b) The physical distribution of various departments for ease in production
A facility layout represents the physical spread of all the equipment, machinery,
parts, etc. in a plant/facility. They are distributed so as to ensure smooth work
flow and maximum efficiency.
29
16. (b) Layout decisions have short-term consequences in terms of cost and the
companys ability to serve its customers.
All the statements are true regarding layout, except statement (b). Layout
decisions have long-term consequences in terms of cost and the companys ability
to serve its customers.
17. (a) Graphic and schematic analysis
In Graphic and schematic analysis templates, two-dimensional cutouts of
equipment drawn to scale are the most common layout-planning tools. Templates
are moved about within a scaled model of the walls and columns of a facility to
identify the best layout through trial and error. These templates are also used for
developing product and fixed-position layouts. Managers can use various models
like load distance and computer models. CRAFT is a type of computer model.
18. (a) Equipment is dedicated to the manufacture of a narrow product line
Product layout is used to produce a narrow product line and all machinery and
equipment is dedicated for this. Material handling costs are low as there is less
scope for product change over. Product layouts are extensively used to produce
standard products and not customized products.
19. (c) Fixed position layout
Fixed position layout involves movement of men, machines and equipment to the
product, which remains stationary. The product here may be bulky, large, heavy
or fragile. Layout adopted in ship building is an example of fixed position layout.
20. (c) Employee layout
Employee layout is not a type of facility layout. The various types of layouts are
process layout, product layout, hybrid layout and fixed position layout.
21. (b) Grouping technology layout
In a grouping technology layout (also called cellular manufacturing layout),
dissimilar machines are grouped into cells and each cell functions like a product
layout within a larger job shop or process layout.
22. (a) Functional layouts
Process layouts, also known as functional layouts or job-shop layouts, involve
grouping of similar equipment or functions (for instance, lathe machines in one
section, drilling machines in another section and all activities related to
assembling the product in another area, etc.).
23. (a) Process layout
Process layouts, which are also known as functional layouts or job-shop layouts,
involve grouping of similar equipment or functions (all lathe machines in one
area, all drilling machines in another area and all assembling works in some other
area).
24. (b) General purpose machines
Process layouts mostly use general purpose machines that can change rapidly to
new operations for different product designs.
25. (d) Increased utilization of men and material
In process layouts, men and machines are utilized most efficiently, owing to use
of general purpose equipment. The other options are not advantages. Production
requires more time as work-in-progress has to travel from one place to another.
This increases accumulation of work at different stages of production.
30
26. (b) Product layout
Product layouts are designed to accommodate only a few, mostly one or two,
standardized products and process designs. Process, hybrid and fixed position
layouts allow production of customized products.
27. (c) Ship-building
Ship-building is an example of fixed position layout where all the men, material
and equipment are brought to the ship that is stationary.
28. (b) CRAFT model
Except line balancing, all other options are models used in process layout
development. CRAFT model finds a layout by evaluating thousands of
alternatives quickly. CRAFT has the capacity to handle plants comprising up to
40 work centers of different shapes and sizes. It can account for mobile and
immobile process centers. The model considers various types of layouts and
different materials-handling methods that a firm can use in its work centers.
29. (c) Load distance model
The load distance model is an important model used to minimize material flow in
a layout. In this model, the number of loads (standardized amount of material)
moved between each pair of process centers over a period of time and distances
between them are considered. Line balancing is used to determine product
layouts.
30. (d) i/q, ii/r, iii/p, iv/s
CRAFT is used to analyze and evaluate thousands of alternative layouts very
quickly. Load distance model is used to reduce material movement costs in a
production plant. Line balancing is used to study workflow in an assembly line.
Graphic and schematic analysis is used to study two-dimensional scaled drawings
of equipment and machinery to arrive at the best possible layout.
31. (a) Line balancing
Line balancing is a part of the assembly line study that involves the selection of a
suitable combination of work tasks to be performed at each workstation so that
the work is performed in a feasible sequence. It ensures that each workstation gets
approximately an equal amount of time.
32. (d) iv-iii-v-i-ii
The steps required for balancing an assembly line are (a) The sequential
relationship among different tasks is specified by using a precedence diagram; (b)
The theoretical minimum number of workstations required to satisfy the cycle
time is determined; (c) A set of rules is identified to shortlist and select the tasks
to be assigned to workstations; (d) The set of rules is applied iteratively till all the
tasks are assigned; and (e) The balance is accepted if the efficiency is satisfactory,
otherwise balancing is done using a different decision rule.
The rules identified to shortlist and select the tasks to be assigned to workstations
are (a) Identification of feasible (remaining) tasks for the same station; (b)
Shortlist the tasks with most followers, among the feasible (remaining) tasks for
the same station; and (c) Select the task with the longest operation time.
34. (c) Mixed-model line balancing
Mixed-model line balancing is used to meet the demand for a variety of products.
It involves multiple lot sizes, lot sequencing, different set-up times for each lot,
differing workstation sizes along the line and task variations that make it very
difficult to design.
31
35. (b) Japan
In Japan, space availability is a major constraint as it is a very small nation in
terms of geographic area. Hence, layouts were designed to use minimal available
space. In contrast, in USA, India and China, as space is not a problem,
comparatively larger layouts are designed.
36. (b) ii-i-iii
The steps involved in the development of a cellular manufacturing layout are (a)
The parts that follow a common sequence of steps are grouped into a family; (b)
The dominant flow patterns of parts-families are identified as a basis for location
or relocation; and (c) The machines and processes are physically grouped into
cells. The machinery parts that cannot be grouped with any cell or family are
placed in a remainder cell.
The problems involved in developing a cellular manufacturing layout are:
developing and classifying a coding scheme for items of different shapes, sizes,
materials, etc.; grouping parts in families to form cell groups on the basis of
processing requirements and routings; and creating the physical layout for
positioning cells relative to each other.
38. (b) The Japanese make most use of the little space available as space is
available at a premium.
All statements are false regarding the Japanese approaches and trends in
manufacturing layouts, except statement (b).
39. (a) Layouts focusing on customer receiving and servicing
Two extremely different types of layout of service facilities exist based on
degrees of customer contact. At one extreme is the layout totally designed around
customer-receiving service functions. The other is the layout designed around
technology, processing of physical materials and production efficiency.
40. (c) Restaurants
In a restaurant, the service layout has to cater to activities of receiving and
servicing customers (customer focus) as well as processing and preparation of
food items (process layout).
41. (d) In service facility layouts such as restaurants, attention is directed only at
the customer receiving and servicing function, and not at the processing and
preparation of food function.
All the statements are true regarding a service facility layout, except statement
(d). In a restaurant, attention is directed both at customer receiving and servicing
as well as on processing and preparation of food. In these layouts, the internal
work of the employees is given secondary importance.
A. Delhi
Total costs = total variable cost + fixed cost
Chandigarh = (300 x 1000) + 400000 = 700000
Gurgaon = (285 x 1000) + 450000 = 735000
Delhi = (275 x 1000) + 500000 = 775000
Delhi would have the highest total cost per year if annual output of a firm located
there is 1000 units.
32
B. Chandigarh
Total revenue when annual ouput is 1000 units = 1000 x 1000 = Rs.10,00,000
Profit = Total revenue Total costs
Profit at Chandigarh = 1000000 700000 = 300000
Profit at Gurgaon = 1000000 735000 = 265000
Profit at Gurgaon = 1000000 775000 = 225000
Chandigarh would have the highest annual profit if annual production is 1000
units and selling price per unit is Rs.1000.
C. Chandigarh
Though variable costs are higher, annual profits are highest at Chandigarh.
Hence, in terms of profit, it is a better choice over Delhi and Gurgaon.
D. 8.11, 10.06
The coordinates of the center of gravity can be identified by
i
i i
c
V
V X
X
i
i i
c
V
V Y
Y
Where,
X
c
= X coordinate of the center of gravity, Y
c
= Y coordinate of the center of
gravity, V
i
= Volume of items transported to and from location i, X
i
= X
coordinate of location i, Yi= Y coordinate of the location i
Distribution
Center
X Y Volume
(V
i
)
V
i
X
i
V
i
Y
i
A 4 4 60 240 240
B 12 6 90 1080 540
C 10 14 110 1100 1540
D 5 13 100 500 1300
Total
360 V
i
2920 X V
i i
3620 Y V
i i
Substituting these values in the equation for
Volume-weighted X coordinate = X
c
=
i
i i
V
V X
X
c
= 2920/360 = 8.11
Volume-weighted Y coordinate = Y
c
=
i
i i
V
Y V
Y
c
= 3620/360 = 10.06
The X and Y coordinates of the point of center of gravity are 8.11 and 10.06.
Unit 21
Aggregate Planning and Capacity Planning
Structure
1. Introduction
2. Objectives
3. Overview of Planning Activities
4. The Aggregate Planning Process
5. Strategies for Developing Aggregate Plans
6. Aggregate Planning Techniques
7. Master Production Schedule
8. Implementing Aggregate Plans and Master Schedules
9. Capacity Planning
10. Summary
11. Glossary
1. Introduction
In the last section of the previous unit, we have discussed service facility layouts. We
have learnt that in case of designing service layouts, there exist two types based on the
degree of customer contact, one, which is designed around the customer service and
the other around the technology. In this unit, we will discuss aggregate planning and
capacity planning.
To satisfy market demand for their products, organizations need to estimate resource
requirements. This is quite easy for organizations that have a single product in their
product portfolio. For organizations that have multiple products, an aggregate output
measured in common terms is worked out by grouping individual products or product
types together. The aggregate plan defines the best combination of workforce level,
inventory on hand, and production rate that will match the companys resources with
market demand. Managers can convert aggregate plans into detailed master
production schedules by dividing operations. Targets in the plan can be met through
sufficient capacity, determined by capacity planning that ensures that there are no
inconsistencies between capacity demanded and capacity required. In this unit, we
shall discuss the strategies and approaches to aggregate planning, capacity planning,
and master production scheduling.
This unit will give you an overview of planning activities, and discuss the aggregate
planning process. We will discuss the strategies for developing aggregate plans, and
then study the aggregate planning techniques. We shall then move on to discuss the
master production schedule, and how to implement aggregate plans and master
schedules. Finally, we would discuss the concept of capacity planning.
34
2. Objectives
identify the different aspects of planning activities.
explain the aggregate planning process.
assess the strategies for developing aggregate plans.
define aggregate planning techniques.
discuss the master production schedule.
determine the process of implementing aggregate plans and master schedules.
define capacity planning.
3. Overview of Planning Activities
Operations planning activities can be long-range, medium-range, or short-range in
nature, Long-range planning focuses on a time period of more than one year. Process
planning and strategic capacity planning are examples of long-range planning.
Medium-range planning focuses on a time period of 6-18 months. Aggregate
planning, master production scheduling, and materials requirement planning are
examples of medium-range planning. Short-range planning focuses on a time period
of less than 6 months. Order and workforce scheduling are examples of such planning.
3.1. Business Planning
The business planning process coordinates the activities of each function or
department such that all the activities and resources are focused on achieving the
organizations objectives. This process is used to address concerns like new product
development, sales levels to be achieved, new process requirements, capital
investments, and new distribution strategies. Decisions regarding these issues are
taken with the help of medium-term and long-term plans and are evaluated on the
basis of their impact on the profitability of a business. This type of business planning
generally involves a committee consisting of various department heads so that all the
medium-term plans are focused on achieving the goals established by the long-term
business plans of the organization.
Long-term business planning is done on the basis of long-term business forecasts.
Planning decisions include setting capital budgets for acquiring new facilities,
expanding plant capacity, and purchasing high cost equipment. These forecasts may
not be too accurate as economic and competitive conditions could change in the
future. Long-term decisions limit the scope for change during the intervening time
period by acting as constraints. Therefore, long-term decisions must be periodically
evaluated for their effectiveness and suitability for achieving organizational goals.
3.2. Operations Planning
An operations or production plan is a part of the business plan that defines how an
organization plans to produce products or services and estimates the cost of
production. It contains information regarding the production process, manufacturing
facilities, inventory requirements, suppliers, etc. This plan is made on the basis of
sales estimates. These plans have to be aligned with business plans and the objectives
of marketing, finance, human resources functions, etc.
4. The Aggregate Planning Process
The aggregate planning process is complex due to the number of variables that must
be considered in the planning process. Following are the basic considerations for
developing an aggregate production plan:
35
a) Concept of Aggregation In this stage, a meaningful measure of output is
identified. This is easy for organizations with a single product but difficult for
those producing several products. For example, tons of sugar produced can be
used as the capacity of a sugar factory while number of patients visited would be
a sound measure for a service organization like a hospital.
b) Aggregation Planning Goals An aggregate plan has to simultaneously satisfy a
number of goals. Aggregate planning should contain information on the required
output level to be produced, inventory levels to be maintained, and the backlogs,
based on the business plan.
c) Forecasts of Aggregate Demand Aggregate planning can deliver better results
through accurate forecasting.
d) Inter-relationships among Decisions All activities in an organization are
interrelated and dependent on each other. Operations managers must therefore
consider the consequences of current decisions for the future.
Check Your Progress
1. Operations planning activities can be long-range, medium-range or short-range.
Aggregate planning typically fall under which category?
a. Long range
b. Medium range
c. Short range
d. Both a & b
2. A production plan does not contain information about which of the following?
a. Production process
b. Inventory requirements
c. Suppliers
d. Customers
3. Operations planning activities can be long-range, medium range or short range in
nature. Process planning typically falls under which category?
a. Long-range planning
b. Medium-range planning
c. Short-range planning
d. Both b & c
5. Strategies for Developing Aggregate Plans
An aggregate plan is developed taking into consideration the different variables which
influence the production plan. These variables are used in different combinations to
enable an organization to satisfy market demands.
Pure Planning Strategies
The production uncertainties and demand fluctuations can be managed effectively by
varying the size and utilization of the workforce, and the size of inventory, through
back orders and subcontracts, and by varying plant capacity. The strategy is called a
pure strategy if only one of these strategies is adopted. However, a combination of
these strategies is generally used instead of the focus being on a single strategy.
Following are some of the pure planning strategies:
36
Varying the workforce size in response to the output requirements
In this strategy, the workforce size is changed by hiring and laying off workers in
direct proportion to demand. Based on the productivity of the average worker, the
management determines the number of workers required to meet each months output
requirements. When the quantity to be produced is less, the workers are laid off and
when there is an increase in orders, workers are hired.
Example: In a textile firm, a worker is capable of customizing three garments per
day. Hiring costs are Rs. 4000, lay-off costs are Rs. 5000, and current employee
strength is 30. Based on the information given in the table pertaining to aggregate
demand, generate a production plan by following the varying workforce strategy.
Assume that the time taken for each garment is the same.
April May June August
Demand 2800 2500 2100 2400
Working Days 24 25 23 24
Solution: At the beginning of the production plan, the workforce level is 30. To
satisfy the demand in April, the organization needs 38 workers. So it hires 8 new
workers. Refer to Table 7.1 for the production plan with varying workforce levels.
Number of units produced by each worker in April with 24 working days = 24 3 = 72
Total output of 30 workers = 72 30 = 2160
Demand for April = 2800. Therefore, the deficit is 640 units (2800-2160).
To meet the demand of 2800, the organization needs 8 more workers (2160 is the
demand met by 30 workers, how many workers are required to meet the demand for
640 units?).
Cost of hiring in April = 8 4000 = Rs. 32000. Similarly, we can calculate the hiring
and laying off cost for other months based on number of workers required to satisfy
the demand.
Table 7.1: Production Plan with Varying Workforce Level
April May June July
Working
days
24 25 23 24
Units per
month/
workers
72 75 69 72
Workers
available
30 38 33 30
Demand 2800 2500 2100 2400
Total output 72 30 = 2160 75 38 = 2850 69 33 = 2277 72 30 = 2160
Deficit 640 - - 240
Surplus - 350 177
Number of
additional
workers
needed
(approx)
8 - - 3
37
April May June July
Hiring costs 32000 0 0 12000
Number of
workers to be
laid off
(approx)
- 5 3 -
Lay-off costs 0 25000 15000 0
Total number
of workers
38 33 30 33
Total Costs
(hire/lay-off)
32000 25000 15000 12000
Varying the Utilization of the Workforce
In this strategy, the firm maintains a stable workforce and alters their utilization in line
with the demand or required output. If the demand is lean, the workforce is scheduled
to produce only the output that will meet the demand. This results in idle work hours.
If the demand is high, the same workforce works overtime to meet the demand.
Varying the Size of inventory
In this strategy, an organization maintains a constant workforce level and production.
If the demand is low, the stable rate of production results in accumulation of
inventories. If the demand is more than the capacity, the additional requirement is met
by using the already accumulated inventories.
Example: The following table gives the aggregate demand for product X for the next
four months:
August September October November
Demand 9000 8600 11000 9200
Activity: In a two-wheeler assembling firm, a worker is capable of assembling 5
two-wheelers per day. Assume that the time taken for each vehicle is the same.
Given:
Hiring costs = Rs. 5000
Layoff costs = Rs. 6000
Current employee strength = 50
Aggregate demand for the next four months is given in the following table:
Demand 4900 4170 3000 3660
Based on the given information, generate a production plan by following the
varying workforce strategy.
Contd
38
Contd
Answer:
The opening stock of inventory is 800 units, inventory holding cost is Rs. 30/unit,
worker productivity is 20 units per day, worker strength is 20, and shortage cost (due
to lost sales) is Rs. 20 per unit. Generate a production plan with varying inventory
levels.
Solution: The workforce is kept constant in aggregate planning with a varying
inventory level. Refer to Table 7.2 for the aggregate production plan with varying
inventory levels.
Actual production in a month = (Number of working days) (Number of workers)
(Worker productivity in units/day)
Closing inventory = Beginning inventory + Actual production Demand forecast
Shortage cost (due to lost sales) = (Units short) (Per unit shortage costs)
Inventory carrying costs = (Excess inventory) (Per unit inventory holding costs)
Excess inventory in one month is taken as the beginning inventory for the next month.
Table 7.2: Production Plan with Varying Inventory Levels
Opening stock of
inventory
800 600 1600 0
Working days 22 24 23 24
Actual Production 8800 9600 9200 9600
Demand Forecast 9000 8600 11000 9200
Shortage in Supply
(Unmet Demand)
0 0 200 0
Shortage Cost (due to lost
sales)
0 0 4000 0
Safety Stock 0 0 0 0
Closing Inventory 600 1600 -200 400
Inventory carrying costs 18000 48000 0 12000
39
Activity: Aggregate demand for product A for four months is given in the
following table:
April May June August
Demand 6200 5000 6500 5800
Given:
Opening stock of inventory = 900 units
Inventory holding cost = Rs. 60/unit
Worker productivity = 25 units/day
Worker strength = 20
Shortage cost (due to lost sales) = Rs. 40/unit
Based on the above information, generate a production plan with varying inventory
levels.
Answer:
Back Orders, Subcontracting and Plant Capacity
The back order strategy is used to maintain smooth operations. In this strategy, current
order commitments are fulfilled in the future assuming that customers are ready to
wait for delivery. Though it effectively smoothens out production, it may sometimes
result in stock-out costs when customers do not wait till the product is delivered and
switch to a competitors product. The subcontracting strategy allows level production
and sources the additional output required from subcontractors. The adjusting plant
capacity strategy allows changing the equipment capacity during the short term and
the long term to absorb demand fluctuations.
Check Your Progress
4. Which of the following is not a pure planning strategy used for developing
aggregate plans?
a. Varying utilization of the workforce
b. Varying workforce size in response to output requirements
c. Varying size of inventory
d. Varying the compensation method
5. Which of the following is not a pure planning strategy used as part of aggregate
planning?
a. Back-order strategy
b. Maintaining fixed plant capacity
c. Sub-contracting
d. Varying workforce utilization
40
Exercises
(Questions A to D)
The aggregate demand for product X for the next four months is given in the
following table:
Jun Jul Aug Sept
Demand 2600 2700 2800 2750
In addition, the following information is given:
Opening stock of inventory = 500 units, Inventory holding cost = Rs.20/unit/month,
Worker productivity = 4 units/day, Worker strength = 25, Shortage cost (due to lost
sales) = Rs.10/unit
Answer the following four questions based on the above given information
A. What is the change in inventory on hand after meeting demand for Product X for
the month of June?
B. Assume that opening stock for the month of July is 500 units. What is the
inventory carrying cost for that month?
C. Calculate the closing inventory for August.
D. What is the shortage cost (due to lost sales) in the month of September if the
opening inventory for the month is zero units?
6. Aggregate Planning Techniques
Aggregate planning models like the graphical, optimal, and heuristic models help
planners formulate the aggregate output plan.
6.1. Graphical Method for Aggregate Output Planning
The graphical method is a two-dimensional model linking cumulative demand to
cumulative output capacity. Following are the steps involved:
a) A graph is drawn by taking the cumulative productive days for the planning time
period on the X or horizontal axis, and cumulative units of output on the Y or
vertical axis. The cumulative demand forecast for the entire planning time period
is plotted on the graph.
b) A planning strategy is selected based on the aggregate planning goals. Planned
output for each period in the planning period is computed and plotted on the same
axis used to plot the demand.
c) The planned output is compared with expected demand and periods of excess
inventory and shortages are identified.
d) The costs involved in the implementation of the plan are calculated.
e) The plan is modified to meet aggregate planning goals by repeating steps (b) to
(d) until a satisfactory plan has been established.
This method is simple to understand and requires minimal computational effort.
41
6.2. Optimal Models for Aggregate Planning
The optimal models are discussed below:
Linear programming The linear programming model is an optimal model used to
formulate aggregate plans. The linear programming procedure identifies the optimal
plan for minimizing costs that specifies the number of units to be produced, the total
number of shifts for which the plan should operate in the planning time horizon, and
the amount of inventory that has to be carried in each time period.
Linear decision rules (LDRs) LDRs are a set of equations for calculating the
optimal workforce, aggregate output rate, and inventory level for each period in the
planning period. This method guarantees an optimal solution and eliminates trial-and-
error computations. It also overcomes the limitation of linear programming by
considering non-linear cost relationships.
Heuristic models Heuristic models are based on the historical aggregate planning
data available with organizations. The management coefficient model is a heuristic
model which uses the regression method to identify capacity requirements based on
the managements past decisions. The management coefficient model is used to
generate a set of equations that represents the historical patterns of a companys
aggregate planning decisions. Heuristic models are easy to construct if the relevant
historical data is available. But they should be applied after careful consideration, as
past pattern may not always be an accurate indicator of future trends.
Computer Search Models
These models are used when an organization has a large quantity of information on
different production variables. A computer program simulates conditions under all
possible combinations of these variables and identifies the most cost-effective one that
satisfies the production requirements.
Computer Simulation in Capacity Evaluation Computer simulation is used for
evaluating the performance of a specific plan based on real-world variables and
situations.
Check Your Progress
6. Which of the following is not an aggregate planning technique?
a. Time series analysis
b. Graphical method
d. Heuristic methods
7. Which model is based on historical aggregate planning data available with an
organization?
a. Heuristic approach
b. Computer search
c. Linear decision rules
d. Linear programming
8. What is the basic use of the computer simulation method, a type of optimal model
used in aggregate planning?
a. To develop a master production schedule
b. To identify variables for developing the plan
c. To evaluate the performance of a specific plan
d. All of the above
42
A Master Production Schedule (MPS) is a detailed plan that states the exact timing for
the production of each unit and is also used in scheduling various stages of
production, depending on the type of operations. It defines the type and volume of
each product that is to be produced within the planning horizon. Following are the
functions of an MPS:
Translate aggregate plans: A master schedule is a manufacturing plan, which breaks
up the firms planned total production into groups of products or product lots.
Evaluate alternative schedules: To evaluate alternative schedules, planners use
computerized production and inventory control systems with simulation capabilities.
Identify material requirement: The master schedule when drawn up, alerts the
materials requirement planning system to produce or purchase the components that are
needed to meet the requirements of the final assembly schedules.
Generate capacity requirements: The master schedule reflects the most economical
usage of labor and equipment capacities.
Effectively utilize capacity: The MPS assigns loads for labor and equipment based on
the requirements.
7.1. Master Production Scheduling
The master production scheduling process involves planning activities of Material
Requirements Planning (MRP) and Capacity Requirements Planning (CRP) to
determine whether or not an operation can achieve the production objectives
mentioned in the MPS. Following are the steps involved in the process:
Determining the gross requirements of materials, components, and sub-
components (total demand in units of the end-product) for each product in the
product line, using MRP.
Obtaining the net requirements for each unit of materials, components, and sub-
components, after considering inventory on hand and inventory on order.
Revising the preliminary MPS to accommodate the inadequacy of materials in
inventory, if any.
Converting adjusted net requirements into planned order releases (the order
quantity for a specific time period) to determine unit or lot-sized production
during the planning horizon.
Developing load reports from the planned order releases.
The MPS is modified or capacity is added in case of a mismatch between
available and required capacities.
Master production scheduling is generally based on the demand forecast results. These
results are not always accurate and the actual production output is not always similar
to the actual market demand.
7.2. Master Schedule Formation
The MPS is based on an estimation of overall demand for the end product. A final
assembly schedule is developed only when customer orders are received. It has to be
properly implemented for achieving the goals set in aggregate plans. Both the
aggregate plan and the MPS are influenced by the market environment and resource
availability. Forecasts and customer orders influence the MPS.
43
Make-to-stock items Demand forecast is the major input for these items in the
MPS. Requirements are based on the need to replenish plant or distributor inventories
of end products or service parts. The MPS is generated after considering the end item
level.
Make-to-order items Detailed scheduling of time and materials required is
essential for these items as the items and quantities specified are unique for a
particular customer order. In this environment, there is no finished goods inventory,
customer orders are backlogged, and production begins only after the orders have
been placed. For e.g., jet engines. Thus, back orders are common for such items.
Example: Forecasted demand for telephone handsets for the next six weeks is 40, 35,
48, 42, 42, and 40. The number of orders booked at the start of the MPS planning
period is 33, 40, 34, 32, 48, and 32. Inventory on hand is 50, lead time is 1 week,
production lot size is 90 units, and quantity on hand is 50. Prepare an MPS schedule
for the telephone set manufacturer.
Solution: Refer Table 7.3 for the MPS for six weeks.
a) First Week
Forecast for the first week is 40 units. This requirement can be satisfied by using on
hand inventory.
Projected inventory on hand at the end of first week = On hand inventory + MPS
quantity Projected requirements for the week = 50 + 0 40 = 10 units
b) Second Week
Forecast for the second week is 35 units but the orders received are for 40 units.
Inventory on hand at the end of the first week is 10 units, which is not sufficient to
satisfy the second weeks requirements. So to make up for the deficiency, the
organization schedules the MPS quantities. As the lead time is one week, the
production should commence in the first week itself to satisfy the requirements of the
second week. From Table 7.3, it is seen that the MPS start quantity for the first week
is 90 units (production lot size).
Projected inventory on hand at the end of second week = On hand inventory + MPS
quantity - Projected requirements for the week = 10 + 90 40 = 60 units
Similarly, projected inventory at the end of each week and MPS quantities can be
calculated.
Table 7.3: MPS for Six Weeks
1 2 3 4 5 6
Forecast 40 35 48 42 42 40
Orders 33 40 34 32 48 32
Projected on hand inventory 10 60 12 60 12 62
MPS quantity 0 90 0 90 0 90
MPS start 90 - 90 - 90 -
Activity: The forecasted demand for mobile handsets for the next six weeks is 50,
55, 58, 52, 52, and 50. And the number of orders booked at the start of the MPS
planning period is 43, 40, 44, 42, 48, and 42. Prepare an MPS schedule for the
mobile handset manufacturer.
Contd
44
Contd
Given,
Inventory on hand = 60
Lead time = 1 week
Production lot size = 80 units
Quantity on hand = 60
Answer:
Check Your Progress
9. __________ translates the aggregate plan into a detailed plan that specifies the
exact timing for production of each unit.
a. Master production schedule
b. Total production schedule
c. Primary production schedule
d. Alternative production schedule
10. A Master Production Schedule (MPS) is based on which of the following?
a. Amount of inventory needed for the end product
b. Estimation of overall demand for the end product
c. Confirmed customer orders for the end product
d. All of the above
11. The two major sources of inputs that influence master production schedule are
forecasts and customer orders. Identify the correct combination from the
following.
i. Make-to-stock environment: Takes inputs from forecasts in deciding the MPS
ii. Make-to-order environment: Takes inputs from customer demand in deciding the
MPS
iii. Make-to-stock environment: Takes inputs from customer demand in deciding the
MPS
iv. Make-to-order environment: Takes inputs from forecasts in deciding the MPS
a. Only iii
b. Only i
c. Both iii & iv
d. Both i & ii
45
12. Identify the false statement from the following about Master Production Schedule
and Master Schedule Formation.
a. MPS of make-to-order organizations deals only with final products.
b. MPS for assemble-to-order organizations concentrates on scheduling major
components assembled to make a product after orders are received.
c. Back orders are common in make-to-stock organizations.
d. There is no finished goods inventory in make-to-order production.
Exercises
(Questions E & F)
The demand forecast for metal rollers used in manufacturing printing machines for the
next three months is 60, 55, 65. The number of orders booked at the start of the MPS
planning period is 55, 60, 65 respectively. Given, Inventory on hand = 75, Lead time
= 1 month, Production lot size = 100 units. Answer the following two questions.
E. What is the projected inventory at the end of the second month?
F. What would be the projected inventory at the end of the third month if orders for
the month increase to 80 from 65?
8. Implementing Aggregate Plans and Master Schedules
Unplanned Events The effects of unplanned events are contained by continuously
updating the aggregate plans. Due to unexpected events, the actual demand for a
product would significantly differ from the forecasted demand. While developing
aggregate plans, unexpected events which disrupt the plans like not achieving the
planned output for the month or the workforce not being able to produce at its average
capacity should be considered. In such case, the actual demand is taken as the input
rather than the forecasted demand.
Behavioral Considerations These are vital for planning and implementing
aggregate plans. Intricacies in planning are dependent on the time horizon. A plan
which is short term and based on judgment and experience would be costly while a
drawing up a long-term plan would be a difficult task. Therefore, an optimal time
period should be selected for aggregate planning. The implementation of an aggregate
plan has an impact on all the functions and departments of an organization.
Capacity is the maximum output that can be produced in a given system. If a factory
has a production capacity of 100 units per hour, it means that it can produce 100 units
per hour under optimal conditions. It most cases it is not possible to have 100%
capacity utilization. Capacity is measured in terms of output, such as units per unit of
time (10 units/hour) or available resource hours (5 machine hours/day). Capacity
planning involves identification and evaluation of the long term and short-term
capacity requirements of an organization, and development of plans to fulfill them. It
involves determining adequate production capacity to meet forecast demand levels
and determining whether or not sub-contracting and/or overtime has to be used.
Overestimation or underestimation of capacity requirements has an adverse impact on
an organizations performance. For an effective capacity plan, an organization has to
first identify current capacity and forecast the future requirements of the capacity;
then identify and evaluate the sources which can be used to meet the capacity
requirements; and finally select the most proper alternative.
46
Measuring Capacity
Capacity of a manufacturing plant is usually measured in terms of input or output of
the plant. For instance, the capacity of a cement plant can be measured in terms of
millions metric tons of cement produced per annum. In contrast, the capacity of milk
processing plant is measured in terms of litres of milk that can be processed per day.
In service organizations like hospitals, the capacity can be measured in terms of
number of beds available, or number of tables available in a restaurant, etc. Capacity
can be measured by using the formula:
Capacity = Available time x utilization x efficiency
Capacity utilization rate is a measure that indicates the capacity level at the production
process is operating.
Hence, 100
avaialable Capacity
used Capacity
rate n utilizatio Capacity
where, capacity available indicates the designed capacity.
The steps for determining capacity requirements are as follows:
1. Employ forecasting methods and find the individual product demand within the
planning horizon.
2. Identify the equipment and human resource requirements to meet the forecasted
demand. In case of multiple products or services, identify the time required for
switching from one product or service to another.
3. Compare capacity required with available capacity for the required time period
and identify the gaps.
4. As determining exact capacity requirements is difficult, organizations in general
allocate extra capacity to meet any contingencies in the future. The extra capacity
allocated for uncertain future requirements is known as the capacity cushion.
Economies of Scale
As the quantity of output increases, the average cost per unit decreases. This is termed
as economies of scale. That is the per unit cost decreases with the increase in the scale
of production. This happens due to reduction in fixed costs, adoption of efficient
processes and automation technologies. But, as the scale of production is further
expanded beyond a point, the cost per unit takes the reverse direction and would
increase gradually. This reverse phenomenon is termed as diseconomies of scale. This
can be attributed to complexities in operations, high costs of modification, need to
replace existing facilities, and increased distribution and storage costs.
Check Your Progress
13. Identify the correct sequence of steps associated with capacity planning.
i. Identify current capacity
ii. Forecast future capacity
iii. Identify and evaluate sources to meet capacity requirements
iv. Select the most appropriate alternative
a. i, ii, iii, iv
b. i, iii, ii, iv
c. iii, i, ii, iv
d. iii, ii, i, iv
47
14. When the scale of production is increased after a certain point, economies of scale
can become diseconomies of scale. What can be the possible reasons for
diseconomies of scale?
a. Complexities in operations
b. High cost of modification & replacement
c. Distribution and storage costs
d. All of the above
15. The capacity utilization rate measures capacity level at which a production
process is operating. Identify the correct formula for capacity utilization rate.
a. Capacity utilization rate = 100
used Capacity
available Capacity
b. Capacity utilization rate = 100
available Capacity
used Capacity
c. Capacity utilization rate = 100
available Capacity
n Utilizatio time Available
d. Capacity utilization rate = 100
n Utilizatio time Available
available Capacity
16. Which of the following cannot be a reason for decrease in per unit cost when
volume of production increases?
a. Decrease in fixed costs
b. Adoption of efficient processes
c. Adoption of automation
d. Increased complexity in operations
17. It is important to determine adequate production capacity to meet forecast
demand levels and to determine whether or not sub-contracting and/or overtime
has to be used. This activity is associated with which of the following?
a. Capacity planning
b. Aggregate planning
c. Scheduling
d. Demand forecasting
10. Summary
An aggregate plan defines a companys production rates, workforce levels, and
inventory position with respect to market demand and available capacity.
Aggregate planning balances market demand and the production rate of the
organization.
Proper implementation of the aggregate plan enables an organization to use all its
available resources to the fullest extent without overloading the production system.
The success of an organization is to a large extent dependent on the way potentially
productive resources such as equipment and people are utilized over a period of time.
Aggregate plans can be developed using the graphical method, linear programming,
linear decision rules (LDRs), and heuristic models and the computer search method.
48
The master production scheduling process disaggregates the aggregate plans into
individual products.
Capacity planning is an important aspect of aggregate planning. Capacity defines the
maximum output possible from a system or a process.
Capacity is measured as the product of available time, efficiency and utilization.
As the production output increases, the unit cost decreases which is known as
economies of scale. A further increase of output beyond a certain point makes the unit
cost of the product to increase again and this is termed as diseconomies of scale.
11. Glossary
Aggregate planning models: These models such as the graphical, optimal, and
heuristic models help planners formulate the aggregate output plan.
Back order strategy: In this strategy, current order commitments are fulfilled in the
future assuming that customers are ready to wait for delivery. Though it effectively
smoothens out production, it may sometimes result in stock-out costs when customers
do not wait till the product is delivered and switch to a competitors product.
Capacity planning: It involves identification and evaluation of the long term and
short-term capacity requirements of an organization, and development of plans to
fulfill them. It involves determining adequate production capacity to meet forecast
demand levels and determining whether or not sub-contracting and/or overtime has to
be used.
Capacity: Maximum output that can be produced in a given system. It is measured in
terms of output, such as units per unit of time (10 units/hour) or available resource
hours (5 machine hours/day).
Computer search models: These models are used when an organization has a large
quantity of information on different production variables. A computer program
simulates conditions under all possible combinations of these variables and identifies
the most cost-effective one that satisfies the production requirements.
Computer simulation: It is used for evaluating the performance of a specific plan
based on real-world variables and situations.
Graphical method for aggregate output planning: It is a two-dimensional model
linking cumulative demand to cumulative output capacity.
Heuristic models: These are based on the historical aggregate planning data available
with organizations.
Linear decision rules: These are a set of equations for calculating the optimal
workforce, aggregate output rate, and inventory level for each period in the planning
period.
Linear programming: It is an optimal model used to formulate aggregate plans. It
identifies the optimal plan for minimizing costs that specifies the number of units to
be produced, the total number of shifts for which the plan should operate in the
planning time horizon, and the amount of inventory that has to be carried in each time
period.
Long-range planning: It focuses on a time period of more than one year. Process
planning and strategic capacity planning are examples of long-range planning.
Master production schedule: It is a detailed plan that states the exact timing for the
production of each unit and is also used in scheduling various stages of production,
depending on the type of operations. It defines the type and volume of each product
that is to be produced within the planning horizon.
49
Medium-range planning: It focuses on a time period of 6-18 months. Aggregate
planning, master production scheduling, and materials requirement planning are
examples of medium-range planning.
Operations plan (or production plan): A part of the business plan that defines how
an organization plans to produce products or services and estimates the cost of
production. It contains information regarding the production process, manufacturing
facilities, inventory requirements, suppliers, etc.
Pure planning strategies: The production uncertainties and demand fluctuations can
be managed effectively by varying the size and utilization of the workforce, and the
size of inventory, through back orders and subcontracts, and by varying plant
capacity. The strategy is called a pure strategy if only one of these strategies is
adopted.
Short-range planning: It focuses on a time period of less than 6 months. Order and
workforce scheduling are examples of such planning.
Subcontracting strategy: It allows level production and sources the additional output
required form subcontracts.
1. Planning acts as a basis on which organizations can plan their future course of
action. Give an overview of planning activities.
2. The aggregate planning process is complex due to the number of variables that
must be considered in the planning process. Explain the aggregate planning
process in detail.
3. An aggregate plan is developed after considering the different variables which
influence the production plan. What are the different strategies used for
developing aggregate plans?
4. Aggregate planning models help planners formulate the aggregate output plan.
Explain the various techniques used for aggregate planning.
5. A Master Production Schedule (MPS) is a detailed plan that states the exact
timing for the production of each unit and is also used in scheduling various
stages of production, depending on the type of operations. Explain in detail. Also
explain the functions of MPS.
6. The master production scheduling process involves the planning activities of
MRP and CRP to determine whether or not an operation can achieve the
production objectives mentioned in the MPS. Explain the various steps involved
in the master production scheduling process. How can an organization prepare
master schedules?
Implementation of aggregate plans and master schedules.
Capacity planning is vital for determining adequate production capacity to
meet forecast demand levels.
Economies and diseconomies of scale.
50
Concepts, Models and Behavior. Fifth Edition. New Delhi: Prentice-Hall of India
Private Limited, 1996.
6. Aggregate Planning
<http://www.uoguelph.ca/~dsparlin/aggregat.htm>
7. Aggregate Planning
<http://www.referenceforbusiness.com/management/A-Bud/Aggregate-
Planning.html>
<http://people.brunel.ac.uk/~mastjjb/jeb/or/masprod.html>
9. Master Scheduling
<http://www.mcts.com/Master-Scheduling.html>
<http://www.snc.edu/socsci/chair/333/percent.htm>
<http://www.uoguelph.ca/~dsparlin/capacity.htm>
12. Capacity Management
<http://www.smthacker.co.uk/capacity_management.htm>
1. (b) Medium range
Medium-range planning focuses on a period of six to 18 months. Examples of
medium range planning are aggregate planning, master production scheduling and
materials requirement planning.
2. (d) Customers
A production plan contains information about the production process,
manufacturing facilities, inventory requirements, suppliers, etc. Such a plan is
usually made based on sales estimates.
3. (a) Long range planning
Long-range planning focuses on a period of over one year and is generally
carried out annually. Process planning and strategic capacity planning are
examples of long-range planning. Medium-range planning focuses on a period of
six to 18 months. Examples of medium range planning are aggregate planning,
master production scheduling and materials requirement planning. Short-range
planning focuses on a period less than six months. Order and workforce
scheduling are examples of such planning.
4. (d) Varying the compensation method
Strategies for aggregate planning include varying utilization of the workforce,
varying workforce size in response to output requirements, varying size of
inventory, back orders, sub-contracting and plant capacity. Varying the
compensation method is part of human resource management function.
51
5. (b) Maintaining fixed plant capacity
Varying workforce utilization is a strategy where the firm maintains a stable
workforce and varies workforce utilization in accordance with demand or
required output. Other pure planning strategies are back-orders, sub-contracting
and varying plant capacity. Adjusting or varying plant capacity by changing
equipment capacity over short-term or long-term is a pure strategy to absorb
demand fluctuations.
6. (a) Time series analysis
Time series analysis is not an aggregate planning technique. It is associated with
forecasting.
7. (a) Heuristic approach
Heuristic models are based on historical aggregate planning data available with
organizations.
8. (c) To evaluate the performance of a specific plan
Computer simulation is used to evaluate the performance of a specific plan,
based on real-world variables and situations. Simulation provides what-if
analysis of different situations, using different variables with alternative values
attached, to judge the system performance under different conditions.
9. (a) Master production schedule
Master production schedule translates the aggregate plan into production
schedules. The Master Production Schedule (MPS) defines the type and volume
of each product to be produced within the planning horizon. The MPS is a
detailed plan that specifies the exact timing for production of each unit.
10. (b) Estimation of overall demand for the end product
MPS is based on an estimation of overall demand for the end product. A final
assembly schedule is developed only when customer orders are received.
11. (d) Both i & ii
The two major sources of inputs that influence the MPS are forecasts and
customer orders. Make-to-stock environment takes inputs from forecasts in
deciding the MPS. On the other hand, make-to-order environment takes inputs
from customer demand and generates an MPS based on that.
12. (c) Back orders are common in make-to-stock organizations
Back orders are common in make-to-order (not make-to-stock) organizations.
This is because actual production does not begin until customer orders are
placed.
13. (a) i, ii, iii, iv
The correct sequence of activities in a capacity plan is to identify current
capacity, forecast future capacity, identify and evaluate sources to meet capacity
requirements and select the most appropriate alternative.
All the stated options can be reasons for diseconomies of scale. Complexities in
operations can lead to high cost due to production bottlenecks. When
modifications in machinery or replacements take place frequently, it may prove
costly. Further, when scale of production increases, distribution and storage costs
also increase.
52
15. (b) Capital utilization rate = 100
available Capacity
used Capacity
Capacity utilization rate measures the rate at which available capacity is used in
production. It is obtained by dividing used capacity by available capacity. To
measure in terms of percentage, multiply the obtained value with 100.
16. (d) Increased complexity in operations
The complexity in operations can lead to diseconomies of scale or increase in per
unit cost. Efficient processes decrease fixed costs, while automation reduces per
unit cost considerably.
17. (a) Capacity planning
Capacity planning is important to determine adequate production capacity to
meet forecast demand levels. Capacity planning is also used by organizations
when deciding on issues like whether or not to use sub-contracting or overtime to
achieve production goals.
A. 0 units
25 workers in 26 days can produce 2600 units. This is exactly equal to the
demand for the month of June, as given in the table. Hence, existing inventory
will remain untouched as there is no necessity to use it to meet demand. The
available inventory at the end of June is the same i.e. 500 units.
B. Rs.6000
In July, 25 people working for 25 days with a daily output of 4 units can produce
2500 units for the month. As the demand is 2700 units, the additional 200 units
are taken from the inventory on hand of 500 units. Hence, the inventory left is
300 units. Thus, inventory carrying cost will be Rs. 20 x 300 units = Rs.6000.
C. 0 units
In August, 25 people working for 25 days with daily output of 4 units can
produce 2500 units for the month. As demand is 2800 units, additional 300 units
are taken from the inventory. Hence, there will be no inventory available.
D. Rs.1500
In September, 25 people working for 26 days with a daily output of 4 units can
produce 2600 units for the month. As the demand is 2750 units, there is shortage
in supply of 150 units. Thus, the shortage cost in September will be 150 units x
Rs. 10 = Rs.1500.
E. 55 units
In the first month, demand is 60 units, which can be met from inventory on hand.
Hence, at the end of the first month inventory available = inventory on hand +
MPS quantity projected requirements for the month. That is = 75 + 0 - 60 = 15.
For the second month, customer orders are 60 and inventory on hand is 15. There
is a deficit of 45. To meet demand for the second month, production has to start in
the first month as production lot size = 100 units. Then, inventory at the end of
the second month = 15 + 100 - 60 = 55 units. (See the following table)
53
1 2 3
Forecast 60 55 65
Orders 55 60 65
MPS quantity 0 100 100
Projected on-hand inventory 15 55 90
MPS start 100 100
F. 75 units
The inventory at the end of the second month is 55 units. The order for the third
month is 80 units. The inventory on hand at the end of the third month = 55 + 100
- 80 = 75 units. (See the following table)
1 2 3
Forecast 60 55 65
Orders 55 60 80
MPS quantity 0 100 100
Projected on-hand inventory 15 55 75
MPS start 100 100
Unit 22
Fundamentals of Inventory Control
Structure
1. Introduction
2. Objectives
3. Purpose of Inventories
4. Inventory Costs
5. Inventory Systems
6. Economic Order Quantity Model
7. Inventory Classification Models
8. Summary
9. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the concept of capacity
planning. We have learnt that capacity planning is a vital aspect of aggregate
planning. In this unit, we will discuss inventory control.
Inventory is a stock of goods held by a firm at a particular time for future use in the
production process or for meeting future demands. Effective inventory management and
control help in reducing inventory costs without compromising on the firms ability to
meet customer demand on time. These involve ordering the right quantity at the right
time without disrupting the production process. Inventories can be direct or indirect.
Direct inventories such as raw materials, work-in-progress goods, etc., play a vital role
in the production process and form a part of the finished product. Indirect inventories are
items that are necessary to run the production process but do not become part of the end
product. Examples are lubricants, grease, oils, stationery, etc. Raw materials are the
items to be used in the production process. Work-in-progress goods are semi-finished
goods that are stored temporarily during the production process. Finished goods are
items stored for delivery to the end consumer. Inventory also includes machinery,
furniture, components, etc. Organizations should carefully decide on the level of
inventory they need to maintain. Stocking large inventory leads to high inventory costs
and stocking too little leads to disruptions in the production process.
This unit will discuss the purpose of inventories. We will discuss inventory costs and
systems. We shall then move on to discuss economic order quantity model. Finally,
we would discuss inventory classification models.
2. Objectives
explain the purpose of inventories.
analyze inventory costs and inventory systems.
discuss the economic order quantity model.
identify the various inventory classification models.
55
3. Purpose of Inventories
Firms maintain inventory at various stages of the production process. The following
are the benefits of maintaining an inventory:
Smooth Production In certain cases, the demand for the item fluctuates widely, but
the production capacity of the firm remains fixed. For example, the demand for air
conditioners is high during summer and it is difficult for an organization to manufacture
the required quantity at that time. In such cases, the organization maintains a constant
production rate and a finished goods inventory. This inventory helps in meeting the high
demand during the period of deficiency in manufacturing capacity.
Better Service to Customers By maintaining an inventory, firms can provide
quicker and better service to their customers. A finished goods inventory helps firms
to continuously supply finished goods to their customers even at times when there is a
temporary stoppage of production or a sudden rise in demand. A machinery spare
parts inventory allows firms to repair facilities in case of a machine breakdown.
Protection against Business Uncertainties Firms maintain an inventory to operate
in an uncertain environment. By maintaining inventories, they can take advantage of
the speculative and unexpected opportunities in the market. For example, by
maintaining an inventory of finished goods, the firm can meet any unexpected rise in
demand. By maintaining a raw materials inventory, the firms can tide over an
expected increase in prices or an anticipated scarcity in the future.
To take Advantage of Quantity Discounts A firm incurs ordering costs each time
it places an order. Therefore, firms try to order a larger quantity than needed so as to
minimize ordering costs. Large orders also attract bigger quantity discounts from the
suppliers, thereby reducing the per unit cost.
Check Your Progress
1. Semi-finished items stored temporarily and used to finish production are termed
_________.
a. Raw material inventory
b. Work-in-progress inventory
c. Finished products inventory
2. Manufacturers maintain an inventory of _________to meet unprecedented
increase in demand.
a. Raw materials
b. Work-in-progress
c. Finished products
3. From the following, identify the benefits of maintaining an inventory.
i. To meet high demand during the period of deficiency in manufacturing capacity
ii. To provide quicker and better service to their customers
iii. To operate in an uncertain environment to take advantage of the speculative and
unexpected opportunities in the market
iv. To attract bigger quantity discounts from the suppliers
a. i, ii, and iii
b. i, iii, and iv
c. ii, iii, and iv
56
4. Inventory Costs
The operations managers decide on the order quantity (quantity to be ordered) and the
inventory levels to be maintained after considering the following costs:
Purchase Costs: The cost of purchasing a unit of item is called its purchase cost. The
purchase cost of an item is nx, where x is the unit price of the item and n is the
number of items that the firm wants to purchase. Suppliers provide discounts based on
the purchase costs.
Carrying Costs: Carrying costs (or holding costs or storage costs) are incurred on
inventories stored in warehouses or stores. Carrying costs include opportunity
costs, storage costs, staffing costs, equipment maintenance costs, insurance costs,
and interest charges for financing the inventories, taxes, security, and other
expenses associated with holding materials in stores. They also include loss of
inventory due to pilferage, spoilage, or breakage in stores, and the cost of
obsolescence. These costs are expressed as a percentage of the material cost
(generally between 25-35%) or as the actual amount incurred on storage of
inventory in a warehouse for a year.
Ordering Costs: Ordering costs are those costs incurred each time an order is placed
with the supplier. These costs are considered fixed and so decrease with increase in
order size. Costs associated with preparing the purchase order, postage, telephone
calls to the vendors, set-up costs if produced in-house, record-keeping and accounting
costs, and material-receiving costs come under ordering costs. These costs are also
known as acquisition costs
Stock-out Costs: Stock-out costs or shortage costs are penalty costs associated with
delays in meeting demand or stoppage in production due to shortage of stock. These
costs include loss of sales to the company caused by shortage of stocks and are
avoided by holding inventory. Shortage of stocks lead to loss of customer goodwill,
thus, leading to the loss of future sales as customers could shift to competitors
products due to the company failing to meet their demand.
Activity: Shakthi India Pvt. Ltd is an Indian company engaged in textile
manufacturing. Realizing that it was incurring huge costs relating to inventories,
the companys management has asked the purchase department to find ways to
reduce the inventory costs. The purchase manager, after going through the
inventory details has found that the inventory carrying costs and the stock-out costs
are huge. The purchase manager has therefore to decide on ways to reduce these
costs. Suggest how the purchase manager can reduce these costs. Do you think that
the company is facing problems regarding shortage of inventory at the time of
production? Suggest ways in which the company can solve these issues.
Answer:
57
Check Your Progress
4. Carrying costs represent cost incurred while inventories are stored in warehouses
or stores. Which of the following is not associated with carrying costs?
a. Insurance costs
b. Maintenance costs
c. Cost of obsolescence
d. Material receiving costs
5. Opportunity cost is associated with which basic category of inventory cost?
a. Carrying costs
b. Ordering costs
c. Purchase costs
d. Stock-out costs
6. Which of the following costs are considered by a firm as part of calculating
inventory costs?
i. Holding costs
ii. Acquisition costs
iii. Ordering costs
iv. Stock out costs
a. i, ii and iii
b. ii, iii and iv
c. i, iii and iv
d. i, ii, iii, iv
7. _______________ are penalty costs associated with delays in meeting demand or
stoppage in production due to shortage of stock.
a. Carrying costs
b. Ordering costs
c. Stock-out costs
d. Purchase costs
8. A firm decides on quantity of material ordered to maintain various inventory
costs. Which of the following costs does not influence quantities ordered by the
firm?
a. Purchase cost
b. Carrying cost
c. Ordering cost
d. Hiring cost
9. Suppliers offer discounts to manufacturers based on which of the following type
of costs?
a. Purchase costs
b. Carrying costs
c. Ordering costs
d. Stock-out costs
58
10. Which of the following does not come under carrying costs?
a. Pilferage
b. Spoilage
c. Maintenance costs
d. Material-receiving costs
11. Match the following inventory costs with their related descriptions.
i. Purchasing costs
ii. Carrying costs
iii. Ordering costs
iv Stock-out costs
p. These costs arise when inventory is damaged
q. Loss of customer goodwill is a consequence of these costs
r. Discounts are given by suppliers on these costs
s. These costs are fixed and come down with increase in size of purchase
a. i/r, ii/q, iii/p, iv/s
b. i/p, ii/q, iii/r, iv/s
c. i/r, ii/p, iii/q, iv/s
d. i/r, ii/p, iii/s, iv/q
5. Inventory Systems
The Inventory Cycle is a series of activities involved in maintaining adequate levels of
inventory. These activities include ordering of inventory, and receiving, storing, and
using them in the production process. Firms place orders on the basis of any of the
following inventory systems: Fixed Order Quantity System or Fixed Order Period
System. Operations managers face questions of when to order (time) and how much to
order (quantity). The time at which the inventory is reordered is called the reorder
point and the quantity of materials reordered is called the reorder quantity.
Fixed Order Quantity System (Q-System)
In this system, the inventory is continuously checked and a new order is placed when
the inventory level reaches a certain point called the reorder point. The system is also
called the reorder point system. The order quantity (Q) is always constant and is
determined by demand and cost factors. The assumptions made by this system are that
the demand for inventories remains constant over a period of time and that the lead
time (time lag between the point of order and receiving the material) for
replenishment is zero. As time passes, the stock level gradually depletes and reaches
the reorder point, R. The stock is replenished by ordering Q units at that point. Since
the assumptions made by the system are not practically applicable, firms try to
enhance the system applicability by using a more practical approach wherein the time
between two successive orders is altered to facilitate the changes in demand. For
example, assume that the order quantity is 50 units and the order period is 10 days in
the fixed order quantity system. If the demand for the period becomes 100 units, then
instead of changing the order quantity, the next order period is reduced to 5 days. The
reorder point is determined by estimating the expected usage of inventory during the
lead time plus the safety stock required. An order is placed as soon as the inventory
level falls below the predetermined reorder level. (Reorder level is the quantity of
inventory where a new order is placed for replenishment.)
59
Fixed Order Period System (P-System)
In this system, the order period is fixed, but the order quantity differs with the
requirement. The order quantity depends on the current inventory level and the future
inventory requirements. The inventory level is measured during the review period and
the order size is estimated based on the available and required inventory level. The
costs involved in conducting constant reviews are saved as the system involves a
periodic review of the inventory level. However, the system requires higher levels of
safety stocks to meet sudden variations in demand.
Operations managers, in general, use a combination of these systems. For example,
firms make use of reorder levels to estimate the order quantity (like in the fixed order
quantity system) and do not order the same quantity of material every time (like in the
fixed order period system). Decisions pertaining to the quantity of materials are taken
based on various costs associated with the inventory.
Check Your Progress
12. Which of the following terms refers to the time lag between the point of order and
receiving the material?
a. Lead-time
b. Slack time
c. Reorder time
d. Order time
13. According to which inventory system inventory is continuously checked and a
new order placed when the level of inventory reaches the reorder point?
a. Q system
b. P system
c. EOQ system
d. Fixed order period system
14. Which inventory model is also referred to as the reorder point system?
a. P system
b. Q system
c. EOQ
15. The quantity at which an order is placed for inventory replenishment is
_________.
a. Safety stock
b. Reorder level
c. Buffer stock
d. Cycle stock
6. Economic Order Quantity Model
The Economic Order Quantity (EOQ) model was developed in 1913 by F.W. Harris to
determine the optimum order quantity that would minimize the total inventory cost.
The following are the assumptions made by the model:
60
The price of the inventory item (p) is independent of the order quantity. This means
that the benefits of economies of scale are not taken into consideration while
purchasing.
The ordering cost (
o
C ) is fixed and is independent of the quantity ordered (Q).
The total holding cost of inventories is proportional to the number of inventory items
stored.
The demand for a product or its usage rate is constant over time.
Materials are always issued in equal quantities to the indenting departments and the
inventory supply rate is always greater than or equal to the usage rate (i.e. there is no
scope for shortage of inventory).
The lead-time for material delivery is known with certainty and it remains constant.
The quantity of inventory ordered is delivered in a single lot and there is no scope for
splitting of deliveries.
Stock-outs are not allowed. It implies that inventory is replenished just before the time
when it becomes zero. Hence, the total cost of maintaining inventory can be assumed
to have only three components: ordering costs, holding costs, and variable item costs.
Reorder Point
The calculation of the reorder point should ensure that the inventory level reaches zero
at the end of each reordering cycle as a positive inventory level at the end of the cycle
would increase the average inventory and related costs. Therefore, the reorder level is
equal to the number of units that are estimated as being used during the lead time. It is
equal to the product of demand per unit time and lead time, where unit time and lead
time are expressed in same units.
Reorder Point = d LT, Where d = Average Daily Demand, LT = Lead time
Optimal Order Quantity
The total cost of maintaining inventory (TC) includes ordering costs, holding costs,
and variable item costs. Stock-out costs are not included while computing the EOQ as
shortage of materials is not allowed. The ordering costs are equal to the fixed cost per
order (
o
C ) times the number of orders placed per unit time as they are assumed to be
independent of the order quantity. The number of orders placed per unit time is equal
to the demand per unit time divided by the order quantity. Operations managers plan
and procure materials to control inventory levels in order to minimize the related
costs. For example, if a firm uses 200,000 units per year and orders 40,000 units per
order, then the number of orders placed per year is five.
Therefore, ordering cost per unit time =
Q
D
o
C ,
Where D = Demand per unit time, Q = Quantity ordered, While the demand rate D is
assumed to be constant, the average inventory level is equal to the arithmetic mean of
the maximum and minimum inventory levels. The reorder point is set in such a way
that the inventory level is zero when the inventory is replenished and the average
inventory level is half the order quantity. The holding cost per unit time is the product
of the holding cost per unit time (
h
C ) and the average inventory level.
61
i.e., holding cost per unit time =
2
Q
h
C , Variable item cost per unit time is equal to
the cost per unit (
p
C ) times the quantity purchased per unit time, D.
Therefore, Total cost (TC) = D
p
C
2
Q
h
C
Q
D
o
C
The total cost will be the least when the ordering cost is equal to the holding cost.
i.e,
2
Q
h
C
Q
D
o
C
Solving the relation we get,
2
h
C
2
Q
D
o
C
h
C
D
o
2C
2
Q Or, Q =
h
C
D
o
2C
= EOQ
Example: Choco Ltd., a company that specializes in making different types of
chocolates and chocolate cakes, uses 6000 tins of cocoa per year at a purchase price of
Rs. 25 per tin. The cost associated with placing an order is Rs. 150 and carrying cost
is Rs. 5 per unit; the lead time is 4 days. Based on the given information, calculate the
EOQ and the reorder point.
Solution:
Given Annual Usage or Demand D = 6000 units
Unit Price = Rs. 25
Ordering cost per unit (
o
C ) = 150
Holding or Carrying cost (
h
C ) = Rs 5
Using the equation,
EOQ =
h
C
D
o
2C
We get,
EOQ=
h
C
D
o
2C
=
5
6000 150 2
= 360000 = 600
Optimal Order Quantity = 600 units. At this quantity level, the firm will be able to
minimize total cost i.e. the carrying and ordering cost.
Reorder point = Lead time Demand per day
Assuming 275 working days annually,
62
Demand Per Day = Total Annual Demand /275
= 6000/275=21.82
We can round off demand per day to 22,
So the Reorder point = 22 4 = 88
Therefore, whenever the inventory level drops to 88, the firm should orders 600 more
units.
Activity: ABC Ltd estimates that the demand for an item would be 200 units per
month. The ordering cost is Rs. 500 per order and the carrying cost is 15% per unit
cost of the item. The price of each individual item is Rs. 80. Assuming the lead
time to be 5 days, calculate the EOQ and the reorder point.
Answer:
Example: Inventory Management at Starbucks
Good service leads to customer loyalty. A retailer may, however, neglect a
customer if a supplier approaches him/her during the business hours with a
delivery. The use of Radio Frequency Identification (RFID) technology can
solve such problems. Seattle-based Starbucks Coffee Company (Starbucks)
used the RFID technology to help with the deliveries of raw materials. As of
2004, the company had 8,570 retail stores in 35 countries. It secured raw
materials (fresh muffins and pastries) daily from about 40,000 suppliers. In
order to manage the suppliers and at the same time give top priority to the
customers, Starbucks designed a strategy called dark deliveries. According to
the strategy, the company would take delivery of all the raw materials including
milk, pastries, and roasted coffee beans, after the regular store or business
hours.
Starbucks identified that it would face certain challenges like managing
physical security and inventory control while implementing the strategy. In
order to solve these problems, the company asked suppliers to use an RFID
license-plate signature for delivering goods. A supplier could gain access to an
RFID-enabled system using a card. The system recorded the time, disabled the
alarm, confirmed the identity of the supplier, unlocked the door, and let the
person in. The system could also record the inventory being delivered. The
company began using RFID in 2003 to secure and track cargo containers
shipped for Guatemala through Seattle/Tacoma ports. The strategy called
Operation Safe Commerce helped in tracking 150 pound bags that were
loaded into cargo containers for shipping.
Adapted from Laurie Sullivan, Starbucks Considers RFID for Deliveries, December 06, 2004,
http://www.informationweek.com/story/showArticle.jhtml?articleID=54800648&tid=5978
63
Check Your Progress
16. On what basis do organizations fix reorder level for raw material under the EOQ
model?
a. Recommendations of finance managers
b. Estimated demand during lead-time
c. Recommendations of suppliers
d. Estimated sales for a financial year
17. What does the EOQ inventory model primarily attempt to minimize?
a. The number of items ordered
b. The number of orders placed
c. Total inventory costs
d. The safety stock
18. Which of the following is not an assumption of the EOQ model?
a. Demand for a product or its usage rate is constant over a period of time
b. Supply rate is always greater than or equal to usage rate
c. The lead-time for material delivery is known with certainty and it remains
constant
d. The purchase price per unit varies depending upon quantity ordered
19. Lead time is assumed to remain constant. This is a condition associated with
which of the following inventory systems?
a. Q-System
b. P-System
c. EOQ
d. Fixed Order Quantity system
20. Which of the following costs are not considered part of EOQ?
a. Purchasing costs
b. Carrying costs
c. Ordering costs
d. Stock-out costs
21. Which of the following is the basic objective of economic order quantity
purchasing?
a. Minimizing total inventory cost
b. Minimizing transport cost
c. Minimizing storage cost
d. Minimizing ordering costs
Exercises
A. Suppose a company consumes a particular product at an average of 50 units
/week. It costs Rs.200 to order and Rs.0.50 per unit per week to hold the item in
inventory. Compute the EOQ.
B. If the lead time for replenishing inventory in a production facility is 7 days and
daily demand is 25 units, calculate the reorder point at which the firm should
order inventory replenishment.
64
(Questions C to F)
A production facility uses a certain type of raw material in its production process for
which details are given below. Annual Demand = 300000 units, Quantity per order =
75000 units, Fixed cost per order = Rs.2000, Holding cost per unit = Rs.5, Item cost
per unit = Rs.10. Using the EOQ model, answer the following four questions.
C. Calculate total ordering costs incurred in a year.
D. Calculate holding costs per order.
E. Calculate total variable cost.
F. Calculate total cost of maintaining inventory.
7. Inventory Classification Models
Inventory classification models are used to classify and categorize inventory items.
They help operations managers devise effective control plans. The following are the
classification models that are discussed in this section.
ABC Classification
In Always Better Control (ABC) classification model, items are classified based on
their consumption or usage value into A, B, C categories. Annual consumption or
usage value is given by the following relationship - Annual usage value = (annual
requirement) x (per unit cost)
Category A includes those items with high proportion of investment (around 75% of
inventory investment) and accounting for nearly 10% of the total inventory volume.
Category A items need highest level of control. Category B items take up around 15%
of the inventory investment and account for around 15% of the total inventory
volume. They require comparatively lower levels of control. Category C items have
the least investment and hence least importance. They account for around 75% of the
total inventory volume.
VED Classification
Vital, Essential, Desirable (VED) classification is based on importance of an item in
the production process. The most important items are termed as vital and are
classified as V. Items which are important but not critical in the production process
are classified as E, and the non important items in the inventory that does not affect
the production process are classified as D. The level of control required is maximum
for V items, and minimum for D items.
FSND Classification
This classification is based on the frequency of usage of items in the inventory. Some
items have faster turnover than others. Such fast moving items are classified as F
while slow moving items are classified as S. N stands for non-moving items and
D for dead items (items which have not been issued in recent years).
Check Your Progress
22. In which of the following types of classification of inventory are items classified
based on annual consumption value?
a. ABC
b. VED
c. FSND
d. Both b & c
65
23. Which of the following inventory classification models is based on importance of
an item in the production process?
a. ABC
b. VED
c. FSND
24. In the __________ inventory classification model, the classification is based on
the frequency of usage of items in the inventory.
a. ABC
b. VED
c. FSND
25. In the ABC inventory classification model, items are classified based on their
consumption or usage value. In this, annual consumption or usage value is given
by:
a. Lead time Demand per annum
b. Annual requirement x Per unit cost
c. Cost per annum x Quantity per annum
8. Summary
Inventory is a stock of goods, commodities, or other resources held by a firm at a
particular time for future use in the production process or for meeting future demands.
Inventories can be direct or indirect.
Effective inventory management and control help in reducing inventory costs without
compromising on the firms ability to meet customer demand on time.
Firms maintain an inventory to ensure smooth production, to provide better service to
customers, to take advantage of quantity discounts, and to operate during times of
business uncertainty.
Operations managers decide on the order quantity (quantity to be ordered) and the
inventory levels to be maintained after considering the purchase costs, carrying costs,
ordering costs, and stock-out costs.
Orders can be placed by firms based on the fixed order quantity system or the fixed
order period system.
Operations Managers use the EOQ model to find out the optimal order quantity,
which minimizes the inventory ordering and holding costs.
Inventory classification models are used by operations managers for easy recognition
and to provide effect control.
9. Glossary
ABC classification: In Always Better Control (ABC) classification model, items are
classified based on their consumption or usage value into A, B, C categories.
Carrying cost (holding or storage cost): Cost incurred on inventories stored in
warehouses or stores.
66
Direct inventories: These play a vital role in the production process and form a part
of the finished product.
Economic order quantity: It is used to determine the optimum order quantity that
would minimize the total inventory cost.
Finished goods: These are items stored for delivery to the end consumer.
Fixed order period system (P-System): The order period is fixed, but the order
quantity differs with the requirement. The order quantity depends on the current
inventory level and the future inventory requirements.
Fixed order quantity system (Q-System or reorder point system): Inventory is
continuously checked and a new order is placed when the inventory level reaches a
certain point called the reorder point.
FSND classification: This classification is based on the frequency of usage of items,
whether they are fast moving, slow moving, non-moving, or dead, in the inventory.
Indirect inventories: These items are necessary to run the production process but do
not become a part of the end product.
Inventory: A stock of goods held by a firm at a particular time for future use in the
production process or for meeting future demands.
Ordering cost: Cost incurred each time an order is placed with the supplier.
Purchase cost: Cost of purchasing a unit of item.
Stock-out cost (shortage cost): Penalty costs associated with delays in meeting
demand or stoppage in production due to shortage of stock.
VED classification: Vital, Essential, Desirable (VED) classification is based on
importance of an item, whether they are vital, essential, or desirable in the production
process.
Work-in-progress: These are semi-finished goods that are stored temporarily during
the production process.
1. Firms maintain inventory at various stages of the production process. What are
inventories? Mention the different types of inventories.
2. Effective inventory management and control help in reducing inventory costs
without compromising on the firms ability to meet customer demand on time.
Explain the significance of maintaining inventory in an organization.
3. Operations managers decide on the order quantity (quantity to be ordered) and the
inventory levels to be maintained after considering various costs. What are the
different inventory costs and inventory systems? Explain briefly.
4. The Economic Order Quantity (EOQ) model is used to determine the optimum
order quantity that would minimize the total cost. Explain the EOQ model in
detail. How can one decide on the optimal quantity to be ordered based on this
model? Explain with an example.
VED classification
ABC classification
FSND classification
67
6. Inventory Management
<http://www.inventorymanagementreview.org/inventory_control/index.html>
7. Inventory Holding Costs
<http://www.inventorymanagementreview.org/2005/09/inventory_holdi.html>
8. Pros and Cons of Inventory
<http://www.inventorymanagementreview.org/2005/09/a_simplified_lo.html>
9. Economic Order Quantity
<http://www.inventorymanagementreview.org/inventory_basics/index.html>
10. Economic Order Quantity
<http://www.inventoryops.com/economic_order_quantity.htm>
11. Inventory Management
<http://www.iimm.org/knowledge_bank/6_purpose-of-inventory-
management.htm>
12. EOQ and Inventory Control Models
<http://home.ubalt.edu/ntsbarsh/Business-stat/otherapplets/Inventory.htm>
1. (b) Work-in-progress inventory
Work-in-progress goods are semi-finished items stored temporarily during the
production process.
2. (c) Finished products
Firms maintain adequate levels of inventory to successfully operate in an
uncertain environment. Inventories help firms take advantage of unexpected
opportunities. For instance, a sudden and unexpected increase in demand can be
met with larger finished goods inventory.
Firms maintain inventory at various stages of the production process. The
following are the benefits of maintaining an inventory: to ensure smooth
production, to provide better service to customers, to protect against business
uncertainties, and to take advantage of quantity discounts.
4. (d) Material receiving costs
Carrying costs include opportunity costs besides storage costs, staffing costs,
equipment and maintenance costs, insurance costs, loss of inventory due to
pilferage, spoilage or breakage in warehouses and the cost of obsolescence.
68
5. (a) Carrying costs
Carrying costs include opportunity costs, storage costs, staffing costs, equipment
and maintenance costs, insurance costs, interest charges for financing inventories,
taxes, security and other expenses associated with holding materials in warehouses.
6. (d) i, ii, iii, iv
Acquisition (purchase) costs, holding costs, ordering costs and stock-out costs are
considered in calculating inventory costs.
7. (c) Stock-out costs
Stock-out costs or shortage costs are penalty costs associated with delays in
meeting demand or stoppage in production due to shortage of stock. These costs
include loss of sales to the company caused by shortage of stocks and are avoided
by holding inventory. Shortage of stocks lead to loss of customer goodwill, thus,
leading to the loss of future sales as customers could shift to competitors
products due to the company failing to meet their demand.
8. (d) Hiring cost
Hiring costs are those incurred by an organization as part of recruitment. It is not
a factor that influences the quantity of material ordered. Purchase, carrying, and
ordering costs influence the quantity ordered.
9. (a) Purchase costs
The cost of purchasing a unit of a particular item is its purchase cost. Suppliers
sometimes provide discounts to customers (manufacturers) based on purchase costs
(quantity of purchase). Discounts are usually given while purchasing quantities in bulk.
10. (d) Material-receiving costs
While pilferage, spillage and maintenance costs come under carrying costs,
material-receiving costs fall under ordering costs.
11. (d) i/r, ii/p, iii/s, iv/q
Discounts are given by suppliers on the basis of total cost of purchase when
material is purchased in bulk. Damage to inventory either in the warehouse or in
production facilities can increase carrying costs. Ordering costs are considered
fixed and so decrease with increase in order size. Marketers may lose customer
goodwill if they cannot supply goods on time due to non-availability of finished
goods in the inventory.
12. (a) Lead-time
Lead time refers to the time between placing the order for the material and
receiving it.
13. (a) Q system
Under the Q system (also called Fixed Order Quantity System), inventory is
continuously checked and a new order is placed when the inventory level reaches
the reorder point.
14. (b) Q system
In Q system, order quantity (Q) is always constant and the order is placed when
the level of inventory reaches the reorder point. This system is also referred to as
the reorder point system.
69
15. (b) Reorder level
Reorder level is the quantity of inventory where a new order is placed for
replenishment. In the Q system, the reorder level is equal to quantity used in lead
time plus safety stock. But in EOQ model, it is equal only to the quantity used in
the lead time.
16. (b) Estimated demand during lead-time
The calculation of the reorder point should ensure that inventory level reaches
zero at the end of each reordering cycle. This is because a positive inventory
level at the end of the cycle raises average inventory and associated costs. To
ensure this condition is satisfied, reorder level is set equal to the number of units
estimated to be used during lead-time.
17. (c) Total inventory costs
EOQ model always aims to reduce total inventory costs, which include ordering
costs, purchasing costs, carrying costs and stock-out costs.
18. (d) The purchase price per unit varies depending upon quantity ordered
One of the assumptions of the EOQ model is that purchase price per unit is fixed
and is independent of order quantity. It means that benefits of economies of scale,
if any, are not taken into consideration.
19. (c) EOQ
In the EOQ system, lead time is known and is assumed to remain constant.
20. (d) Stock-out costs
One of the assumptions of EOQ concept is that stock-outs are not allowed. It
implies that inventory is replenished just before the time when it becomes zero.
Hence, the total cost of maintaining inventory can be assumed to have only three
components: ordering costs, holding costs and variable item costs.
21. (a) Minimizing total inventory cost
EOQ method is used to identify order quantity to minimize the total inventory cost.
22. (a) ABC
ABC is one of the most widely used inventory classification models. It is also
known as Always Better Control model. As per ABC classification, items are
classified on the basis of their annual consumption value. Items with highest
value are classified as A, next lower value items are classified as B and the lowest
value items are classified as C.
23. (b) VED
Vital, Essential, Desirable (VED) classification is based on importance of an item
in the production process. The most important items are termed as vital and are
classified as V. Items which are important but not critical in the production
process are classified as E, and the non important items in the inventory that
does not affect the production process are classified as D. The level of control
required is maximum for V items, and minimum for D items.
24. (c) FSND
FSND inventory classification model is based on the frequency of usage of items
in the inventory. Some items have faster turnover than others. Such fast moving
items are classified as F while slow moving items are classified as S. N
stands for non-moving items and D for dead items (items which have not been
issued in recent years).
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25. (b) Annual requirement x Per unit cost
In Always Better Control (ABC) classification model, items are classified
based on their consumption or usage value into A, B, C categories. Annual
consumption or usage value is given by the following relationship: Annual usage
value = (annual requirement) x (per unit cost).
A. 200 units
Assuming 50 units /week as weekly demand, EOQ can be calculated using the
formula:
EOQ =
h
C
D
o
2C
Where, Co is the ordering cost (Rs. 200), D is the demand in units per unit time
(50 units), Ch is the holding cost per unit per unit time (Rs. 0.50). Hence, EOQ =
((2 x 200 x 50)/ 0.5) = 200 units.
B. 175 units
Reorder point = average daily demand x lead time
= 25 x 7
= 175 units
C. Rs.8000
Total order cost (A) = fixed cost per order x (demand / quantity per order)
= 2000 x (300000/75000)
= 2000 x 4
= 8000
D. Rs.150000
Holding costs per order (B) = holding costs per unit x (quantity per order /2)
= 5 x (75000/2)
= 5 x 37500
= 150000
E. Rs. 3000000
Total Variable cost (C) = item cost x demand
= 10 x 300000
= 3000000
F. Rs. 3158000
Total cost of maintaining inventory = Total order cost (A) + Holding cost per
order (B) + variable cost (C)
= 8000 + 150000 + 3000000
= Rs. 3158000
Unit 23
Purchase Management
Structure
1. Introduction
2. Objectives
3. Importance of Purchasing
4. Organizing Purchasing
5. Responsibilities of a Purchase Manager
6. Purchasing Process
7. Duties of Buyers
8. Make-or-Buy Analysis
9. Ethics in Buying
10. Summary
11. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the inventory classification
models. We have learnt that inventory classification models like ABC, VED, and
FSND are used by operations managers for easy recognition and to provide effective
control. In this unit, we will discuss purchase management.
Organizations purchase materials from external sources as they do not have the
capability to manufacture them internally or because they are cheaper to purchase than
to make. Until recently, the purchasing process involved placing an order with the
supplier who offered materials at a low price. However, of late, the growing
competition, market demand, and scarcity of resources have forced organizations to
expand their purchasing function. Purchasing department ensures that the right
materials, equipment, and services are procured in the right quantity, from the right
source, at the right time, and at a competitive price. Factors like low price, high
quality, and goods after-sales service are considered by the purchase department while
buying material and supplies from a supplier.
This unit will give you the importance of purchasing, and explain the ways to organize
the purchasing function. We will discuss the responsibilities of a purchase manager,
and then study the purchasing process. We shall then move on to discuss the duties of
buyers, and make-or-buy analysis. Finally, we would discuss the ethical issues
involved in buying.
2. Objectives
recognize the importance of purchasing.
explain how to organize purchasing.
identify the responsibilities of a purchase manager.
discuss the purchasing process.
72
state the duties of buyers.
analyze the make-or-buy decisions.
recall the importance of ethics in buying.
3. Importance of Purchasing
Purchasing refers to buying of a material or an item from a company or division that
supplies materials. The purchase department has to purchase the right materials at low
cost, develop a network of vendors, and provide the necessary information about the
new products, materials, and services to other departments. A firm purchases an item
only, when the cost of purchasing the item is less than the cost of making it, when it
does not have the requisite manpower to make the item, when the expected returns on
the investment in manufacturing the item in-house are not attractive and the demand
for the item (to be manufactured) is seasonal and there is a risk in storing and
maintaining it.
Management of purchasing activities is very important for a firm for the following
reasons:
As the costs of procuring raw materials have an impact on the profitability of the firm.
Automated manufacturing facilities have resulted in low labor costs making the
purchase departments role more significant.
Competition globally has forced companies to globalize their purchasing activities.
4. Organizing Purchasing
Purchasing systems are of two types: Centralized purchasing systems and
decentralized purchasing systems. In centralized purchasing system, all the purchasing
activities are carried out by a separate department called the purchasing department.
This system is effective for organizations which have a number of production sites or
many autonomous production units within the same site which require raw materials
with the same or similar specifications. In decentralized purchasing system, particular
department heads purchase the raw materials according to their requirements. The
method gives departments the flexibility to alter their production policy based on their
specific requirements. Most organizations generally use a combination of both types
of purchasing systems.
Check Your Progress
1. Which of the following factors should a purchase department consider while
purchasing materials and supplies from a supplier?
i. Low price
ii. High quality
iii. Good after sales service
a. i and ii
b. i and iii
c. ii and iii
d. i, ii, and iii
2. If the material requirement in the various production facilities of India Metallics
Company differs significantly, which type of purchasing system is most suitable
for the company?
Purchase Management
73
a. Centralized purchasing
b. Decentralized purchasing
c. A combination system
d. Outsource the purchasing function
3. In a centralized purchase system, which department is responsible to the user
department for proper delivery of components?
a. Supplier
b. Purchase department
c. Top management
d. Quality control department
4. Identify the statements that hold true regarding centralized purchasing system.
i. In this system, particular department heads purchase the raw materials according
to their requirements.
ii. All the purchasing activities are carried out by a separate department called the
purchasing department.
iii. It gives departments the flexibility to alter their production policy based on their
specific requirements.
iv. It is effective for organizations which have a number of production sites or many
autonomous production units within the same site which require raw materials
with the same or similar specifications.
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
5. Responsibilities of a Purchase Manager
A purchasing manger should undertake the following activities:
Vendor Development: The purchase manager should search for and evaluate
suppliers and should judge them on their quantitative and qualitative ability to meet
the firms requirements.
Selection of Suppliers: The purchase manager should select the prospective suppliers
from the list of vendors and asks them for a quotation for materials. After obtaining
the quotations, the purchase manager examines the cost of items, delivery charges,
discount charges, and supplementary charges like taxes payable. The selection is made
after analyzing the vendors ability to deliver on time items of the required quality and
in the required quantity (based on the past experience with vendors). Vendor rating is
a method used for selecting suppliers. It is a scientific ranking technique in which the
purchasing managers rate the vendors according to their performance. The purchasing
manager identifies the factors that are important for evaluating the vendors and
assigns weights to each of them. Based on the factors considered, each of the vendors
is rated on a scale of 0 to 10. The score of each factor is multiplied with the
appropriate weight to obtain the weighted score. The vendor score is then obtained
after summing up the weighted score of each factor. The vendor score for all the
vendors is calculated and the vendor who obtains the highest score is selected.
74
Contract Negotiation and Communication Interface: After selecting a vendor, the
purchasing manager negotiates with the vendor and specifies the terms and conditions
that the vendor must stick to while supplying the items. These include the price of the
items, quality and other performance standards, technical specifications, delivery
schedule, freight payment, payment terms, etc. The communication between the
various departments and the suppliers flows through the purchase manager.
Value Analysis: The purchase manager conducts a value analysis to assess the value
of the material. Value analysis mainly aims at controlling costs of purchasing
material. It evaluates the materials by analyzing the functionality of the item, checking
whether it is possible to run the system without the item, checking if the item can be
substituted with a standard part, evaluating the cost of the item, and checking if the
functions performed by two or three materials be clubbed together and replaced by
any other material.
Value analysis involves the combined efforts of various departmental units, and helps
in reviewing purchase activities to ensure that the amount is expended to get an
appropriate value. The following is the procedure for value analysis:
Examining all the products/materials that are being reordered and identify each
product/material that needs an improvement.
Gathering all possible information about the designs, costs, scrap rates, etc. of the
product.
Forming a team that includes experts from various functional areas related to the
material.
Generating alternatives by generating new ideas and ways of accomplishing the tasks.
Evaluating the alternatives on criteria like cost and feasibility.
Refining the feasible alternatives and selecting the optimal alternative.
Activity: Ram has been appointed as the purchase manager of a new plastic
manufacturing plant at Hyderabad. It is his first job and he has been given the
responsibility of finding suppliers of raw materials for the plant. How should Ram
go about it? Assist him in the process.
Answer:
6. Purchasing Process
During the purchasing process, the purchase department interacts with the production
department, the finance department, and the sellers. The purchasing department deals
with purchasing instruments like purchase indents (or requisitions), requests for
quotations, and purchase orders. Purchase requisitions are made by departmental
representatives stating the quantity of material they need and the date of requirement.
After receiving the requisition from the indenting department, the purchase
department sends requests for quotations to the prospective suppliers. Based on these
requests, the suppliers give quotations comprising the price, delivery schedule, the
Purchase Management
75
mode of transportation, and special conditions, if any. The purchase department
selects the supplier who offers the best quotation and negotiates the terms and
conditions in order to enter into a deal. The purchase department subsequently issues a
purchase order to the supplier.
A Purchase Order is a legal document that authorizes the supplier to supply the goods
and represents the buyers obligation to buy the materials against the specified terms.
Once the supplier delivers the materials the finance department releases the payment.
There are some variations in the purchasing procedures of different firms depending
on the material required. Nowadays, many organizations use the Internet for
purchasing.
Check Your Progress
7. Value analysis is an organized effort to control cost of _____________.
a. Materials purchased
b. Materials exported
c. New product development
d. Marketing efforts
8. Which of the following is not a primary responsibility of the purchase
department?
a. Vendor development
b. Selection of suppliers
c. Contract negotiation
d. Quality control
9. What are the tasks of a purchase department in an organization?
a. Processing requisition for materials and supplies
b. Locating suppliers or vendors
c. Negotiating purchasing contracts
d. All of the above
10. Identify the logical sequence that best represents a simple purchase process.
a. Purchase indent - Purchase order - Quotation
b. Purchase indent - Quotation - Purchase order
c. Quotation - Purchase indent - Purchase order
d. Purchase order - Quotation - Purchase indent
11. Which of the following is not an activity performed by the purchase manager?
a. Vendor analysis and development
b. Supplier selection
c. Value analysis
d. ABC analysis
12. Purchase indents are also called __________.
a. Purchase requisitions
b. Purchase quotations
c. Purchase orders
d. Purchase information
76
13. Who generally issues a purchase indent?
a. User department
b. Purchase department
c. Vendor
d. Top management
14. Which of the following authorizes suppliers to supply materials/goods?
a. Purchase indent
b. Quotation
c. Purchase order
d. All of the above
15. From the list of questions given below, identify the one not considered under
value analysis.
a. Is it possible to run the system without the item?
b. Can the item be substituted with a standard part?
c. Can the vendor supply the material at the right time?
d. How much does the item cost?
7. Duties of Buyers
Organizations employ qualified and experienced people in teams for carrying out the
purchasing activities. Each buyer is assigned the task of procuring a particular input,
say, raw materials, tools, electrical components, etc. With this specialization, buyers
become competent and have a complete understanding of the manufacturing processes
of the organization and the vendors. Buyers should be cost and value conscious,
should be aware of the legalities of purchasing, should have good negotiating skills,
and should be able to build good relations with suppliers.
8. Make-or-Buy Analysis
Before including an item in the purchase order, managers conduct a make-or-buy
analysis. This analysis helps them to find out whether it is more feasible to
manufacture the item in-house or to purchase it from external vendors. Usually, make-
or-buy analysis is based on the break-even analysis. For the make-or-buy analysis,
organizations consider factors like cost, availability of raw materials in the long run,
and the ability to monitor and control quality.
The total cost of purchasing material is the product of the price per unit (P) and the
number of units procured (Q). The organization does not incur any fixed cost during
purchase of a product.
Total Cost
Buy
= P Q
If the item is produced in-house, the organization incurs a fixed cost (F) for
installation of equipment and facilities. It also incurs variable production cost,
which is the product of the variable cost per unit (V) and the number of units
demanded (Q).
Purchase Management
77
Make or Buy Analysis
Total Cost
Make
= (VQ) + F
From Figure, we can see that the total cost of buying is equal to the total cost of
making the item in-house at the break-even point. Assume that Q
1
is the demand to
reach the break-even point.
P Q
1
= (VQ
1
) + F, where, Q
1
=
V P
F
If the annual demand for the product is less than Q
1
, the total cost of purchasing the
product from an external vendor will be less than the total cost of making the product
in-house and vice-versa, if the annual demand for the product is more than Q
1
. This
analysis is useful in determining whether the purchase cost of a product is less than
the cost of producing it in-house. For the make-or-buy analysis, organizations
consider factors like cost, availability of raw materials in the long run, and the ability
to monitor and control quality.
Most organizations opt for external suppliers as they specialize in producing the
products, maintain high quality standards, and ensure timely delivery for fear of losing
the contract. Organizations usually opt for in-house production when they want to
retain control over all the value chain activities, put excess plant capacity to
productive use, and ensure that the design of a product is kept a secret.
9. Ethics in Buying
Ethics is the science of morals, moral principles, and recognized rules of conduct. It
also implies systematizing, defending, and recommending concepts of right and
wrong behavior. A purchasing department might sometimes get involved in unethical
and illegal activities like manipulating quotations, fixing prices, favoring a specific
supplier while placing an order, altering a product sample with the intention of getting
approval for a substandard item, etc. Vendors also give personnel gifts like free
lunches, stays at holiday resorts, etc. as part of relationship building. Though it is a
normal practice, organizations should state the type of gifts that the purchasing
personnel are permitted to accept and should clearly draw the line beyond which
accepting gifts would be considered unethical.
78
Check Your Progress
16. Which of the following is not a reason for organizations to opt for in-house
production?
a. To gain control over all value chain activities
b. To put excess plant capacity to productive use
c. To ensure that the design of a product is kept secret
d. To take advantage of knowledge and expertise of suppliers
17. Which of the following statements is incorrect regarding make-or-buy analysis?
a. It is based on break-even analysis.
b. It is conducted by managers after they include an item in the purchase order.
c. It helps them to find out whether it is more feasible to manufacture the item in-
house or to purchase it from external vendors.
d. Organizations consider factors like cost, availability of raw materials in the long
run and the ability to monitor and control quality.
18. India Rubber Ltd. requires on a continuous basis a certain rubber component for
their product. When should the firm opt for buying the component rather than
producing it in-house?
a. When the quantity of the part required is huge
b. When the fixed cost to make the product is less than buying costs
c. When the total cost to make the product is less than buying costs
d. When the quantity of the part required is small
19. Buyers should:
i. be cost and value conscious.
ii. be aware of the legalities of purchasing.
iii. have good negotiating skills.
iv. be able to build good relations with suppliers.
Activity: Krushi Incorporation is a company that has been engaged in
manufacturing agricultural tools and equipment for almost 20 years. Recently,
there has been a change in the management of the company. The new management
is verifying the various practices of the company in the past years. During the
process, the management has come to know that the company had been purchasing
raw materials from only two suppliers. On investigation, they have found that
though these suppliers supply the materials at a higher price than the others in the
market, the purchasing department had been favoring them. Inquiry revealed that
the favors that the purchasing personnel had received from the suppliers had
prompted them to place orders consistently with the same suppliers. The
management has decided to lay down rules regarding the ethical practices to be
followed in the organization with respect to purchasing. Assist the management in
this process.
Contd
Purchase Management
79
Contd
Answer:
10. Summary
Purchasing refers to buying a material or an item from a company or division that
supplies materials.
A purchasing department ensures that the right materials are procured at competitive
price.
Purchasing systems are centralized and decentralized.
A purchasing manager should undertake activities of vendor development, selection
of suppliers, contract negotiation, communication interface, and value analysis.
During the purchasing process, the purchase department interacts with the production
department, finance department, and the sellers. It deals with purchasing instruments
like purchase requisitions, requests for quotations, and purchase orders.
The purchase managers conduct a make-or-buy analysis to find out whether it is
feasible to manufacture the item in-house or purchase it from external vendors.
Organizations should follow ethical practices while purchasing.
11. Glossary
Centralized purchasing system: In this system, all the purchasing activities are
carried out by a separate department called the purchasing department.
Decentralized purchasing system: In this system, particular department heads
purchase the raw materials according to their requirements. The method gives
departments the flexibility to alter their production policy based on their specific
requirements.
Make-or-buy analysis: This helps firms find out whether it is more feasible to
manufacture the item in-house or to purchase it from external vendors.
Purchase order: A legal document that authorizes the supplier to supply the goods
and represents the buyers obligation to buy the materials against the specified terms.
Purchase requisitions: These are made by departmental representatives stating the
quantity of material they need and the date of requirement.
Purchasing: It refers to buying of a material or an item from a company or division
that supplies materials.
Requests for quotations: The purchase department sends requests for quotations
to the prospective suppliers, based on which the suppliers give quotations
comprising the price, delivery schedule, the mode of transportation, and special
conditions, if any.
80
1. Purchasing refers to buying of a material or an item from a company or division
that supplies materials. Why is purchasing important for an organization? Explain
the different types of purchasing systems.
2. The purchase department is one of the key players in achieving the strategic
objectives of a firm. What is the role of a purchase manager in the purchasing
process?
3. During the purchasing process, the purchase department interacts with all the
departments of the firm. Explain the purchasing process. Also explain the duties
of the buyers in brief.
4. A make-or-buy analysis helps in finding out whether it is more feasible to
manufacture the item in-house or to purchase it from external vendors. How can a
purchase manager conduct this analysis?
5. Organizations develop a set of rules and guidelines to ensure that the purchasing
conduct of its personnel is ethical. Why should organizations follow purchasing
conduct that is ethical? Mention a few important rules of ethics.
6. Make-or-Buy Decisions
<http://www.ifm.eng.cam.ac.uk/csp/projects/mvb.html>
<http://web.mit.edu/ctpid/www/Whitney/morepapers/make_buy.pdf>
<http://business.enotes.com/management-encyclopedia/make-buy-decisions>
1. (d) i, ii and iii
All the above factors must be taken into consideration by the purchase department
while buying material and supplies from a supplier.
2. (b) Decentralized purchasing
When specific material requirements vary between production facilities, a firm
must adopt a decentralized purchasing system. Centralized purchasing reduces
flexibility and outsourcing reduces control of the firm over the purchasing
function.
Purchase Management
81
3. (b) Purchase department
The purchase department is responsible for proper delivery of goods purchased.
As this department acts as an interface between the user department and suppliers,
it is answerable to the user department for delays in delivery of material.
Purchasing systems are of two types: Centralized purchasing systems and
decentralized purchasing systems. Statements ii and iv refer to a centralized
purchasing system, while statements i and iii refer to a decentralized purchasing
system. Most organizations generally use a combination of both types of
purchasing systems.
5. (a) Materials purchased
Value analysis aims at reviewing design of materials to be procured and attempts
to modify the design to replace high cost and obsolete parts with cost effective
parts and designs. Value analysis mainly aims at controlling costs of purchasing
material.
6. (d) Quality control
Quality control is part of raw material purchase. It is an activity taken up by the
production/ quality control department, sometimes in conjunction with the
purchase department.
Processing requisition for materials and supplies, locating suppliers or vendors,
and negotiating purchasing contracts are tasks carried out by the purchase
department.
8. (b) Purchase indent - Quotation - Purchase order
A purchase indent from a department within the firm initiates the purchase
process. This is followed by request for quotations from suppliers by the purchase
department. After selecting a supplier, the purchase order is placed by the
purchase department.
9. (d) ABC analysis
ABC analysis is used in materials management and is not performed by the
purchase manager.
10. (a) Purchase requisitions
Purchase indents are also called requisitions, which include a clear specification
of materials required.
11. (a) User department
The user department that utilizes material or goods issues purchase indents. They
are issued to the purchase department, which requests for quotations from
vendors for the materials.
12. (c) Purchase order
The purchase order is the legal document authorizing the supplier to supply
goods. It represents the buyers obligation to buy materials against specified
terms.
13. (c) Can the vendor supply the material at the right time?
Value analysis is concerned about increasing product value by reviewing design
and modifying the product without affecting its usability. Option (d) relates to
vendor supply and does not come under value analysis.
82
14. (d) To take advantage of knowledge and expertise of suppliers
Organizations opt for in-house production when they want to control all value
chain activities, to use excess plant capacity productively, or when they do not
want competitors to get to know the product design. Suppliers knowledge and
expertise is a factor when the organization decides to outsource rather than
produce in-house.
15. (b) It is conducted by the managers once they include an item in the
purchase order.
All the statements are true regarding make-or-buy analysis, except statement (b).
Before including an item in the purchase order, managers conduct a make-or-buy
analysis.
16. (d) When the quantity of the part required is small
India Rubber can buy the part when the quantity required is small or when the
total costs to make it are more than buying costs.
Each buyer is assigned the task of procuring a particular input. With this
specialization, buyers become competent and have a complete understanding of
the manufacturing processes of the organization and the vendors. Buyers should
be cost and value conscious, should be aware of the legalities of purchasing,
should have good negotiating skills, and should be able to build good relations
with suppliers.
Unit 24
Materials Management
Structure
1. Introduction
2. Objectives
3. Necessity of Materials Management
4. Functions of Materials Management
5. Materials Management Technology
6. Materials Management Techniques
7. Summary
8. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the ethical issues involved
in buying. We have learnt that organizations should develop a set of rules and
guidelines to ensure that the purchasing conduct of its personnel is ethical. In this unit,
we will discuss materials management.
Materials management is the study of flow of materials through various operations in
a production facility. The American Production and Inventory Control Society
(APICS) has defined materials management as, the grouping of management
functions supporting the complete cycle of material flow, from the purchase and
internal control of production materials to the planning and control of work-in-
process to the warehousing, shipping, and distribution of finished products.
Materials management helps in assessing material requirements at various stages of
the production process and in maintaining a control over the firms production and
distribution functions.
This unit will introduce you to the necessity of materials management. We will
discuss the functions of materials management. We shall then move on to discuss
materials management technology. Finally, we would discuss the various techniques
used in materials management.
2. Objectives
explain the necessity of materials management.
discuss the functions of materials management.
identify the various technologies used in materials management.
evaluate the various techniques used in materials management.
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3. Necessity of Materials Management
A major portion of investment is made in materials. Though the range of investments
made varies from industry to industry, about 50% of the total capital is invested in
materials. Therefore, they need to be effectively and efficiently managed. For
example, if a hospital runs out of a single item like a syringe, a seemingly
insignificant item in its inventory, it brings most operations to a standstill. Such
shortages also delay service delivery and increase the expenses for the firm. Materials
management is very important for the following reasons:
Due to scarcity and increasing demand of materials firm should minimize wastage.
Material is the only major area for cost reduction therefore should be effectively
managed.
The quality of the end product or service is dependent on the materials management.
Materials management helps in preserving important and scarce resources.
Materials management helps in obtaining the lowest possible prices for materials
purchased.
4. Functions of Materials Management
The materials management process is explained by three inter-related functions:
production control, inventory control, and materials handling.
4.1. Production Control
The production control function involves directing and regulating the movement of
goods through the entire manufacturing cycle from the process of purchasing
materials to producing the finished product. The purchasing, receiving, raw materials
inventory, and production departments perform this function by providing an adequate
supply of materials for production.
Purchasing department: The purchasing department acquires the required materials
in the right quantity, of the right quality, from the right source, at the right time, and at
the least possible cost.
Receiving department: The receiving department processes the incoming shipments
of materials. In most firms, the purchasing department itself acts as the receiving
department. The receiving department performs tasks like unpacking incoming
materials, checking their quantity and quality, and generating receiving reports.
Raw materials inventory department: The raw materials inventory department
manages the raw materials inventory, which is the collection of inputs used in the
production process. The department performs tasks like storing and protecting raw
materials, auditing existing raw materials, and repackaging and labeling raw materials
to make them ready for use in the production process. Most firms use Materials
Requirement Planning (MRP) to manage raw material inventory.
Production department: The production department allows the continuous flow of
goods during the production process without any stoppages. Some of the functions of
the production department include monitoring the flow of raw materials, determining
and adjusting inventory storage capacity, and identifying material flow bottlenecks.
4.2. Inventory Control
The inventory control function involves the maintenance of stock in various stages of
production in the desired quantities so that the overall cost of production is
minimized. This function is performed by the raw material inventory, production, and
finished goods departments. Production control focuses only on materials availability
whereas inventory control also emphasizes cost minimization.
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Finished goods inventory department: The finished goods inventory department
checks the quantity and quality of the products in the production process, stores the
products to protect them from pilferage and other damage, audits the finished goods
inventory, and retrieves the finished goods from the stocks.
Materials Handling
The materials handling function manages the physical movement of materials
into, through, and out of the firm to the required location in a timely and cost-
effective manner without affecting the primary objectives of the other two
materials management functions. The primary objective of materials management
is to move materials to the required location in a timely and cost-effective way
without affecting the primary objective of production control and inventory
control functions. Factors like the type of plant layout, type of production process
used, the nature of materials, and the material handling equipment influence the
materials handling function. Materials handling equipment are of two types
fixed path equipment and variable path equipment. Fixed path equipment like
conveyors, monorail devices, and pulley-drive equipment, move on a fixed path.
Overhead cranes also belong to this category with a slight variation. Variable path
equipment does not restrict the direction of movement of materials. However, the
size of the equipment, as in the case of trucks, forklifts, mobile cranes, and
industrial tractors, affects their movement.
The materials handling function is performed by the purchasing, receiving, raw
material inventory, production, finished goods, and shipping departments, and
distribution centers and warehouses.
Shipping department: The shipping department delivers goods from the finished
goods inventory department to customers. Some of the tasks carried out by this
department include staging or organizing orders to be shipped; weighing, labeling, and
packing orders to be shipped; and physically checking orders to make sure their
content is consistent with the order.
Distribution centers and warehouses: Distribution centers and warehouses are
physical facilities used to store and ship inventory. Distribution centers are located
near markets to provide better customer services.
Activity: Suketu has been appointed as the head of the materials handling
department in a manufacturing company. He has to manage the movement of the
materials into, through, and out of the company. He has identified that the materials
handling function is not being properly done in the organization. What are the
departments in an organization that carry out the materials handling function?
Assist Suketu in the process of developing a materials handling function in the
organization.
Answer:
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Check Your Progress
1. Which of the following is not a function of materials management?
a. Vendor analysis
b. Production control
c. Materials handling
d. Inventory control
2. The departments involved in production control are purchasing, receiving, raw
materials, and production department. Which of the following tasks does the raw
material inventory department carry out?
i. Repackaging and labeling incoming stock
ii. Storing and protecting raw materials
iii. Auditing existing raw materials
iv. Unpacking incoming materials
a. i and ii
b. ii and iv
c. i, ii, and iii
d. i, ii, and iv
3. The shipping department is associated with the materials handling function.
Which of the following tasks are carried out by this department?
i. Staging or organizing orders to be shipped
ii. Weighing, labeling, and packing orders to be shipped
iii. Physically checking orders to make sure their content is consistent with the order
iv. Storing raw materials safely
a. i and iii
b. ii and iii
c. i and ii
d. i, ii, and iii
4. What is the basic objective of materials handling function under materials
management?
a. To maintain stock of materials in various stages of production and in desired
quantities
b. To direct and regulate movement of goods through the entire manufacturing cycle
from the process of purchasing materials to making the finished product
c. To move materials to the required location in a timely and cost-effective way
without affecting the primary objective of production control and inventory
control
d. All of the above
5. Materials management comprises production control, inventory control and
materials handling. Which department is not associated with inventory control
function?
a. Purchase department
b. Raw materials inventory department
c. Production department
d. Finished goods inventory department
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6. Production control is one of the functions of materials management. Which of the
following is not a function of the production department associated with
production control function?
a. Monitoring flow of raw materials
b. Determining and adjusting inventory storage capacity
c. Locating and receiving raw materials
d. Identifying material flow bottlenecks
7. Which of the following tasks are not performed by the receiving department
under the production control function of materials management?
a. Unpacking incoming orders
b. Processing requisitions for material
c. Inspecting the quality of incoming material
d. Preparing receiving reports
8. The detailed study of complete material flow process in a firm is termed _______.
a. Operations management
b. Inventory management
c. Materials management
d. Purchase management
9. How does shortage in materials affect a firms functioning?
i. It breaks the flow of operations
ii. It delays delivery
iii. It increases operational efficiency
iv. It increases operational expenses
a. i and ii
b. i, ii, and iii
c. i, ii, and iv
d. i, ii, iii, iv
10. Materials management comprises production control, inventory control and
materials handling. Which of the following departments is not associated with
production control function?
a. Purchase department
b. Raw material inventory department
c. Finished goods inventory department
d. Production department
5. Materials Management Technology
The latest technologies like Robots and Automated Storage and Retrieval Systems
(AS/RS) have made the execution of materials management functions convenient,
easy, and economical.
Robots
Robots are computer-controlled, re-programmable, multi-functional manipulators
designed to move materials, parts, tools, and other specialized devices through
variable programmed motions to perform various tasks independently. Several robots
are fixed and installed on the floor, with an arm that can reach different locations.
Robots are used for processing and pick-and-place applications.
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Physical capabilities of a robot: A robots capability can be determined by its work
envelope and grippers (hands). The work envelope is the physical movement
capability of the robots arms and hands. The grippers of a robot consist of the jaw
hand which is used to pick up materials, turn them, and keep them on a nearby
conveyor (or location) within its work envelope, while the claw hand has teeth for
grasping the materials.
Robots can be broadly classified into:
Physically operated robots These robots have a mechanical arm and hand and are
used by workers to pick up materials.
Fixed sequence robots These robots perform a sequence of operations based on a
predetermined set of procedures. Electronic sensors are used to activate these robots.
Variable-sequence robots The sequence of actions performed by these robots can be
easily changed depending on the nature of operations to be performed, while their
functioning is similar to that of fixed sequence robots.
Numerical control robots (NC robots) -- These robots perform a set of operations
based on numerical data fed into them through punched tapes, data cards, and digital
switches. They are used to perform manufacturing operations which require high
precision.
Playback robots These robots store a sequence of operations in memory. An
operator initially performs these operations using a robot.
Intelligent robots These robots perceive the environmental conditions of the
workplace through tactile or visual perception or both and can make necessary and
suitable decisions by using on-board computers.
Automated Storage and Retrieval System (AS/AR)
AS/AR systems are computer-controlled and mechanically-operated materials
handling systems. These systems function like physically operated robots. The system
executes inventory stocking and picking functions and automated material handling
functions, which are integrated and controlled by a computer.
Automated guided vehicles (AGVs) These systems are used to store and retrieve
inventory items from stock. Semi-automatic AGVs, which are a combination of
computer and human control, can move independently on their guided paths to a
specific workstation and then signal to the operator to perform the required
operation.
Conveyance systems In conveyance systems, the inventory items are stored in
standardized boxes. These boxes have a trip control device that prevents the
inventory items from spilling out. The systems are controlled by a Computer
Integrated Manufacturing System. To pick up a particular inventory item, the
computer releases the control device at the place where that item is located and
the box automatically falls onto the conveyor. The conveyor then sends the
boxed items to the order-processing area where a robot or a human being
collects them. To store the items, the computer directs the AGVs to locate and
replenish inventory boxes (which the AGV carries from the receiving areas) to
the desired locations.
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Example: Robotics for Production Efficiency
Manufacturers worldwide are using robotics to improve their production
efficiency and reduce labor costs. The use of robots in palletizing has evolved
over the years. In the 1950s, palletizing was performed through row forming.
In row forming, rows of cartons or cases were made and then pushed forward,
to allow for another row until the pallet was completed. Flexibility began to
evolve in palletizing with the use of robotics. The use of robotics in
palletizing is more beneficial with the constantly changing packaging design
and size, along with the need for multiple cell applications. Robots have the
ability to switch to other areas of the plant and to palletize varying load sizes.
Apart from being flexible, they are designed to handle the need to change
pallet-loading patterns.
American manufacturers have begun using robots with AGVs in specific
manufacturing areas just like their European counterparts who have been
using them since a long time. The US manufacturers can achieve efficiencies
by partnering robots with AGVs in a cell for a particular purpose like
palletizing. QComp Technologies Inc. was among the first US companies to
design and manufacturer an AGV to face the domestic competition.
Adding an AGV to the palletizing line has enhanced the flexibility of
palletizing. The palletizer takes a pallet from the stack, places it on the floor,
and fills it. An AGV then enters to remove the pallet and the process is
repeated. Using robotics in palletizing helps in reducing labor costs by getting
rid of full-time positions, saves on the use of labor in traditional areas, reduces
the risk associated with lifting heavy boxes and driving forklifts, and reduces
workplace injury risk. By using robotics and AGVs, manufacturers need to
employ only one person in the place of three or more. With new technological
advancements, it is left to the manufacturer to decide on how a particular
technology should be put to use so as to allow it to compete in the marketplace.
The use of robotics technology helps in enhancing his production efficiency
and at the same time benefits the companys financials.
Adapted from Jan Rupnick, Robotics Partner with AGVs to Increase Production Flexibility
and Speed, Robotics World Magazine, June 06, 2006,
http://www.roboticsonline.com/public/articles/articlesdetails.cfm?id=2425
Activity: The management of a company Khaled Ltd. wants to know about the
various technologies that can be used in carrying out the materials management
function. It has appointed Kevin to identify and report to it on the various
technologies. Assist Kevin in the process.
Answer:
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Check Your Progress
11. Which of the following category of robots, based on the nature of their
operations, can change their sequence of tasks to suit the operational process?
a. Playback robot
b. NC robot
c. Variable-sequence robot
d. Intelligent robot
12. ___________ robots carry out a sequence of operations based on a predetermined
set of procedures.
a. Fixed-sequence
b. Variable-sequence
c. Physically-operated
d. Numerical control
13. Which of the following types of robots perceive the environmental conditions of
the workplace through tactile or visual perception or both, and can make
necessary and suitable decisions by using on-board computers?
a. Playback robots
b. Intelligent robots
c. Physically operated robots
14. Identify the statement that does not hold true regarding automated storage and
retrieval systems.
a. These systems function like physically operated robots.
b. These systems store a sequence of operations in memory.
c. These are computer-controlled and mechanically-operated materials handling
systems.
d. These systems execute inventory stocking and picking functions and automated
material handling functions that are integrated and controlled by a computer.
15. In which of the following systems are the inventory items stored in standardized
boxes with a trip control device that prevents the inventory items from spilling
out?
a. Robots
b. Kanban systems
c. Conveyance systems
d. Automated guided vehicles
6. Materials Management Techniques
The most widely used materials management techniques are the Kanban card systems,
ABC classification systems, and Just-In-Time (JIT) purchasing. The transportation
method of linear programming is also useful for minimizing the materials
transportation distance.
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6.1. JIT Purchasing
According to this concept, the size of the purchased quantities is reduced to such an
extent that the materials directly reach the production point. This results in a reduction
in wastage, storage, and maintenance costs. The method advocates reduction in size of
purchased quantities to the extent that materials reach the production point directly.
Hence, safety stocks need not be maintained. In JIT purchasing, flexibility is higher in
terms of ability to change materials required at the last minute depending on changes
in customer/client preferences, etc. Apart from reduction in carrying costs, the other
advantages of JIT purchasing are improved quality and enhanced responsiveness. The
following are the basic features of JIT purchasing:
Buyers and sellers can reach the stage of zero defects through the proper use of JIT
systems.
JIT involves frequent shipments in small lot sizes.
A firm following the JIT system ensures that the high value components and materials
arrive only when they are required. This reduces maintenance costs.
Delivery delays are avoided by using a good transportation system for transporting
materials.
Standard shipping methods are used to ensure the safe transportation of materials.
Stable production schedules are developed and communicated to the suppliers.
Electronic data exchanges are used to provide information about the current status of
the production process and the inventory level.
Buyers and sellers enter into long-term agreements and develop lasting relationships.
6.2. Kanban Systems
The Kanban system was developed by the Toyota Motor Company, Japan. To use this
system, firms have to store their materials and other inventory items in a single-use
container like trays or boxes. A card called the Kanban is attached to each container
that holds a specific amount of materials or other inventory parts used to manufacture
the product. These cards are used for initiating the transactions. For example, when
the material in a container is depleted, a Kanban is kept in the container which defines
the requirement of inventory items to continue the production process. A Kanban
system uses three types of cards to initiate material transactions: the production
authorization card, the vendor authorization card, and the conveyance authorization
card. The production authorization card authorizes the production department to start
the production process. It specifies the products name, identification number and
description, and the list of materials needed for continuing the production process. A
vendor authorization card authorizes a vendor to supply the required materials in the
specified quantity. It specifies the products name, vendors name, and the quantity
ordered. A conveyance authorization card authorizes a materials handling agent to
move the tray to a specified destination. It specifies the products name, its
identification number, and the delivery destination. The following are the benefits
derived from the Kanban systems:
Reduces work-in-process and raw materials stores
Eliminates stock-out situations
Improves customer service by minimizing the lead time
Ensures effective supply chain management
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A Single-card Kanban System
A single-card Kanban system uses the conveyance card. Following are the steps
involved in the functioning of the system:
An assembly line worker needs some inventory items to manufacture a product.
He/she puts an empty tray at point A and issues a conveyance Kanban specifying the
materials or the other inventory parts required.
The materials handling agent takes the tray from a point A to a point B in the
inventory department.
The tray is filled with the desired inventory and the materials handling agent collects
the filled tray at point C. Here, the materials manager should ensure that the required
amount of inventory is ready to be picked up; otherwise the production process gets
delayed.
The agent moves the tray to point D in the assembly area where it is required for
processing, and then it again goes to point A.
This cycle is repeated whenever there is a materials requirement in the assembly line.
A Dual-card Kanban System
A dual-card Kanban system uses the conveyance card and the vendor card. In this
system, the required quantity is obtained from the vendor and a vendor authorization
card is used in the process. Following are the steps involved in the functioning of the
system:
Figure 12.1: Dual-Card Kanban System
A conveyance card is put in an empty tray at point A and the materials handling agent
moves it to point B in the inventory department. The tray is collected at point C and is
sent to point D in the assembling area just as in the single card system.
The vendor card is introduced at point X, authorizing a vendor (at point Y) to deliver
the materials that are specified in the card.
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After receiving the card, the vendor delivers the materials into the empty trays that are
available at point Z.
The filled container is placed in the bins at the position X. It remains at this position
till a conveyance card arrives from Point B to Point C, authorizing the movement of
material from Point C to Point D.
Once the container is authorized to move, the vendor card is removed and sent to the
vendor and the cycle repeats itself.
Kanbans operate in closed loops and they continue to operate until the materials
manager withdraws them. However, the disadvantage is that the system is highly
dependent on the people.
6.3. ABC Classification Systems
Firms use different varieties of material in the production process. As materials vary
in prices, usage, and lead-time, it is difficult for the materials managers to control all
of them. Therefore, in ABC classification systems, attention is paid more to those
items whose usage value or consumption value is high and less to those whose usage
value is low. Usage value is the product of the number of units of a material used per
year and the cost per unit. Based on the usage value, materials are classified into three
categories: A, B, and C. Category A represents materials of high usage value per
annum accounting for 60-70% of the total cost. Category B represents materials of
moderate usage value per annum accounting for 10-30% of the total cost. Category C
represents materials of low usage value accounting for 5-15% of the total cost.
However, these percentages vary from industry to industry and also from one firm to
another within the industry. One limitation is that ABC analysis does not consider the
aspect of availability of materials. The ABC classification system is also referred to as
ABC (Always Better Control) analysis, which is done to change the expenses
associated with material control based on their usage value. Following is the
procedure:
List all the materials that the firm holds.
List the unit cost and the annual demand (in units) of each material.
Calculate the usage value of each material.
Tabulate the materials in the descending order of their usage value.
Classify the items into categories: A, B, and C based on their usage values.
Example: The following table lists the number of items used per year and the cost per
unit of the materials. Classify them on the basis of ABC analysis.
Type of Material Number of Materials Used per Year Cost per Unit
1000 5000 20
1001 400 150
1002 1200 30
1003 500 50
1004 700 15
1005 200 25
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Type of Material Number of Materials Used per Year Cost per Unit
1006 400 7.5
1007 50 35
1008 60 12
1009 20 9
Solution: Calculate the usage values of the items and arrange them in descending
order based on the values.
Type of Material Usage Value % of Usage Value Cumulative Value
1000 100,000 41.30 41.30
1001 60,000 24.78 66.08
1002 36,000 14.87 80.95
1003 25,000 10.32 91.27
1004 10,500 4.34 95.61
1005 5000 2.06 97.67
1006 3000 1.24 98.91
1007 1750 0.72 99.63
1008 720 0.30 99.93
1009 180 0.07 100
Total 242,150 100.00
The items which can be classified under Category A are 1000 and 1001. They use
about 66% of the total expenditure on inventory. The items which can be classified
under Category B are 1002, 1003, and 1004. They use about 29.53% of the total
expenditure on inventory. The remaining items: 1005, 1006, 1007, 1008, and 1009 are
classified under Category C. They use around 4.39% of the total expenditure on
inventory.
Check Your Progress
16. Materials managers should pay more attention to items whose usage value or
consumption value is high and less attention to items whose usage value is low.
Which inventory classification model seeks to alter the expenses associated with
controlling materials according to their usage value?
a. ABC
b. VED
c. FSND
d. FIFO
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17. A Kanban system uses different types of cards to initiate material transactions.
Which of the following type of Kanban card authorizes a materials handling agent
to move the tray to a specified destination?
a. Conveyance authorization card
b. Production authorization card
c. Vendor authorization card
d. Dual-card Kanban system
18. Which of the following is not a characteristic of the ABC inventory classification
system?
a. It classifies inventory items based on the size of resources required to control
usage value.
b. The greater the usage value, the greater the resources to be allocated to control
usage of an item.
c. The system considers availability of materials.
d. Extent of allocation of resources is based on value of the inventory.
19. On what principle is ABC analysis based upon?
a. An item is critical if its usage is high.
b. There are usually a few critical items and several items that are less critical.
c. The safety stock (in terms of volume) should be higher for A items than for C
items.
d. An item is critical if its unit price is high.
20. JIT purchasing has many advantages over traditional purchasing. Which among
these is not an advantage?
a. Reduction in carrying costs
b. Improved quality
c. Increased responsiveness
d. Reduced flexibility
21. A Kanban system uses different types of cards to initiate material transactions.
Which of the following type of Kanban card authorizes the production
department to commence the production process?
a. Conveyance authorization card
b. Production authorization card
c. Vendor authorization card
d. Dual-card Kanban system
22. What does the concept of just-in-time purchasing highlight?
a. Maintain bulky inventory
b. Maintain safety stock in case of adversity
c. Maintain minimum inventory till the next replenishment
Exercises
A. The following table gives the unit cost and annual usage rates for different items.
Classify items based on their rupee volume using ABC classification and identify
them under A-classification.
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Type of Item Cost per Unit (Rs) Annual Usage
1 400 50
2 510 40
3 10 600
4 11 500
5 0.50 1,000
6 0.25 1,500
(Questions B to E)
Assume that JKL Industries uses 5 types of materials in its production process.
The quantity of each type of material used per year and the cost per unit is given
in the table below. Use this data to answer the following four questions.
Material Type Quantity Used per Year Cost per unit
1 2000 20
2 4500 10
3 1500 35
4 3000 20
5 2500 25
B. Use ABC analysis to identify the type of material that has the most usage value.
C. What is the least usage value of a material that requires lowest allocation of
resources?
D. Which type of material can be classified under A category?
E. Which material falls under the C category of ABC analysis?
Activity: A company uses a variety of raw materials in the manufacture of three-
wheelers. The following is the list of those materials based on their bin card
numbers and the cost of those materials. Classify them on the basis of ABC
analysis.
Answer:
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7. Summary
Materials management encompasses all operations management functions from
purchasing to the final delivery of the end items.
An organization can achieve significant cost savings, reduction in lead time,
improvement in production efficiency, and reduction in wastage by properly
managing materials.
Materials management covers purchase of raw materials, management and control of
work-in-process items, stores and warehouse management, and distribution of
finished products.
The flow of materials is divided into three overlapping functions of production
control, inventory control, and materials handling.
The inventory control function involves maintaining stock in various stages of
minimized.
The materials handling function involves the physical movement of materials into,
through, and out of the firm.
Techniques like the Kanban system, ABC classification system, and JIT purchasing
are used in the management and control of material in an organization.
8. Glossary
ABC classification system: Based on the usage value, materials are classified into
three categories: A (materials of high usage value per annum accounting for 60-70%
of the total cost), B (materials of moderate usage value per annum accounting for 10-
30% of the total cost), and C (materials of low usage value accounting for 5-15% of
the total cost).
Automated and semi-automated guided vehicles: These are used to store and
retrieve inventory items from stock. Semi-automated guided vehicles, which are a
combination of computer and human control, can move independently on their guided
paths to a specific workstation and then signal to the operator to perform the required
operation.
Automated storage and retrieval systems: These are computer-controlled and
mechanically-operated materials handling systems. These systems function like
physically operated robots.
Conveyance systems: The inventory items are stored in standardized boxes, which
have a trip control device that prevents the inventory items from spilling out. To pick
up a particular inventory item, the computer releases the control device at the place
where that item is located and the box automatically falls onto the conveyor. The
conveyor then sends the boxed items to the order-processing area where a robot or a
human being collects them.
Distribution centers and warehouses: These are physical facilities used to store and
ship inventory.
Finished goods inventory department: It checks the quantity and quality of the
products in the production process, stores the products to protect them from pilferage
and other damage, audits the finished goods inventory, and retrieves the finished
goods from the stocks.
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Fixed sequence robots: These perform a sequence of operations based on a
predetermined set of procedures.
Intelligent robots: These robots perceive the environmental conditions of the
workplace through tactile or visual perception or both and can make necessary and
suitable decisions by using on-board computers.
Inventory control: It involves the maintenance of stock in various stages of
minimized. This function is performed by the raw material inventory, production, and
finished goods departments.
JIT Purchasing: The size of the purchased quantities is reduced to such an extent that
the materials directly reach the production point.
Kanban system: Firms store their materials and other inventory items in a single-use
container like trays or boxes. A card called the Kanban is attached to each container
that holds a specific amount of materials or other inventory parts used to manufacture
the product. These cards are used for initiating the transactions.
Materials handling: It manages the physical movement of materials into, through,
and out of the firm to the required location in a timely and cost-effective manner
without affecting the primary objectives of the other two materials management
functions.
Materials management: The study of flow of materials through various operations in
a production facility. It helps in assessing material requirements at various stages of
the production process and in maintaining a control over the firms production and
distribution functions.
Numerical control robots: These perform a set of operations based on numerical
data fed into them through punched tapes, data cards, and digital switches.
Physically operated robots: These have a mechanical arm and hand and are used by
workers to pick up materials.
Playback robots: These robots store a sequence of operations in memory. An
operator initially performs these operations using a robot.
Production control: It involves directing and regulating the movement of goods
through the entire manufacturing cycle from the process of purchasing materials to
producing the finished product.
Production department: It allows the continuous flow of goods during the
production process without any stoppages.
Purchasing department: It acquires the required materials in the right quantity, of
the right quality, from the right source, at the right time, and at the least possible cost.
Raw materials inventory department: It manages the raw materials inventory,
which is the collection of inputs used in the production process.
Receiving department: It processes the incoming shipments of materials.
Robots: These are computer-controlled, re-programmable, multi-functional
manipulators designed to move materials, parts, tools, and other specialized devices
through variable programmed motions to perform various tasks independently.
Shipping department: It delivers goods from the finished goods inventory
department to customers.
99
Single-card and dual-card Kanban system: In a single-card Kanban system, a
conveyance card is used, while in a dual-card Kanban system, the conveyance card
and the vendor card is used. In this system, the required quantity is obtained from the
vendor and a vendor authorization card is used in the process.
Usage value: The product of the number of units of a material used per year and the
cost per unit.
Variable-sequence robots: The sequence of actions performed by these robots can
be easily changed depending on the nature of operations to be performed, while their
functioning is similar to that of fixed sequence robots.
1. Materials management is viewed as a trouble avoidance and opportunistic tool to
improve a firms profits. Define materials management and explain the need for
it.
2. The materials management process is explained by three inter-related functions of
an organization. Explain in detail the different functions of materials
management.
3. The use of the latest technology has enhanced the efficiency of materials
management. What are the various technologies available for material managers
for managing materials?
4. Various techniques are being used by organizations to manage and control
materials. What are the different materials management techniques being used?
Explain in detail.
6. Just-In-Time Inventory Management and Lean Manufacturing
<http://www.tvdance.com/information/jit/>
7. Traditional Costing, ABC, JIT
<http://www.maaw.info/TradABCJIT.htm>
8. Kanban
<http://www.ifm.eng.cam.ac.uk/dstools/process/kanban.html>
9. Just-In-Time
<http://www.inventorymanagementreview.org/2005/10/the_risks_of_be.html>
10. Kanban
<http://www.strategosinc.com/kanban.htm>
100
1. (a) Vendor analysis
The functions of materials management are production control, materials
handling and inventory control. Vendor analysis is associated with purchase
management (purchase department).
2. (c) i, ii and iii
Alternatives i, ii and iii are tasks carried out by the raw material inventory
department. Alternative iv is associated with the receiving department. The
tasks of the receiving department include unpacking incoming materials,
checking quantity and inspecting quality and then generating receiving reports.
Storing raw materials safely is a task of the raw material department. All other
tasks are carried out by the shipping department.
4. (c) To move materials to the required location in a timely and cost-effective
way without affecting the primary objective of production control and
inventory control
Materials handling refers to managing the physical movement of materials into,
through, and out of the firm. The primary objective of materials management is to
move materials to the required location in a timely and cost-effective way without
affecting the primary objective of production control and inventory control
functions.
5. (a) Purchase department
The inventory control function is represented in three departments - Raw
materials inventory department, production department and finished goods
inventory department. Purchase department is associated with the inventory
control function of materials management.
6. (c) Locating and receiving raw materials
Locating and receiving raw materials is the function of the raw materials
inventory department. All the other options are functions of the production
department. The function of production control aims at directing and regulating
goods movement through the entire manufacturing cycle from the process of
purchasing materials to making the finished product. The departments involved in
this function are purchasing department, receiving department, raw materials
inventory department and production department.
7. (b) Processing requisitions for materials
Processing requisitions for material is done by the purchase department and not
by the receiving department. The main task of the former is to acquire the
required materials in the right quantity, of the right quality, from the right source,
at the right time and at the least possible cost. The primary responsibility of the
receiving department is to process incoming shipments of materials.
8. (c) Materials management
Materials management is the study of flow of materials through various
operations in a production facility. Inventory management deals with managing
inventory and maintaining it at optimum levels. Operations management
encompasses both materials management and inventory management. Purchase
management is a separate sub-function under materials management.
101
9. (b) i, ii and iv
Shortage in materials supply affects the firm in many ways. They include
stoppage or breakage in production, delay in delivery to customers, increase in
operational expenses, etc. On the other hand, the efficiency of the production
process actually decreases rather than rising.
10. (c) Finished goods inventory department
Purchase department, raw material inventory department, receiving department
and production department are associated with production control. The finished
goods inventory department is associated with inventory control function.
11. (c) Variable-sequence robot
The function of variable-sequence robots is similar to that of fixed-sequence
robots, but the sequence of tasks can be changed depending on the nature of
operations to be performed.
12. (a) Fixed-sequence
Fixed-sequence robots perform a sequence of operations based on a
predetermined set of procedures. Electronic sensors are used to activate these
robots.
13. (b) Intelligent robots
Intelligent robots perceive the environmental conditions of the workplace through
tactile or visual perception or both and can make necessary and suitable decisions
by using on-board computers.
14. (b) These systems store a sequence of operations in memory.
All the statements are true regarding automated storage and retrieval systems,
except statement (b). Playback robots store a sequence of operations in memory.
15. (c) Conveyance systems
In conveyance systems, the inventory items are stored in standardized boxes.
These boxes have a trip control device that prevents the inventory items from
spilling out. The systems are controlled by a Computer Integrated Manufacturing
System.
16. (a) ABC
The ABC classification system is also referred to as ABC (Always Better
Control) analysis. The purpose is to alter expenses associated with controlling
materials according to their usage value.
17. (a) Conveyance authorization card
A Kanban system uses three types of cards to initiate material transactions:
production authorization card, vendor authorization card and conveyance
authorization card. A conveyance authorization card authorizes a materials
handling agent to move the tray to a specified destination. This specifies the
products name, its identification number and delivery destination. The dual-card
Kanban system makes use of two Kanban cards, a conveyance card and a vendor
card.
18. (c) The system considers availability of materials.
Resource allocation is made based on value of the inventory. The more valuable
the inventory is, the more the resources allocated. Even though the method
facilitates selective control of materials, the method suffers from several
limitations. One limitation is that ABC analysis does not consider the aspect of
availability of materials.
102
19. (a) An item is critical if its usage is high
In ABC analysis, an item is said to be critical if its usage is high. The purpose of
this analysis is to alter expenses associated with controlling materials according
to their usage value.
20. (d) Reduced flexibility
In JIT purchasing, flexibility is higher in terms of ability to change materials
required at the last minute depending on changes in customer/client preferences,
etc. Thus, flexibility is not reduced. It rather increases.
21. (b) Production authorization card
A Kanban system uses three types of cards to initiate material transactions:
production authorization card, vendor authorization card and conveyance
authorization card. The production authorization card authorizes the production
department to start the production process. This card describes the products
name, identification number and description and the list of materials needed for
continuing the production process.
22. (c) Maintain minimum inventory till the next replenishment
JIT purchasing implies that inventory can be replenished just-in-time for
manufacture. The method advocates reduction in size of purchased quantities to
the extent that materials reach the production point directly. Hence, safety stocks
need not be maintained.
A. Items 1 & 2 fall under A-classification
Calculate usage value of each material and arrange them in the descending order
of their usage values.
Type of
Material
Usage Value
(Cost per Unit x Annual Usage)
% of Usage
Value
Cumulative
Value
1 20000 37.90 37.90
2 20400 38.65 76.55
3 6000 11.37 87.92
4 5500 10.42 98.34
5 500 0.95 99.29
6 375 0.71 100
Total 52775 100
Here, we can see that two materials (materials 1 and 2) out of 6 materials
account for 76.55% of total costs. That means 76.55% of total resources are to be
assigned to control 33.33% of the materials (two out of six materials). So,
materials 1 and 2 are categorized A type materials.
103
B. Type 5
Material
Type
Quantity Used
per Year
Cost per
Unit
Usage Value
(Quantity Used x Cost per Unit)
1 2000 20 40000
2 4500 10 45000
3 1500 35 52500
4 3000 20 60000
5 2500 25 62500
C. 40000
Material Type Quantity Used per Year Cost per Unit Usage Value
1 2000 20 40000
2 4500 10 45000
3 1500 35 52500
4 3000 20 60000
5 2500 25 62500
D. Type 5
From the above table it is evident that Type 5 materials have the highest usage
value of Rs. 62500. Hence, they fall under A category.
E. Type 1
Type 1 material has the least usage value of Rs. 40000. Hence, this material is
under C category.
Course Components
Block
VI
OPERATIONS CONTROL
UNIT 25
Operations Scheduling 1-33
UNIT 26
Enterprise Resource Planning 34-47
UNIT 27
Supply Chain Management 48-66
UNIT 28
Just-In-Time (JIT) Management System 67-77
UNIT 29
Productivity and Quality Management 78-96
UNIT 30
Facilities and Maintenance Management 97-116
Expert Committee
Hyderabad Hyderabad


Hyderabad


Prof. Vivek Gupta
Hyderabad

Hyderabad

Ms. Smita Singh
IU, Sikkim

Mr. Ch Syamala Devi
IU, Meghalaya

Hyderabad

IU, Mizoram
Aizawal

IU, Dehradun

Mr. Manoj Kumar De
IU, Tripura
Agartala






Block VI
The sixth block of the course on Project & Operations Management deals with
operations control. The block contains six units. The first unit explains
operations scheduling. The second unit focuses on enterprise resource
planning. The third unit examines the concept of supply chain management.
The fourth unit deals with Just-In-Time manufacturing system. The fifth unit
discusses productivity and quality management, and the sixth unit deals with
facilities and maintenance management.
The first unit, Operations Scheduling, discusses the purpose of scheduling.
The unit focuses on the various scheduling methods and activities. It deals
with scheduling by type of operations, and scheduling personnel in service
operations. The unit also provides an idea about the various techniques used
for scheduling.
The second unit, Enterprise Resource Planning, deals with evolution of
enterprise resource planning (ERP). The unit also explains the concepts of
business process reengineering, and business modeling for ERP. It discusses
the implementation of ERP. The unit also deals with the use of ERP by
organizations to gain a competitive advantage.
The third unit, Supply Chain Management, provides an idea about the business
drivers in supply chain management. The unit explains the principles of
supply chain management, the forces shaping supply chain management. It
discusses the supply chain management framework, and the customer focus in
supply chain management. It also examines electronic supply chain
management.
The fourth unit, Just-In-Time (JIT) Management System, explains the concept
and importance of JIT system. The unit discusses the advantages of JIT
systems. It also examines the characteristics of JIT systems.
The fifth unit, Productivity and Quality Management, discusses about
productivity, and the strategic role played by quality. The unit discusses the
vital role played by inspection in quality control, and the concept of cost of
quality. It also explains the statistical concepts in quality control, and about
acceptance plans. The unit also examines the use of computers in quality
control, and the concept of total quality management.
The sixth unit, Facilities and Maintenance Management, discusses facilities
management, and the necessity of maintenance management. The unit
explains the various types of maintenance, and the economics of maintenance.
It examines how to evaluate the preventive maintenance policies, and the
modern approaches to preventive maintenance. The unit also deals with the
recent trends in maintenance.
Unit 25
Operations Scheduling
Structure
1. Introduction
2. Objectives
3. Purpose of Scheduling
4. Scheduling Methods
5. Scheduling Activities
6. Scheduling by Type of Operations
7. Scheduling Personnel in Service Operations
8. Scheduling Techniques
9. Summary
10. Glossary
1. Introduction
In the last unit of the previous block, we have discussed materials management. We
have learnt that materials management encompasses all operations management
functions from purchasing to the final delivery of the end items. In this unit, we will
discuss operations scheduling.
Scheduling is a process of setting up operation processing times so that jobs will be
completed on time. Scheduling of operations helps in providing the best service to
customers by making efficient use of the firms resources.
This unit will discuss the purpose of scheduling. We will discuss the various
scheduling methods and activities. We shall then move on to discuss the scheduling
by type of operations, and scheduling personnel in service operations. Finally, we
would discuss the various techniques used for scheduling.
2. Objectives
state the purpose of scheduling.
discuss the various scheduling methods and activities.
define scheduling by type of operations.
evaluate the role played by scheduling personnel in service operations.
explain the various scheduling techniques.
Operations Control
2
3. Purpose of Scheduling
Scheduling of operations helps in maximizing customer satisfaction and minimizing
service delays. By properly scheduling their operations, firms can make the optimum
allocation of their production capacity and resources to meet customer requirements
on time, carry out the production process most efficiently, reduce costs, and increase
profitability. Scheduling high capacity would result in facilities remaining idle for a
time and in wastage of resources whereas scheduling low capacity would result in
incomplete jobs at the specified time, resulting in poor customer service. So firms
have to develop their schedules in such a way that the resources are optimally
allocated to meet customer requirements.
4. Scheduling Methods
Many methods can be used for scheduling operations. Selection of a scheduling
method depends mainly on the volume of production and the nature of the operation.
Scheduling operations are classified into: forward scheduling, backward scheduling,
and a combination of both.
Forward Scheduling
In this method, the actual production activities start when a job order is received. The
operations manager schedules each operation forward in time starting from the date of
production. This method is used to determine the start and finish times for jobs to be
done by assigning them to the earliest available time slots at the work center. Forward
scheduling is used in fabrication operations where products are customized based on
customer specifications.
Backward Scheduling
In this method, orders are scheduled based on their due dates. The operations manager
obtains the due dates for the job orders and develops the schedule backward, thereby
determining the latest point when the production activity can be started in order to
complete the order on time. The start and finish times for jobs are assigned to the
latest available time slots. This method is also used in service organizations when the
demand for services is anticipated earlier.
Depending on the nature of the job, firms use either forward or backward scheduling.
Both these methods are also useful to wholesalers and retailers. For example,
wholesalers use forward scheduling for replenishing stock, while backward
scheduling is used for making arrangements for special events like marriages.
Example: Gamma Machines Limited has two job orders, X and Y. Both orders have
to be processed on two machines 1 and 2. The route sheets for the jobs are given in the
table. Both the jobs should be ready in the next eight hours and both the machines are
to start processing now. Develop schedules for both the jobs using forward and
backward scheduling.
Job X Route Sheet Job Y Route Sheet
Routing
Sequence
Machine
Processing
Time (hours)
Routing
Sequence
Machine
Processing
Time (hours)
1 1 2 1 1 2
2 2 3 2 2 3
3 1 1
Total 6 Total 5
3
Solution:
Forward Scheduling Backward Scheduling
M 1 M 2 M1 M 2
8 Y2 X3 Y2
7 X2
6 X3
5 X2
4 Y1 X1 Y2
3
2 X1 Y1
1
Activity: Classy Machines Limited has two job orders, A and B. Both orders have
to be processed on two machines 1 and 2. The route sheets for the jobs are given in
the table. Both jobs should be ready in the next eight hours and both the machines
are to start processing now. Develop schedules for both the jobs using forward and
backward scheduling.
Job A Route Sheet Job B Route Sheet
Routing
Sequence
Machine Processing
Time
(hours)
Routing
Sequence
Machine Processing
Time
(hours)
1 1 3 1 1 3
2 2 1 2 2 2
3 1 2
Total 6 Total 5
Answer:
Operations Control
4
Check Your Progress
1. In which type of scheduling method, are orders scheduled according to their due
dates?
a. Forward
b. Backward
c. Routing
d. Hybrid
2. Which of the following is not a basic objective of scheduling activities?
a. To meet customer requirements on time
b. To carry out the production process most efficiently
c. To minimize service delays
d. To minimize inventory costs
Exercises
(Questions A to F)
Use the following table to answer the following six questions. The table shows two
jobs on two machines and their respective routing sequences. Both jobs should be
completed in 9 hours.
Job X Route Sheet Job Y Route Sheet
Routing
Sequence
Machine Processing
Time
(Hours)
Routing
Sequence
Machine Processing
Time
(Hours)
1 1 3 1 2 2
2 2 2 2 1 3
3 1 2 2 1
Total 7 Total 6
A. What will be the representation of forward scheduling for Jobs X and Y?
B. What will be the representation of backward scheduling for Jobs X and Y?
C. Using forward scheduling, what is the earliest finish time of Job X?
D. What is the earliest finish time of Job Y in forward scheduling?
E. What is the latest start time for Job X in backward scheduling?
F. What is the latest start time for Job Y in backward scheduling?
5. Scheduling Activities
The scheduling process involves three activities: routing, loading, and dispatching.
Routing
Routing gives the specifications of the work-flow. It provides the sequence of
operations and processes to be followed in order to produce a particular product.
Routing determines what work is to be done, and where and how it is to be done. The
5
operations manager develops routing sheets (hard copy) or routing files (electronic
copy for computerized organizations) that provide detailed information regarding the
sequence in which a product is manufactured.
Loading
Loading is the process of assigning specific jobs to each work center for the planning
period. The capacity limitations of each work center have to be considered for loading
in order to assign jobs to the work centers. In general, operations managers load jobs
onto a work center up to its standard capacity. Loading helps in minimizing costs by
reducing machine idle time, the amount of inventory, etc. It also includes the task of
sequencing jobs so that the machine idle times are minimized and the jobs are
completed within the least possible time.
Dispatching
Dispatching is the final act of releasing job orders to the workers to go ahead with the
production process. The following dispatching or priority rules are used by
manufacturing and service firms for scheduling their production activities:
Earliest due date In this method, firms prioritize their jobs based on their earliest
due date.
Longest processing time In this method, jobs that have the longest processing time
are loaded first onto the work center as they are considered more valuable to the
organization.
Shortest processing time In this method, firms prioritize their jobs on the basis of the
shortest processing time of jobs. Under this rule, jobs with shorter processing times
get completed earlier than jobs with longer processing times. This rule ensures that
minimum number of jobs are left for processing.
First in, first serve In this method, firms process their jobs in the order of their
arrival.
Slack time remaining (STR) In this method, the slack time of each job is calculated
which is the difference between the time remaining in the due date and the processing
time required.
Example: Fifth Avenue Bakery specializes in making deliveries of varieties of
chocolate cakes. Due to the Christmas season and New Year, the orders have
increased. On a particular day, the following are the movements of the customers:
Customer Arrival Making Time (Hours) Due Time (Hours)
A 9 am 4 6
B 11 am 3 4
C 1 pm 5 8
D 3 pm 1 2
E 5 pm 2 3
Find out the order in which these customers are to be served by considering the
following:
Earliest Due Date, Longest Processing Time, Shortest Processing Time, First In First
Serve, and Slack Time Remaining. Also calculate the average delay of a job in each
case.
Operations Control
6
Solution:
a. Earliest Due Date
The order of jobs according to their earliest due date is, D E B A C.
Customer Making Time Due Time Flow Time Delay
D 1 2 0+1=1 0
E 2 3 1+2=3 0
B 3 4 3+3=6 2
A 4 6 6+4=10 4
C 5 8 10+5=15 7
The average delay for the job is (0+0+2+4+7)/5 = 13/5 = 2.6 hours.
b. Longest Processing Time
The order of jobs according to their longest processing time is, C A B E D.
Customer Making time Due time Flow time Delay
C 5 8 0+5=5 0
A 4 6 5+4=9 3
B 3 4 9+3=12 8
E 2 3 12+2=14 11
D 1 2 14+1=15 13
The average delay for the job is = (0+3+8+11+13)/5 = 35/5 = 7 hours
c. Shortest Processing Time
The order of jobs according to their shortest processing time is, D E B A C.
D 1 2 0+1=1 0
E 2 3 1+2=3 0
B 3 4 3+3=6 2
A 4 6 6+4=10 4
C 5 8 10+5=15 7
d. First In First Serve Schedule
The arrival of the jobs is in the order A B C D E.
7
A 4 6 0+4=4 0
B 3 4 4+3=7 3
C 5 8 7+5=12 4
D 1 2 12+1=13 11
E 2 3 13+2=15 12
The average delay for the job is = (0+3+4+11+12)/5 = 30/5 = 6 hours
e. Slack Time Remaining
The slack times of the jobs A, B, C, D, and E are (6-4), (4-3), (8-5), (2-1), and (3-2)
respectively. B, D, and E have the same slack time values. Since the processing time
of D is lower than the processing times of B and E, job D is dispatched before jobs B
and E. Similarly, since the processing time of E is lower than the processing time of
B, job E will be dispatched before job B. Therefore, the order of jobs according their
slack time remaining is D E B A C.
Customer Slack Time Making Time Due Time Flow Time Delay
D 2-1 = 1 1 2 0+1=1 0
E 3-2 = 1 2 3 1+2=3 0
B 4-3 = 1 3 4 3+3=6 2
A 6-4 = 2 4 6 6+4=10 4
C 8-5 = 3 5 8 10+5=15 7
Activity: Kubera Printer Works is involved in printing and binding works. The
company has received orders from four customers P, Q, R, and S (in the same
order) at the beginning of the week.
Customer Making Time (hours) Due Time (hours)
P 3 4
Q 5 7
R 4 6
S 2 5
Find out the order in which these customers are to be served considering the
following:
Earliest Due Date, Longest Processing Time, Shortest Processing Time, First In
First Serve, and Slack Time Remaining. Also calculate the average delay of a job
in each case.
Contd
Operations Control
8
Contd
Answer:
Check Your Progress
3. In which scheduling activity is the capacity limitation of each work center to be
considered while assigning jobs?
a. Loading
b. Sequencing
c. Expediting
d. Routing
4. Which scheduling activity describes the specification of work flow in operations
scheduling?
a. Routing
b. Loading
c. Dispatching
d. All of the above
5. Assigning specific jobs to each work center for the planning period is called
___________.
a. Routing
b. Loading
c. Dispatching
6. Which of the following dispatching rules do firms use when they want to
maximize the number of completed jobs and reduce the number of jobs in
waiting?
a. Longest processing time
b. Shortest processing time
c. First in, first serve
d. Slack time remaining
Exercises
(Questions G to Q)
Sriram Welders undertakes customized welding and fabrication works for different
customers across the country. Jobs A, B, C, D and E are to be taken up at the
beginning of the week. Processing times and due dates for these jobs are given in the
following table. Use this data to answer the following eleven questions.
9
Job (In Order of Arrival) Processing Times (days) Due date (Days Hence)
A 4 4
B 5 8
C 4 6
D 2 5
E 3 7
G. What is the order in which jobs are taken for processing using the earliest due
date rule?
H. What is the average time of a job using the earliest due date rule?
I. The shortest processing time among all jobs is for job D. What is the total delay
for job D if the longest processing time rule is used?
J. What is the average delay using the longest processing time rule?
K. What is the delay for the last job processed using the first in-first serve rule?
L. What is the average delay when the first in-first serve rule is used?
M. Using the slack time remaining (STR) rule, the job with the shortest slack time is
dispatched first. Which of the following jobs have the shortest slack time?
N. What is the time delay for the last job processed using the slack time remaining
(STR) rule?
O. What is the average delay if the STR rule is used to dispatch jobs?
P. What is the average time if the shortest processing time rule is used?
Q. Which dispatching rule would you suggest to Sriram Welders if the objective is to
reduce the average delay in the work?
6. Scheduling by Type of Operations
Operations managers have to schedule inventories for manufacturing operations,
undertake coordination between vendors and workers, ensure that there is no wastage
of resources, and also make sure that the idle time of the machinery and the equipment
is minimal. In service operations, services are delivered only when they are
demanded. Therefore, scheduling should be done based on demand requirements
rather than on inventory requirements.
Job Operations
Job operations involve manufacturing of products or delivery of services in low
volumes on the basis of orders. Therefore, there are considerable variations in the
materials used, set up time, etc. Scheduling is done as per the customers
requirements. Gantt charts, job sequencing methods, and critical ratio are the methods
used for scheduling these operations.
Repetitive Operations
Repetitive or continuous operations involve mass production of a product or a service.
Therefore, there are few variations in the production process. These operations use
trained labor and equipment designed for a narrow range of applications. There is a
Operations Control
10
need to control flow of materials and application of labor resources to minimize idle
time. Scheduling for these operations focuses on matching customer demand with the
production activities of the firm and avoiding delays in the flow of materials. JIT
principles and queuing analysis are the methods used for scheduling these operations.
Labor-Intensive Operations
As the work involved in labor-intensive operations is routine, managers consider the
opinions of employees while scheduling their work times. Operations managers use
certain personnel-related scheduling approaches like: Flextime Employees choose
their work timings, provided that a specified number of hours are completed in a
week. Flextour Employees choose their start time, but must work each day for eight
hours. Staggered times Employees select their work hours from a list of available
shifts. Compressed workweek Employees work for ten hours a day for four days in a
week. Part time Employees work for less than forty hours, usually twenty hours per
week on a temporary basis. The benefits that firms derive by using part-time workers
are reduced personnel costs as part-time workers do not get any fringe benefits and
improved performance of the firm as part-time workers are less likely to find their
jobs monotonous. The benefit to the employees is that a part-time job can be taken up
in addition to a regular job.
Service Operations
Scheduling service operations is different from scheduling manufacturing operations
as services cannot be stored to meet the demand at peak hours. For example, unused
seats in a plane cannot be stored for future use. Demand fluctuates highly in service
operations. For example, a deadline to pay telephone bills creates a peak in demand
for bill paying facilities on the due date. Service operations, in general, are operated
on a first in-first serve basis. Scheduling provides both better customer service and
more efficient use of service facilities. However, there is a trade-off between the two
as service facilities are normally limited and over-utilization of staff and facilities may
adversely affect quality. During peak times, demand is met by engaging part-time
workers. However, this is not always possible as the capacity of the service facilities
is fixed. Therefore, different methods are used by operations managers to deal with
such constraints and to schedule their operations. Some of the methods used to meet
customer demand under situations of limited availability of service facilities are:
Appointment systems Firms use appointment systems to schedule their resources to
satisfy the requirements of individual customers. Using this system, the operations
manager can control customer arrival timings so that the firms resources can be fully
utilized. In this system, customers are allotted a time, called the appointment time, to
meet the service provider.
Reservation systems Firms use reservation systems to schedule multiple resources
and facilities together to meet the demands of several customers. For example, a hotel
can schedule all its resources like room, bed, food, and other facilities to serve a
customer when he/she reserves a room. These systems also allow firms to discontinue
unprofitable business operations. For example, several travel agencies mention a
disclaimer in their contractual agreement that allow them to cancel the tour if a
sufficient number of customers do not make bookings on a tour.
Strategic product pricing Strategic product pricing helps firms to adjust to
fluctuations in demand. For example, the use of electricity increases during summer.
Thus, the electricity companies adopt a summer price strategy where they hike the
electricity charges during the season.
11
Check Your Progress
7. In which of the following type of labor-intensive scheduling approach, are
employees given the freedom of choosing their start time, but have to work for
eight hours each day?
a. Flextime approach
b. Flextour approach
c. Compressed work week
d. Staggered times approach
8. Repetitive operations normally involve mass production of a product or a service.
Which of the following is not a characteristic of repetitive operations?
a. Mass production of a product
b. Need to control flow of materials and application of labor resources to minimize
idle time
c. Focus on synchronizing customer demand with production activity
d. There are large variations in the production process and the equipment is
designed for a broad range of applications
9. In which of the following personnel scheduling approaches are employees given
an option of choosing their work timings, provided they complete a specified
number of hours a week?
a. Flextime approach
b. Flextour approach
c. Compressed work week
d. Staggered times
10. The scheduling of operations is different for different types of operations. In
which of the following operations is flow of material given utmost importance?
a. Job operations
b. Repetitive operations
c. Labor-intensive operations
d. All of the above
7. Scheduling Personnel in Service Operations
Service firms have to meet varying demand requirements across different time
periods. They make use of different schedules to meet the demand accordingly. A
service organization can develop weekly, daily and hourly schedules. A weekly
schedule for each employee with two consecutive days off in a week can be drawn up
using scheduling consecutive days off approach. Scheduling daily work time helps
determine the least number of workers required to accomplish the daily work load.
Service requirements may vary from hour to hour in service firms such as hotels and
restaurants. So these firms engage more workers when the demand is high using the
scheduling hourly work time approach. Let us understand the scheduling daily work
time approach with an example.
Example: A firm is engaged in manufacturing four types of toys A, B, C and D. Each
toy is manufactured through three functions: molding, assembly, and decorating work.
The following table provides the production rate (number of units per hour) of each
function for each type of product.
Operations Control
12
Product Volume Production Rate (units per hour)
Molding Assembly Decorating work
X 200 2.5 3.5 5.26
Y 100 1.5 3 2
Z 150 2 4 3
Solution: Based on the above information, we calculate the time required for
completing each function of all types of products.
Product Processing times Total time
Molding Assembly Decorating work
X 80 57 38 177
Y 67 33 50 150
Z 75 38 50 163
Total 222 128 138 488
By assuming each employee works for eight hours a day, we obtain the number of
employees required by dividing the total number of hours with 8.
Therefore, the number of employees required for molding is 222/8 = 27.75, assembly
work is 128/8 = 16, and decorating work is 138/8 = 17.25.
In total, 61 employees are required to complete all the work.
So, the firm should engage 27 employees for molding work, 16 employees for
assembly and 17 employees for decorating work; and one employee can be engaged in
molding work for 75 percent of time (6 hours a day) and decorating work for 25
percent of time (2 hours a day).
8. Scheduling Techniques
Operations managers use several techniques like Gantt charts, job sequencing rules,
queuing theory, and critical ratio methods, to schedule jobs in various departments.
Gantt Charts
The Gantt charts named after Henry L. Gantt are a graphical display of the duration of
a set of activities. These are simple bar charts used to schedule any type of operation.
They display the use of resources over a period of time graphically. The vertical axis
of the chart represents the firms facility and the horizontal axis represents the
schedule duration. Gantt charts help communicate important job information easily
and clearly. However, they do not consider hurdles like production breakdown and
human performance. They are useful only when the number of work centers is limited,
the job times are long, and the job routings are short. Gantt charts are of two types:
Workload charts and Scheduling charts.
13
Figure 1: Gantt Workload Chart
Workload charts Workload charts are used to represent workload levels for
equipment, work centers, or departments. The vertical axis of the chart represents the
machines or any other facilities used to manufacture or process job orders and the
horizontal axis represents the time taken. Refer Figure 1 for a typical workload chart.
Here, the vertical axis represents the machines P, Q, R, and S used to process the job
orders A, B, and C represented on the horizontal axis. Each of these machines is
assigned to a number of jobs shown as rectangular boxes. The length of the rectangle
represents the time requirement of that job. The time estimates used in these charts are
obtained from standard time estimates. After working for a specified period, the
machine requires some maintenance activity. Through the charts, the manager can
plan for routine maintenance for each facility. The charts also depict the idle time for
each machine. The idle time of a machine is represented by the space between two
consecutive jobs. Thus, the manager can identify the idle times of various machines
and fill them with unplanned jobs to enhance the overall productivity.
Scheduling charts Scheduling charts depict the progress of the jobs as they pass
through various work centers. These charts are useful when a particular job requires
the use of several machines. Refer Figure 2 for a typical scheduling chart. The chart
shows the progress of jobs A, B, C, and D through various work centers. The dotted
vertical line represents the current date. In the figure, the dotted line is at the middle of
week five. The chart shows that job A is half a week behind schedule, job B is
completed on schedule, job C is ahead of schedule, and job D has been completed on
schedule.
Johnsons Job Sequencing Rules
Job sequencing is very important for the proper scheduling of jobs. It maximizes the
operations efficiency, minimizes the processing time of jobs, and reduces the
processing costs of the firm over a period of time. Jobs processed in a single stage of
production can be simply scheduled one after another whereas for those involving two
or more stages of production, firms should ensure that jobs are sequenced in a way
which minimizes the idle time. Operations managers use Johnsons rules to develop a
job sequence that minimizes the total time span required in completing the given jobs.
Operations Control
14
Figure 2: Gantt Scheduling Chart
Johnsons rule for two-stage production - Assume that the firm has to perform n
jobs and each job involves processing on two machines A and B in the order AB. For
example, the job involves first the printing operation in machine A and then the
binding operation in machine B. There are n numbers of books that are to be printed
and then bound. Assume the expected processing times of these jobs are A
1
, A
2
,---A
n
on machine A and B
1
, B
2
,---B
n
on machine B. We should determine the sequence in
which the n jobs should be processed using the two machines in order to minimize the
total elapsed time. To solve the above problem, Johnson and Bellman developed the
following steps:
a) Identify the least processing time in A1, A2,--- An; and B1, B2,--- Bn. If there is
a tie, select either of the processing times.
b) If the least processing time is A
r
(r
th
job on machine A), then the r
th
job is placed
at the beginning of the sequence. If it is B
s
(s
th
job on machine B), then the s
th
job
is placed at the end of the sequence. If A
r
= B
s
, then the r
th
job is placed at the
beginning and the s
th
job is placed at the end of the sequence.
c) If there is a tie for the least processing times on machine A, then any of the jobs
can be placed at the beginning of the sequence. If there is a tie for the least
processing times on machine B, any of the jobs can be placed at the end of the
sequence.
d) Identify the next least processing time and repeat the above steps. The process is
continued till all the jobs have been assigned in a sequence. The sequence
obtained is called the optimum sequence.
e) After finding out the optimum sequence, the total elapsed time and idle time on
machines A and B are calculated using the following formulae:
Total elapsed time = Time between starting of the first job and the last job in the
optimum sequence.
15
Idle time on machine A = The difference between the time when the last job in the
optimum sequence is completed on machine B and the time when the last job is
completed on machine A.
Idle time on machine B = (Time taken by machine A to complete the first job in the
optimum sequence) + [(time when k
th
job starts on machine B) (time when (k-1)
th
job finishes on machine B)]
Example: A firm processes six types of jobs on two machines: machine A and
machine B.
The processing times for each type of job (in hours) on both machine A and machine
B are given here.
Machines/Jobs 1 2 3 4 5 6
Machine A 6 6 4 6 5 8
Machine B 4 2 10 5 3 6
Using this information, determine an optimum sequence to process the various jobs so
that the total elapsed time is the minimum. Also calculate the total idle time on
machine A and machine B.
Solution:
Here, the least processing time is 2 hours for job 2 and it occurs on machine B. So this
job is placed at the end of the sequence, i.e. in the 6
th
place. This job is assigned first
and performed last.
2
Now, the next least processing time is 3 hours for job 5 on machine B. So, job 5 is
placed at the end of the sequence next to job 2 i.e., in the 5
th
place.
5 2
Now, the minimal values are 4 hours for job 3 on machine A and 4 hours for job 1 on
machine B. So job 3 is placed at the beginning of the sequence i.e. in the 1
st
place and
job 1 is placed before job 5 at the end of the sequence i.e. in the 4
th
place.
3 1 5 2
Now, the next least time is 5 hours for job 4 on machine B. We put job 4 in 3
rd
place
and the remaining job 6 in the 2
nd
place. So the optimum sequence obtained is:
3 6 4 1 5 2
We now develop the schedule of each job in the optimum sequence.
Schedule of 6 Jobs on 2-Machines
Job-
Sequence
Machine A Machine B
Time In
Processing
Time
Time
Out
Time In
Processing
Time
Time Out
3 0 4 4 4 10 14
6 4 8 12 14 6 20
Operations Control
16
Job-
Sequence
Machine A Machine B
Time In
Processing
Time
Time
Out
Time In
Processing
Time
Time Out
4 12 6 18 20 5 25
1 18 6 24 25 4 29
5 24 5 29 29 3 32
2 29 6 35 35 2 37
Therefore, the total elapsed time is 37 hours.
The idle time for machine A = 37 35 = 2 hours
The idle time for machine B = 4 + (35 32) = 4 + 3 = 7 hours
Total idle time = 2 + 7 = 9 hours
Activity: A firm is involved in processing six types of jobs on two machines X and
Y. The processing times for each type of job (in hours) on both machine X and
machine Y are given here.
Machines/Jobs 1 2 3 4 5 6
Machine X 40 110 60 30 100 110
Machine Y 80 105 100 70 40 20
Determine an optimum sequence to process the various jobs so that the total
elapsed time is the minimum. Also calculate the total idle time on machine X and
machine Y.
Answer:
Johnsons rule for three-stage production - In an n-job and three-machine
sequencing problem, three machines A, B, and C, are involved, and each job is
processed in the order ABC. Suppose the expected processing time for n-jobs on the
three machines A, B, and C are A
1
, A
2
,---A
n
; B
1
, B
2
,--- B
n
; C
1
, C
2
,--- C
n
. We should
determine the sequence in which these n-jobs should be processed on the three
machines to minimize the total operation time. In this procedure, any one of the
following conditions should be satisfied:
a) The smallest processing time on machine A should be greater than or equal to the
largest processing time on machine B.
b) The smallest processing time on machine C should be greater than or equal to the
largest processing time on machine B.
17
Assume that there are two machines, G and H, and the corresponding times of these
machines G
i
and Hi are obtained as:
G
i
= A
i
+ B
i
H
i
= B
i
+ C
i
We solve the problem in terms of n jobs and two machines, with an order of GH. The
resulting optimum sequence will also become the optimum sequence for the problem
of 3 machines and n-jobs.
Example: A firm is involved in five types of jobs, each of which must be processed
on three machines, A, B, and C in the order ABC.
The processing time of each job (in hours) on the three machines is given here:
Job Processing Times
A B C
1 8 5 4
2 10 6 9
3 6 2 8
4 7 3 6
5 11 4 5
Determine the sequence for the five jobs that minimizes the total operation time. Also
find the idle time of each machine A, B, and C.
Solution:
First we check whether the problem satisfies the conditions discussed earlier.
The smallest processing time on machine A is 6 and it is greater than or equal to the
largest processing time on machine B, i.e. 6.
Therefore, we can use Johnsons n-jobs, 3 - machine procedure to solve the problem.
G = A+ B H = B+ C
1 13 9
2 16 15
3 8 10
4 10 9
5 15 9
The optimum sequence is, 3, 2, 5, 4, and 1.
Now, we calculate the total operation time with the optimum sequence obtained.
Operations Control
18
Schedule of 5 jobs on 3-machines
Job
Sequence
Machine A Machine B Machine C
3 0 6 6 6 2 8 8 8 16
2 6 10 16 16 6 22 22 9 31
5 16 11 27 27 4 31 31 5 36
4 27 7 34 34 3 37 37 6 43
1 34 8 42 42 5 47 47 4 51
Thus, the total operation time is 51 hours.
Idle time on machine A = 51 42 = 9 hours.
Idle time on machine B = 6 + [(16 8) + (27 22) + (34 31) + (42 37)] + (51 47)
= 6 + 8 + 5 + 3 + 5 + 4 = 31 hours.
Idle time on machine C = 8 + [(22 16) + (37 36) + (47 43)] = 8 + 6 + 1 + 4 = 19
hours.
Total idle time = 9 + 31 + 19 = 59 hours
Activity: A firm is involved in five types of jobs, each of which must be processed
on three machines, X, Y, and Z in the order XYZ. The processing time of each job
(in hours) on the three machines is given here:
X
i
Y
i
Z
i
1 19 11 9
2 20 13 19
3 13 6 17
4 17 7 15
5 22 10 11
Determine the sequence for the five jobs that minimizes the total operation time.
Also find the idle time of each machine X, Y, and Z.
Answer:
19
Johnsons rule for n-jobs and m-machines - The process of sequencing n-jobs
through m-machines is as follows:
a) Suppose there are n jobs, 1, 2, 3 ...n and m-machines; A
1
, A
2
, A
3
A
m-1
, A
m
.
Suppose the processing times of job 1 on m-machines are A
11
, A
12
, A
13
A
1m
. For
job 2, they are A
21
, A
22
, A
23
, A
24
.A
2m
. Similarly, for job n, they are A
n1
, A
n2
,
A
n3
A
nm
. Check whether any one of the following conditions is satisfied:
The minimum time on machine A
1
is greater than or equal to maximum time on
machines A
2
, A
3
,..A
m-1
The minimum time on machine A
m
is greater than or equal to maximum time on
machines A
2
, A
3
A
m-1
.
b) Convert the m-machine problem into an equivalent two-machine problem by
introducing two fictitious machines, G and H. The processing times of these
machines are calculated as,
G
i
= A
i1
+A
i2
+A
i3
++A
im-1
H
i
= A
i2
+A
i3
+A
i4
++A
im
Then the optimum sequence is determined for these two machines.
Example: Determine the optimum sequence of processing for the given sequencing
problem of four jobs: A, B, C, D and four machines: P, Q, R, and S.
Job
Machines
P Q R S
A 13 8 7 14
B 12 6 8 19
C 9 7 5 15
D 8 5 6 15
Also find the total elapsed time and idle time on each machine.
Solution:
Here, minimum time on P = 8,
Maximum time on Q and R are 8 and 8 respectively.
Since the minimum on machine P is equal to the maximum time on machines Q and R
respectively, the problem can be solved using this method.
Now we take two fictitious machines, G and H whose processing times are
Job G = P + Q + R H = Q + R + S
A 28 29
B 26 33
C 21 27
D 19 26
Now we consider this as an n-job, 2-machine problem.
Operations Control
20
The optimum sequence is obtained as:
D C B A
The calculation of total elapsed time is shown here.
Machine P Machine Q Machine R Machine S
D 0 8 8 8 5 13 13 6 19 19 15 34
C 8 9 17 17 7 24 24 5 29 34 15 49
B 17 12 29 29 6 35 35 8 43 49 19 68
A 29 13 42 42 8 50 50 7 57 68 14 82
The total elapsed time is 82 hours.
The idle time of machine P is (82-42) = 40 hours.
The idle time of machine Q = 8 + [(17 13) + (29 24) + (42 35)] + (82 50) =
= 8 + 4 + 5 + 7 + 32 = 56 hours
The idle time of machine R is, 13 + [(24 19) + (35 29) + (50 43)] + (82 57) =
= 13 + 5 + 6 + 7 + 25 = 56 hours.
The idle time of machine S = 19 hours
Total idle time = 40 + 56 + 56 + 19 = 171 hours
Activity: Determine the optimum sequence of processing for the given sequencing
problem of four jobs: P, Q, R, S and four machines: A, B, C, and D. Also find the
total elapsed time and idle time on each machine.
Job
Machines
A B C D
P 11 8 6 10
Q 10 7 5 8
R 9 5 3 7
S 13 9 4 10
Answer:
21
Queuing Analysis
Queuing analysis involves the study of waiting lines and queuing systems. A queue
refers to customers or units waiting for a service. A queue is formed if the rate of
arrival of customers exceeds the service rate and customers or units have to wait to
receive the service. The waiting time often proves costly for service firms and needs
to be minimized. Increasing the capacity of service facilities reduces the queue, but
the facilities become idle when the customer arrival rate slows down. Queuing
analysis is used for balancing the costs of waiting time with the costs of providing
additional service facilities. It helps them to determine the optimum number of service
stations required. The disadvantages of queuing models are a) Poisson distribution
cannot effectively represent real life situations, like arrivals at a shopping center, b)
arrivals are assumed to come from an infinite population, c) the waiting space
available for the population arriving at the service facility is considered infinite, and
d) the effects of long queues on new arrivals are not considered.
Critical Ratio Method
The Critical Ratio Method is a technique of job sequencing used to verify whether a
job is being operated on schedule. The operations manager calculates the critical ratio
of a job as the ratio of the actual time remaining to complete the job and the scheduled
time remaining to complete the job.
Critical Ratio =
remaining work
remaining time Actual
The operation is considered to be behind schedule if the critical ratio is less than one.
If it is more than one, the operation is considered to have been processed ahead of
schedule. The method is used to revise the job status from time to time and to re-
prioritize them.
Example: Alpha Manufacturing Ltd. has started three jobs that require 29, 19, and 26
days to complete, respectively. The managing director of the company has engaged
three teams to execute each of these jobs. After 15 days, the operations managers of
the three jobs state that the number of days required to complete the jobs are 17, 10,
and 12 respectively. Calculate the critical ratio of each job and find out which job is to
be given priority.
Solution: The critical ratios and priorities are as follows:
Job Critical Ratio Priority Order
A (29-15)/17 = 1.21 0.82
B (19-15)/10 = 2.5 0.3
C (26-15)/12 = 1.09 0.92
The job with lower critical ratio will be given the top priority to be sequenced in the
next days production activities.
Activity: Phi Manufacturing Ltd. has started three jobs that require 32, 23, and 29
days to complete, respectively. The managing director of the company has engaged
three teams to execute each of these jobs. After 20 days, the operations managers
of the three jobs state that the number of days required to complete the jobs are 15,
11, and 13 respectively. Calculate the critical ratio of each job and find out which
job is to be given priority.
Contd
Operations Control
22
Contd
Answer:
Check Your Progress
11. Critical ratio method is a sequencing technique used by the operations managers
in scheduling work. Identify the correct formula for calculating the critical ratio.
a. Total time to complete the job / work remaining
b. Actual time remaining / work still remaining
c. Actual work remaining / planned time remaining
d. Total time remaining / actual time remaining
12. Operations managers generally use several techniques to schedule jobs in various
departments. How does the sequencing of jobs using Johnsons job sequencing
rules help a firm?
a. It minimizes processing time
b. It maximizes operating efficiency
c. It reduces processing costs
d. All of the above
13. Operations managers generally use several techniques to schedule jobs in various
departments. Which of the following is one of them?
a. Routing
b. Loading
c. Scheduling
d. Critical ratio
14. Which of the following scheduling methods is more suitable for an industry
where jobs are processed in multiple stages of production?
a. Line balancing
b. Sequencing rules
c. CRAFT
d. Linear programming
15. Which of the following statements about queuing analysis is incorrect?
a. Study of waiting lines and queuing systems.
b. Helps balance the costs of waiting time with the costs of providing additional
service facilities.
c. It helps maximize the number of service workstations required.
d. A queue will result if customer arrival rate is greater than service delivery rate.
23
16. The critical ratio method is a job sequencing technique that an operations
manager can use to verify whether a job is being performed on schedule. In this
technique, ________ the critical ratio, _______ the priority.
a. Lower, lower
b. Higher, higher
c. Lower, higher
d. Higher, lower
17. Under Johnsons sequencing rule, a problem of m machines and n jobs can be
simplified into two fictitious machines and n jobs. Using this criterion, identify
the correct mathematical representation of simplifying m machines into two
machines.
a. G
i
= A
i1
+A
i2
+A
i3
++A
im
H
i
= A
i2
+A
i3
+A
i4
++A
im
b. G
i
= A
i1
+A
i2
+A
i3
++A
im
H
i
= A
i2
+A
i3
+A
i4
++A
im-1
c. G
i
= A
i1
+A
i2
+A
i3
++A
im-1
H
i
= A
i2
+A
i3
+A
i4
++A
im
d. G
i
= A
i1
+A
i2
+A
i3
++A
im-1
H
i
= A
i2
+A
i3
+A
i4
++A
im-1
18. Which of the following situations leads to the formation of a queue in a service
organization?
a. Rate of arrival of customers is less than rate at which service is rendered
b. Rate of arrival of customers is equal to the rate at which service is rendered
c. Rate of arrival of customers is greater than the rate at which service is rendered
d. Both b and c
19. Which of the following is not a benefit associated with queuing analysis?
a. To minimize waiting costs
b. To determine optimum number of work/service stations
c. To balance waiting costs with the costs of providing additional service stations
d. To minimize processing time of jobs
Exercises
(Questions R to T)
Crescent SoftDesign, a designing company, currently has five projects A, B, C, D, and
E on hand which require150 days, 135 days, 180 days, 140 days and 120 days
respectively to complete. After 100 days, the operations manager identifies that these
projects still require 60 days, 30 days, 70 days, 45 days and 30 days respectively for
completion. Based on the given information, answer the following three questions.
R. Which of the projects has the least critical ratio?
S. Which of projects is(are) ahead of schedule?
T. Using the critical ratio method, give the order of priority based on the revised
time of completion after 100 days?
Operations Control
24
(Questions U & V)
Given below is a Workload Gantt chart where X, Y, Z represents three machines. A,
B, and C represent jobs to be performed on these machines during a particular week.
Answer the following two questions.
Work
Center
Week Number
1 2 3 4 5 6 7 8
X A B C
Y C A
Z B C A
U. Calculate the number of weeks required to complete job A.
V. From the Gantt chart select the machine most utilized.
W. Jobs A G involve processing on workstation 1 and 2. The time required at each
workstation for each job is given in the table below. Use Johnsons rule to
sequence these jobs.
(Questions X & Y)
Jagson Ltd. has started three jobs and engaged three teams to execute each job. Today
is day 20. The due dates and scheduled time remaining for each job are given in the
table below. Answer the following two questions.
Job Due Date Work Days Remaining
1 25 7
2 32 14
3 27 5
X. Calculate the critical ratios for job 1, 2 & 3 respectively?
Y. Which job should get highest priority?
9. Summary
Organizations schedule their activities to meet customers requirements on time and
improve their operational efficiency.
Operations can be scheduled in different ways. Broadly they can be divided into
forward scheduling, backward scheduling, and a combination of both.
Scheduling activities include routing, loading, and dispatching. Routing gives the
sequence of operations and the work centers that perform the work.
The various priority rules in dispatching are: earliest due date, longest processing
time, shortest processing time, first in first serve, and slack time remaining.
Depending on the type of operation, the method of scheduling also differs.
25
Service operations can be scheduled by following various approaches like
appointment systems, reservation systems, and strategic product pricing.
The scheduling of personnel in service organizations will vary depending on demand.
This can be done on a weekly basis, daily basis or hourly basis.
Operations managers follow several scheduling techniques such as Gantt charts,
Johnsons job sequencing rules, queuing analysis, and the critical ratio method to
schedule operations.
10. Glossary
Backward scheduling: In this, orders are scheduled based on their due dates. The
operations manager obtains the due dates for the job orders and develops the schedule
backward, thereby determining the latest point when the production activity can be
started in order to complete the order on time.
Compressed workweek: Employees work for ten hours a day for four days in a
week.
Critical Ratio Method: The ratio of the actual time remaining to complete the job
and the scheduled time remaining to complete the job.
Dispatching: It is the final act of releasing job orders to the workers to go ahead with
the production process. As the work involved in labor-intensive operations is routine,
managers consider the opinions of employees while scheduling their work times.
Flextime: Employees choose their work timings, provided that a specified number of
hours are completed in a week.
Flextour: Employees choose their start time, but must work each day for eight hours.
Forward scheduling: In this method, the actual production activities start when a job
order is received. The operations manager schedules each operation forward in time
starting from the date of production.
Gantt charts: A graphical display of the duration of a set of activities. These are
simple bar charts used to schedule any type of operation. They display the use of
resources over a period of time graphically.
Johnsons job sequencing rules: It is very important for the proper scheduling of
jobs. It maximizes the operations efficiency, minimizes the processing time of jobs,
and reduces the processing costs of the firm over a period of time.
Loading: It is the process of assigning specific jobs to each work center for the
planning period. It also includes the task of sequencing jobs so that the machine idle
times are minimized and the jobs are completed within the least possible time.
Part time: Employees work for less than forty hours, usually twenty hours per week
on a temporary basis.
Queue: Customers or units waiting for a service. A queue is formed if the rate of
arrival of customers exceeds the service rate and customers or units have to wait to
receive the service.
Queuing analysis: The study of waiting lines and queuing systems. It is used for
balancing the costs of waiting time with the costs of providing additional service
facilities. It helps them to determine the optimum number of service stations required.
Routing: It provides the sequence of operations and processes to be followed in order
to produce a particular product. It determines what work is to be done, and where and
how it is to be done.
Operations Control
26
Scheduling charts: They depict the progress of the jobs as they pass through various
work centers. These charts are useful when a particular job requires the use of several
machines.
Scheduling: A process of setting up operation processing times so that jobs will be
completed on time. It helps in providing the best service to customers by making
efficient use of the firms resources.
Staggered times: Employees select their work hours from a list of available shifts.
Workload charts: These are used to represent workload levels for equipment, work
centers, or departments. The vertical axis of the chart represents the machines or any
other facilities used to manufacture or process job orders and the horizontal axis
represents the time taken.
1. Scheduling is a process of setting up operation processing times so that the jobs
will be completed on time. Explain the purpose and importance of scheduling
operations in an organization.
2. Organizations use various methods for scheduling operations. Explain them in
detail.
3. Scheduling of operations helps in maximizing customer satisfaction and
minimizing service delays. Explain the scheduling process in detail.
4. Operations scheduling is different for different operations. Why? Explain in
detail.
5. Operations managers use several techniques to schedule jobs in various
departments. What are the various scheduling techniques that operations
managers use?
1. Gantt Chart
<http://www.mindtools.com/pages/article/newPPM_03.htm>
2. Gantt Chart
<http://www.netmba.com/operations/project/gantt/>
3. Gantt Chart
<http://www.ganttchart.com/index.html>
4. Job Sequencing
<http://members.tripod.com/KewHL/job.htm>
1. (b) Backward
The backward scheduling method schedules orders as per their due dates. The
operations manager schedules production activity based on due dates for job
orders so that the production activity can be timed to complete the order on time.
Forward and hybrid scheduling are also types of scheduling methods. Routing is a
scheduling activity.
2. (d) To minimize inventory costs
Minimizing inventory costs is the objective of inventory management. Scheduling
is concerned with meeting customer requirements on time by carrying out the
production process efficiently and by reducing service delays.
27
3. (a) Loading
When assigning specific jobs to each work center, loading decides capacity
limitations of centers as well.
4. (a) Routing
It explains the sequence of operations and processes to be followed to produce a
particular product. Routing determines what work is to be done and where and
how it is to be done. Hence, routing describes the specification of workflow.
5. (b) Loading
Loading is defined as assigning specific jobs to each work center for the planning
period. Loading of jobs is done upto the standard capacity of the workstation.
6. (b) Shortest processing time
Here, jobs are processed in the shortest time. Under this rule, jobs with shorter
processing times get completed earlier than jobs with longer processing times.
This rule ensures that minimum number of jobs are left for processing.
7. (b) Flextour approach
Under Flextour, employees are given some freedom in choosing their start time,
but they must work eight hours a day.
8. (d) There are large variations in the production process and the equipment is
designed for a broad range of applications
There are few variations in the production process for repetitive operations. In
these operations, labor is trained and the equipment designed for a narrow range
of applications.
9. (a) Flextime approach
Under flextime, employees are given the option of choosing their work timings
provided they work for a specified number of hours in a given time period, say a
week.
10. (b) Repetitive operations
Repetitive operations are also called continuous operations as they are performed
continuously to produce goods in bulk. Here, stock-outs can hinder the
production process and lead to high costs for the firm.
11. (b) Actual time remaining / work still remaining
Critical ratio is calculated by dividing the actual time remaining to complete work
by work remaining (in time units). If the critical ratio of an operation is less than
one, the operation is behind schedule. If the critical ratio is more than one the
operation is being processed ahead of schedule.
Johnsons job sequencing rules help the operations managers in minimizing
processing time, maximizing the operating efficiency, and reducing the operating
costs.
13. (d) Critical ratio
The critical ratio method is a job sequencing technique an operations manager can
use to verify whether a job is on schedule. Whatever the method employed, the
process of scheduling involves three activities: routing, loading and dispatching.
Operations Control
28
14. (b) Sequencing rules
When jobs are processed in a single stage of production, they can be scheduled
one after another. If two or more stages of production are required, firms should
ensure that jobs are sequenced in a way that idle time is minimized. Operations
managers can use job sequencing rules and develop a job sequence that
minimizes total time required to complete a given job.
15. (c) It helps maximize the number of service workstations required.
Queuing analysis helps determine the optimum (not maximum) number of
workstations required to meet demand.
16. (c) Lower, higher
The lower the critical ratio, the higher the priority in sequencing the job in the
next days production activities.
17. (c) G
i
= A
i1
+A
i2
+A
i3
++A
im-1
H
i
= A
i2
+A
i3
+A
i4
++A
im
A problem of n jobs and m machines can be simplified to n jobs and two
machines to use Johnsons sequencing rule. Two fictitious machines (G
i
and H
i
)
are introduced where
G
i
= A
i1
+A
i2
+A
i3
++A
im-1
and H
i
= A
i2
+A
i3
+A
i4
++A
im
18. (c) Rate of arrival of customers is greater than the rate at which service is
rendered
In a service organization, when the arrival rate of customers is greater than the
rate at which service is rendered to each customer a queue forms.
19. (d) To minimize processing time of jobs
Waiting time in a queue often proves costly to service firms and so they use
queuing analysis to minimize this as far as possible. Queuing also helps
operations managers to determine the optimum number of service stations
required, which can lead them to striking a balance between waiting costs and
cost of providing additional service stations. Johnsons job sequencing rules is
useful for proper scheduling of jobs. It helps firms minimize the processing time
of jobs.
A.
Time 1 2 3 4 5 6 7 8 9
M 1 X1 X1 X1 Y2 Y2 Y2 X3 X3
M 2 Y1 Y1 X2 X2 Y3
In forward scheduling, both jobs start immediately after job orders are received. Job X
starts on machine 1 (M1) and job Y on machine 2 (M2). X runs on M1 for 3 hours and
Y runs on M2 for 2 hours. Y remains idle for the third hour as X is under process on
M1. In the fourth hour Y goes to M1 for 3 hours and X goes to M2 for 2 hours. Hence
in the sixth hour X has to wait to be processed on M1 as Y is still on M1. In the
seventh hour, X goes to M1 for 2 hours and Y goes to M2 for 1hour. Hence, Job Y
gets completed at the end of seventh hour and Job
X gets completed at the end of eight hour.
29
B.
Time 1 2 3 4 5 6 7 8 9
M1 X1 X1 X1 Y2 Y2 Y2 X3 X3
M2 Y1 Y1 X2 X2 Y3
In backward scheduling, the schedule is calculated backwards from the due date of
completion. As this is nine hours, scheduling starts at the ninth hour and works
backwards. Here the last sequence for jobs X and Y are placed at the ninth hour. X3
needs 2 hours and Y needs 1 hour. M1 is occupied up to the eighth hour. In the
seventh hour Y2 is processed on M1 and X2 on M2. Y2 requires 3 hours and X2
requires 2hours. Y2 would be on M1 until fifth hour and X2 would be completed in
the sixth hour itself. In the fourth hour, X1 must be completed on M1 and Y1 on M2
in the third hour. Hence, X1 starts in the second hour and Y1 in the third hour.
C. 8 hours
starts on machine 1 (M1) and job Y on machine 2 (M2). X runs on M1 for 3hours and
Y runs on M2 for 2hours. Y remains idle for the third hour as X is under process on
seventh hour, X goes to M1 for 2hours and Y goes to M2 for 1hour. Hence, Job Y gets
completed at the end of seventh hour and Job X gets completed at the end of the
eighth hour.
D. 7 hours
starts on machine 1 (M1) and job Y on machine 2 (M2). X runs on M1 for 3hours and
Y runs on M2 for 2hours. Y remains idle for the third hour as X is under process on
seventh hour, X goes to M1 for 2hours and Y goes to M2 for 1hour. Hence, Job Y gets
completed at the end of the seventh hour and Job X gets completed at the end of
eighth hour.
E. 2 hours
requires 2 hours. Y2 would be on M1 until the fifth hour and X2 would be completed
in the sixth hour itself. In the fourth hour, X1 must be completed on M1 and Y1 on
M2 in the third hour. Hence, X1 starts in the second hour and Y1 in the third hour.
F. 3 hours
requires 2hours. Y2 would be on M1 until the fifth hour and X2 would be completed
in the sixth hour. In the fourth hour, X1 must be completed on M1 and Y1 on M2 in
the third hour. Hence, X1 starts in the second hour and Y1 in the third hour.
Operations Control
30
G. A D C E B
From the given data, the earliest due dates are given below:
A 4 days, B 8 days, C 6 days, D 5 days, and E 7 days. Therefore, the order of
jobs is A D C E B.
H. 4.2 days
Job Sequence Processing Time Due Date Flow Time Delay
A 4 4 0 + 4 = 4 4 - 4 = 0
D 2 5 4 + 2 = 6 6 5 = 1
C 4 6 6 + 4 = 10 10 6 = 4
E 3 7 10 + 3 = 13 13 7 = 6
B 5 8 13 + 5 =18 18 8 = 10
Average time = (0+1+4+6+10)/5 = 21/5 = 4.2 days
I. 13 days
B 5 7 0 + 5 = 5 5 5 = 0
A 4 4 5 + 4 = 9 9 5 = 5
C 4 6 9 + 4 = 13 13 6 = 7
E 3 7 13 + 3 = 16 16 7 = 9
D 2 5 16 + 2 = 18 18 5 = 13
Hence, the total delay for job D is 13 days.
J. 6.8 days
B 5 7 0+5 = 5 5 5 = 0
A 4 4 5+4 = 9 9 5 = 5
C 4 6 9+4 = 13 13 6 = 7
E 3 7 13+3=16 16 7 = 9
D 2 5 16+2 = 18 18 5 = 13
Average delay = (0+5+7+9+13) /5 = 34/5 = 6.8 days
K. 11 days
Job Sequence Processing Time Due Date Time Flow Delay
A 4 4 0 + 4 = 4 4 4 = 0
B 5 8 4 + 5 = 9 9 8 = 1
31
C 4 6 9 + 4 = 13 13 6 = 7
D 2 5 13 + 2 = 15 15 5 = 10
E 3 7 15 + 3 =18 18 7 = 11
The last job performed using this rule is E and the delay for job E is 11 days.
L. 5.8 days
A 4 4 0+4 = 4 4 4 = 0
B 5 8 4+5 = 9 9 8 = 1
C 4 6 9+4 = 13 13 6 = 7
D 2 5 13+2 =15 15 5 = 10
E 3 7 15+3=18 18 7 = 11
Average delay = (0+1+7+10+11)/5 = 29/5 = 5.8 days
M. A
Job A has the shortest slack time as the difference between due date and processing
time for job A is (4 4) = 0 days.
N. 11 days
A 4 4 0+4 = 4 4 4 = 0
C 4 6 4+4 = 8 8 6 = 2
D 2 5 8+2 =10 10 5 = 5
B 5 8 10+5 =15 15 8 = 7
E 3 7 15+3=18 18 7 = 11
Jobs D and B are having the same slack time of three (5 2) & (8 5) days
respectively. But job D has a processing time of 2 days, which is less than for job B (5
days). Here D is dispatched before B. But the last job to be processed using this rule is
E, which has a maximum slack time of 4 (7 3) days. The time delay for job E is 11
days.
O. 5 days
A 4 4 0+4 = 4 4 4 = 0
C 4 6 4+4 = 8 8 6 = 2
D 2 5 8+2 =10 10 5 = 5
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32
B 5 8 10+5 =15 15 8 = 7
E 3 7 15+3=18 18 7 = 11
Average delay = (0+2+5+7+11)/5 = 25/5 = 5 days
P. 4.4 days
D 2 5 0+2 =2 0
E 3 7 2+3=5 0
A 4 4 5+4 = 9 9 4 = 5
C 4 6 9+4 = 13 13 6 = 7
B 5 8 13+5 =18 18 8 = 10
Average time delay = (0+0+5+7+10)/5 = 22/5= 4.4 days
Q. Earliest due date
Average delay using each of these rules (calculated earlier) is as follows:
Earliest due date = 4.2 days, First in, first serve = 5.8 days, Shortest processing time =
4.4 days, and Slack time remaining = 5.0 days. Hence, to reduce the average delay to a
minimum, earliest due date rule can be suggested for the job A, B, C. D, and E.
R. E
Critical ratio is calculated by dividing the planned time remaining to complete the
work by actual work remaining (in time units). Critical ratio for Project A = (150 -
100)/60 = 0.833, Critical ratio for Project B = (135 - 00)/30 = 1.167, Critical ratio for
Project C = (180 -100)/70 = 1.143, Critical ratio for Project D = (140 -100)/45 =
0.889, Critical ratio for Project E = (120 -100)/30 = 0.667. Projects A, D and E have
critical ratio less than one. Hence they are on priority as they are behind schedule.
Among them Project E has the least critical ratio of 0.667 and therefore is of highest
priority.
S. B and C
If the critical ratio of an operation is less than one, it can be said the operation is
behind schedule. If the critical ratio is more than one, the operation is being processed
ahead of schedule. Of the five projects, only B and C have a critical ratio more than
one. Hence, B and C are ahead of schedule.
T. E A D C B
The lower the critical ratio, the higher the priority for sequencing that job during
further production. Hence, by arranging the five projects in order from least critical
ratio to highest critical ratio, we get, E A D C B.
U. 5 weeks
Job A was processed on machine X in the first two weeks and on machine Y in the 6
th
and 7
th
weeks. Finally, it is processed on machine Z in week 8. The total time is 5
weeks.
33
V. Machine X
Machine X was the most utilized. From the Gantt chart, it is clear it was used for 6
weeks. Machines Y and Z were utilized for 4 weeks each.
Jobs A B C D E F G
Workstation 1 9 8 7 6 1 2 4
Workstation 2 6 5 7 3 2 6 7
W. E-F-G-C-A-B-D
The least time on workstation 1 is for job E. Place E at the beginning of the sequence.
Least time on workstation 2 is again job E, which is already placed. The next least
time is for job D on workstation 2. Place D at the end of the sequence. Continue this
process to arrive at the sequence: E-F-G-C-A-B-D.
X. Job 1 = 0.714; Job 2 = 0.857; Job 3 = 1.400
Critical ratio = Planned time remaining / actual work remaining
Job Due Date Actual work
Remaining
Planned Time
Remaining
Critical Ratio
1 25 7 25-20 = 5 0.714
2 32 14 32-20 = 12 0.857
3 27 5 27-20 = 7 1.400
Y. Job 1
The critical ratio for job 1 is the least at 0.714. Hence, it is given first priority over job
2. Job 3 is already ahead of schedule.
Unit 26
Enterprise Resource Planning
Structure
1. Introduction
2. Objectives
3. Evolution of ERP
4. Business Process Reengineering
5. Business Modeling for ERP
6. ERP Implementation
7. ERP and Competitive Advantage
8. Summary
9. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the scheduling techniques
such as Gantt charts, Johnsons job sequencing rules, queuing analysis, and the critical
ratio method used by operations managers to schedule operations. In this unit, we will
discuss enterprise resource planning.
The necessity of organizations to integrate different business processes for smooth
functioning is fulfilled by Enterprise Resource Planning or the ERP system. ERP uses
a single database that stores information from different functional domains. This
database meets the information needs of different entities. Through this integrated
approach, the production department located in one geographical area can send
financial information to the head office and the marketing information of one location
can be accessed by the production department at another location, so that the market
changes can be identified and the appropriate responses designed. Proper ERP
implementation facilitates effective decision-making by providing relevant and timely
information to the management.
This unit will introduce you to the evolution of ERP. We will discuss the concept of
business process reengineering, and then study business modeling for ERP. We shall
then move on to discuss the implementation of ERP. Finally, we shall discuss how
ERP can be used by organizations to gain competitive advantage.
2. Objectives
explain the evolution of ERP.
discuss business process reengineering.
define business modeling for ERP.
evaluate the ERP implementation process.
assess the role played by ERP in helping organizations gain competitive advantage.
35
3. Evolution of ERP
Organizations were always working towards integrating all their business units to enhance
productivity but the tools to achieve this integration were not available. The increase in
advanced software tools over the years led to the development of software packages that
allowed timely information sharing and allowed the integration of different functional
units. The history of ERP can be traced back to 1972 when five employees of IBM left the
company and established SAP (Systems, Application, and Products in Data Processing) in
Walldorf, Germany. SAP was the first company to develop and maintain ERP software.
The development of ERP can be traced back to the concepts of MRP and MRP II. MRP
systems are used in manufacturing to automate inventory management and production
processes. MRP II is an extension of MRP, developed with the objective of automating all
the manufacturing functions and providing an interface with other functional domains.
ERP extends the functionality of MRP and MRP II systems to provide complete business
solutions. ERP has the ability to integrate different business entities without being
restricted by geographical and functional differences.
4. Business Process Reengineering
Business process reengineering is defined as the fundamental rethinking and radical
redesign of business processes to achieve dramatic improvements in critical,
contemporary measures of performance such as cost, quality, service, and speed.
Business Process Reengineering (BPR) advocates a complete overhaul of the existing
systems and processes in an organization in order to increase productivity, reduce costs,
and improve business practices. Business process is defined as a set of logically related
tasks performed to achieve a defined business outcome. BPR transforms labor- and
machinery-based productivity into knowledge- and information-based productivity. The
relationship between a company and its customers has gained new dimensions and
expanded from the buying and selling of products to customer service, consulting, and
pricing to production and distribution. Due to products and services being more widely
available, customers have become increasingly selective. BPR makes companies more
customer-focused and responsive to changes in the marketplace.
BPR and IT
The extensive application of IT in business has forced organizations to go in for BPR
as implementation of IT requires changes in business processes. Through BPR,
organizations can take full advantage of the benefits offered by IT as BPR and IT are
inter-related.
Activity: Zack & Cody Inc is a 20-year-old textile manufacturing company.
Whenever the company felt that it needed to restructure, the first step it took was to
lay off employees. Recently, the management decided to restructure the entire
organization. It again decided to start with downsizing. However, the senior
managers and the middle level managers protested against the managements
decision and suggested that the company should go in for business process
reengineering. Which do you think is a better option: downsizing or going in for
business process reengineering? In what way do you think reengineering would
help a company like Zack & Cody?
Answer:
Operations Control
36
Check Your Progress
1. Which among the following options involves a fundamental rethinking and
radical redesigning of the business processes in order to achieve dramatic
improvements in critical, contemporary measures of performance such as cost,
quality, service, and speed?
a. Supply chain management
b. Enterprise resource planning
c. Business process reengineering
d. Manufacturing resource planning
2. All the statements given below are true regarding business process reengineering,
except:
a. It advocates a complete overhaul of the existing systems and processes in an
organization in order to increase productivity, reduce costs and improve business
practices.
b. It transforms knowledge and information-based productivity into labor and
machinery-based productivity.
c. It makes companies more customer-focused and responsive to changes in the
marketplace.
d. It helps organizations take full advantage of the benefits offered by information
technology.
3. Which of the following statements is not correct regarding the evolution of
Enterprise Resource Planning (ERP)?
a. The history of ERP can be traced back to 1972.
b. IBM was the first company to develop and maintain ERP software.
c. ERP extends the functionality of MRP and MRP II systems to provide complete
business solutions.
d. ERP has the ability to integrate different business entities without being restricted
by geographical and functional differences.
4. Which among the following can be defined as a set of logically related tasks
carried out to achieve a defined business outcome?
a. Strategies
b. Activity
c. Business model
d. Business process
5. Business Modeling for ERP
Business modeling is a forerunner of BPR, ERP implementation, etc. A business
model is a representation of various business systems and processes, and their
interconnections and interdependencies. It provides a general overview of the
operations of a business without giving the technical details of the processes and
systems. Broadly, it defines the activities performed and the workflow structure. A
good business model should be clear, consistent, and absolute. A business model is
developed on the basis of the organizations goals, objectives, and strategic plans. It
37
shows how various business processes exchange information among themselves and
the underlying database. An ERP system is implemented to provide the requisite
information to individuals to enable them to perform business processes more
efficiently and effectively.
Integrated Data Model
One of the critical steps in ERP implementation is the development of an integrated
data model. The model ensures that the ERP system is able to integrate and provide
coordination between various departments, functions, and levels of management.
Integration enables the smooth flow of information that helps in the decision-making
process, minimizes data redundancy, and ensures the availability of right information
to all concerned. A well-designed data model for the ERP system should integrate
information from various processes and functions. Issues like security, confidentiality,
accuracy, during the integration process leads to generation of a data model that
represents the entire organization with an integrated data flow structure.
The following issues should be considered for successful ERP implementation:
Functionality The functions of the ERP package should complement the prevailing
best business practices in the companys field of operation.
Technology The ERP package should be scalable and should support open and non-
proprietary technology standards. This would reduce risk and ensure compatibility of
the systems with other IT solutions.
Implementability The ERP package should be easy to configure and use, and
flexible enough to accommodate the optimization of business processes.
6.1. ERP Implementation Methodology
The following are the different stages in a typical ERP implementation program:
Identify the Needs for the ERP package In this stage, the needs that are to be
satisfied by adopting the ERP package are identified. Companies can then evaluate
how ERP implementation can help satisfy these needs.
Evaluating the as-is Situation of the Business In this stage, the various
processes involved in the working of the organization are identified.
Decisions about the Desired Would-Be Situations for the Business In this
stage, the desired attributes for each of the processes are identified. Performance
standards are set for each process by using benchmarking techniques.
Reengineering of Business Processes to Achieve the Desired Results
Organizations can achieve the desired standards in business processes by
reengineering their current processes.
Evaluation of Available ERP Packages After conceptualizing the process of
designing the business processes, the ERP packages are evaluated to identify the
package that will provide a comprehensive solution to the organizations
requirements. The points that need to be considered for selecting a package are:
Global Presence The ERP package should be globally acceptable.
Local Presence The package should also be able to handle country-specific business
practices.
Operations Control
38
R & D Investment Selection should be based on the amount of R&D put in by the
ERP vendor.
Target Market The type of industry for which the package is being designed is to be
considered.
Price The selection depends upon the price of the ERP.
Modularity The package should be available in separate modules.
Ease and cost of implementation As the process of ERP implementation calls for
organizational structural changes, it should be quick, trouble-free, and should allow
smooth transition from the old systems.
Installation of requisite hardware and networks After selecting the package, the
hardware requirements like servers, PC workstations, network equipment, etc. should
be considered.
6.2. Implementation of ERP packages
The following are the steps involved in ERP implementation:
Formation of implementation teams: The ERP implementation team should consist
of personnel from IT and other functions along with implementation consultants. A
steering committee is to be formed to continuously monitor the implementation
process to identify deviations, cost overruns, resource requirements, etc., during the
process. To carry out successful ERP implementation, the members of the steering
committee should be able to understand business redesign and integration. The
steering team should be trained in process mapping and reengineering methodology
and it should be fully involved in the process redesign so that it can guide the team
members (implementation team) properly.
Preparation of implementation plan: Various elements of the implementation
process are identified and a comprehensive plan is devised to cover those elements.
The activities of the plan are scheduled using PERT/CPM techniques. The plan should
include training for project teams, mapping business processes onto the software,
function- or module-wise implementation, customization, transferring data from
existing systems, trial runs, parallel run, and transition.
Mapping of business processes onto the package: In this stage, the reengineered
business processes are mapped onto the software. Gaps are identified if the
requirements are not fulfilled by the available system.
Gap analysis: Gap analysis helps in identifying the areas that are not handled by the
standard system. Results from Gap analysis are divided into gaps that can be
eliminated with minimal programming, gaps that require extensive rework and
additional resources, gaps that cannot be handled by the system. For the first category
of gaps, the project team can take action, while for the second and third categories, the
steering committee should take action such as allocating extra resources, if required.
Customization: Customization of the ERP package is done by gathering information
from mapping and the gap analysis. After identifying the customization needs,
functional teams are given the responsibility of customizing the package to meet the
firms requirements and finalize the structure of the package.
Uploading of data from existing systems: After finalizing the structure of the
package, the information from the old systems is transferred to the new system. Errors
or discrepancies during the transfer are verified by double-checking the transfer.
39
Test runs: Test runs are conducted to see how the system performs after
customization and master data transfer.
User training: End users are trained based on their functional requirements and are
informed about the functionality of the new system.
Parallel run: In this stage, both the old system and the new system are put into
operation simultaneously. This helps in a smooth transition from the old system to the
new without hampering operations.
Migration to the new system: The organization migrates to the new system after
ensuring that the parallel run is error-free and the users feel confident about operating
the new system.
User documentation: This provides detailed information on how to carry out
transactions.
System monitoring and fine-tuning: IT personnel should monitor the performance
of the system to keep it optimal. If needed, they should fine-tune the database.
6.3. Guidelines for ERP Implementation
To benefit from the ERP system, organizations should follow the following
guidelines:
Define corporate needs and culture: Defining corporate needs before ERP
implementation helps the organization to assess its readiness to change. ERP
implementation involves redefining the roles of different functional departments, and
the authority and responsibility of individuals throughout the organization.
Complete business process change: Before going in for actual implementation, a
short business process redesign exercise should be carried out on the basis of the ERP
package structure so that there is no variation between the required functionalities and
those provided by the package, and to assess the implications of the changes.
Communicate across the organization: The different entities involved or affected by
ERP implementation will be aware of its effects on their jobs through communication.
Provide strong leadership: The successful implementation of an ERP system
requires strong leadership.
Select a balanced team: Because of the size and complexity of ERP implementation
and maintenance, a balanced team of professionals from different functions is
essential.
Select a good method of implementation: Project leaders should set the targets to be
achieved in the various phases of implementation and continuously review the
progress against the targets. They should clearly define the project scope, develop the
work breakdown structure (WBS), and estimate the time required to complete each
activity identified in the WBS. This helps them reach a realistic project plan. They
need to ensure that the quality of the system is maintained.
Organization-wide training: ERP is a complex and organization-wide system that
requires training to derive the full advantage of the capabilities of the system. The
steering team should be trained in process analysis and redesign, the IT personnel
should be aware of the package architecture, design, and configuration, and the
functional managers should learn how the system performs and how it can be useful in
the decision-making process.
Operations Control
40
Example: Nestls ERP
In 2000, Switzerland-based Nestl SA signed a $ 200 million contract with SAP to
install an ERP system for its employees in 80 countries. The company also paid an
additional $ 80 million for consulting and maintenance. The installation was
scheduled to be carried out for three years in the companys largest sites along with
others. The main idea behind implementing ERP was to unify the companys
operations. Nestl aimed to consolidate all of its operations and leverage on its size
and buying power. In addition, the company could centralize its operations and
control data to ensure consistency and accuracy. Since each unit of the company
was an autonomous unit, the company faced a competitive disadvantage. Nestl
decided to go in for one system that could be used by all the units, so that it could
become more efficient and survive in the industry.
Nestl UK and Nestl USA, subsidiaries of Nestl SA, had already implemented
the ERP system. Nestl UK had implemented SAP R/3 over five years in 18 of the
companys manufacturing sites in the UK. The implementation ended in 1999 and
it was considered to be one of the countrys largest ERP systems with more than
6,000 users. Within two years of implementing ERP, Nestl UK gained back its
entire investment. It helped the company to reduce inventory levels. The company
was able to tighten its control on inventory, and discipline its business processes.
Implementation of ERP fostered a culture of continuous improvement in the
subsidiary. The priorities were clearly defined first on internal opportunities,
second on business-to-business, and third on business to consumer. Nestl UK also
hired a process development manager who acted as a bridge between business and
the IT department and ensured that the employees focused on continuous
improvement rather than on maintaining the existing systems.
Nestl USA spent $ 200 million and implemented an ERP project in 1997 known as
Best (Business Excellence through Systems Technology). The project was scheduled
for six years and was wrapped up in early 2003. For the US subsidiary, the aim was to
create One Nestl by integrating all the brands of the company into one. Before ERP
implementation, the US subsidiary had nine different general ledgers and 28 points of
customer entry. The aim of the ERP project was to bring down these numbers to one.
Though the subsidiary faced a bumpy ride while implementing ERP, it finally paid off.
As of 2002, Nestl USA claimed that it had realized savings of about $ 325 million
mostly by making improvements in the supply chain.
Adapted from Derek S. Dieringer, ERP Implementation at Nestle, June 24, 2004,
http://www.uwosh.edu/faculty_staff/wresch/ERPNestle.htm
Activity: Utopia Ltd is a US company which has been implementing ERP for the past
five years. However, the management of the company felt that it was not reaping the
benefits of ERP. It therefore, appointed an outside consultant to find out the reasons for
this. The consultant found that the company had failed to implement ERP properly. She
stated that Utopia was facing the same kind of situations that other companies who had
failed to implement ERP properly were facing. Do you think the company failed to take
into account the factors which are necessary for implementing ERP? What are the ERP
implementation problems faced by companies like Utopia?
Answer:
41
Check Your Progress
5. Strong leadership is an important success factor in implementing an ERP system.
Which of the following will enable the steering committee to produce successful
results in ERP implementation?
i. The committee should understand the redesign and integration
ii. The committee should be trained in process mapping
iii. The committee should be fully involved in process redesign so that it can guide
the team members
a. Only i
b. i and ii
c. ii and iii
d. i, ii, and iii
6. Business modeling is a precursor to business process reengineering, ERP
implementation, etc. What is the purpose of business modeling?
a. To provide details of activities performed and workflow structure
b. To provide an overview of operations without focusing on processes and systems
c. To provide details of processes and systems
d. Both a & b
7. A good business model should be comprehensible, coherent and complete. Which
of the following is not a primary basis for developing a business model?
a. Goals
b. Objectives
c. Strategic plans
d. Market structure
8. The key activity of _____________ is to monitor the implementation process
continuously in order to identify deviations, cost overruns, resource requirements,
etc., during implementation.
a. Project member
b. Project leader
c. Project team
d. Steering committee
9. Which of the following types of information are required to customize an ERP
package as per an organizations requirements?
i. Information from mapping of business processes
ii. Information from gap analysis
iii. Market information
iv. Information about the companys competitors
a. Only i
b. i and ii
c. ii and iii
d. Only iii
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42
10. One of the critical steps of ERP implementation is the development of an
integrated data model. How does this help an organization?
i. Increases connectivity between departments
ii. Helps in smooth flow of information between departments
iii. Increases data redundancy
iv. Ensures availability of right information
a. i, ii, iii
b. i, ii, iv
c. ii, iii, iv
d. i, ii, iii, iv
11. What is the basic objective behind defining corporate needs of an organization
before ERP implementation?
a. To assess the readiness of the organization to accept change
b. To identify the gaps in terms of handling information
c. To facilitate speedy implementation
d. All of the above
12. An organization is required to undergo a brief business process redesign exercise
before actual ERP implementation. Why?
a. To assess the readiness of the organization to change
b. To assess the implications of the changes
c. To facilitate speedy implementation
d. To identify the gaps in terms of handling information
7. ERP and Competitive Advantage
An organization should have a competitive advantage over others to attract and retain
business. An organization can gain a competitive advantage by understanding the
scope of a particular market and identifying the various inherent differences between
various markets. ERP enables the organization to optimize and organize different
qualifiers and order-winners to gain a competitive advantage in the market. Qualifiers
are the most basic attributes that an organization must possess before any customer
decides to deal with it. They provide the initial impetus to customers to deal with an
organization. But to close a deal, organizations must have order-winners, which could
be price advantage, quality, etc. The following are some of the order-winners and
qualifiers:
Price The ERP package helps in identifying the cost centers and assists in devising
plans to reduce the production costs. The company can become cost-efficient by
setting up cost targets and an accurate monitoring system. ERP should be
implemented in areas where significant costs are involved so that appropriate resource
allocations can be made and management attention can be focused on them.
Delivery Reliability and Speed Customers judge an organizations competitiveness
through delivery reliability. ERP can streamline procurement and distribution
activities and reduce the lead-time involved in purchasing raw materials and the
distribution of finished products.
Quality ERP helps in achieving the quality objectives by bridging the gap between
the existing process and the best process.
43
Product Range Organizations need a variety of products in their product line to
satisfy the requirements of different segments of the market and to face the growing
competition. ERP with an integrated functionality and a common database enhances
the capabilities that assist organizations in this direction.
Activity: The top management of Happy Living, a healthcare organization, decided
to go in for ERP, which is used by the manufacturing sector. The companys
employees were surprised by the managements decision. The management of the
company explained the importance of the ERP system in its business. Do you think
the managements decision is right? Can ERP be applied in the service sector?
What could be the possible benefits that a healthcare company like Happy Living
could derive through the use of ERP?
Answer:
Check Your Progress
13. If HDFC Bank offers a wide range of products that cover every market segment;
it can be termed as an order winner with respect to _____________.
a. Price
b. Product range
c. Quality
d. Delivery reliability
14. When an ERP marketer uses price as an order winner, it should focus on certain
areas to reduce the costs involved during ERP implementation. Which of the
following will not facilitate this objective?
a. Identify the cost centers and devise plans to reduce production costs
b. Set up tough cost targets
c. Set up tough quality targets
d. Set up a rigorous monitoring system to make the production process cost efficient
15. __________ are the most basic attributes that an organization must possess before
any customer decides to deal with it, while __________ are the attributes required
by organizations to close a deal with the customers.
a. Qualifiers, targets
b. Qualifiers, order-winners
c. Targets, order-winners
d. Order-winners, qualifiers
16. Which of the following are order-winners and qualifiers for organizations?
i. Price and quality
ii. Speed of delivery
iii. Speed of reliability
iv. Product range
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44
8. Summary
ERP is an organization-wide system that allows coordination among various
functions.
BPR advocates the complete overhaul of the existing systems and processes in a firm.
BPR makes the company more customer-focused and responsive to changes in the
market.
Changes in BPR are implemented by redefining the companys activities in holistic
and process-oriented terms rather than automation of the business processes.
Business modeling is one of the first activities in any ERP project.
ERP implementation is an event that involves the entire organization.
The steps involved in ERP implementation are: identifying the need for an ERP
package, evaluating the as-is situation of the business, taking decisions about the
desired would-be situation for the business, reengineering business processes to
achieve the desired results, evaluating the available ERP packages, installing the
requisite hardware and networks, and implementing of the ERP package.
9. Glossary
Business model: A representation of various business systems and processes, and
their interconnections and interdependencies. It provides a general overview of the
operations of a business without giving the technical details of the processes and
systems.
Business process reengineering: The fundamental rethinking and radical redesign of
business processes to achieve dramatic improvements in critical, contemporary
measures of performance such as cost, quality, service, and speed.
Business process: A set of logically related tasks performed to achieve a defined
business outcome.
Enterprise Resource Planning: An organization-wide system that allows
coordination among various functions.
Gap analysis: It helps in identifying the areas that are not handled by the standard
system. Results from Gap analysis are divided into gaps that can be eliminated with
minimal programming, gaps that require extensive rework and additional resources,
and gaps that cannot be handled by the system.
Manufacturing Resource Planning (MRP): It is used in manufacturing to automate
inventory management and production processes.
Manufacturing Resource Planning II (MRP II): It is an extension of MRP,
developed with the objective of automating all the manufacturing functions and
providing an interface with other functional domains.
45
1. The proper implementation of Enterprise Resource Planning (ERP) facilitates
effective decision-making. What is ERP? Explain the evolution of ERP and its
importance.
2. Business Process Reengineering (BPR) advocates a complete overhaul of the
existing systems and processes in an organization in order to increase
productivity, reduce costs, and improve business practices. What do you
understand by BPR? Explain the use of IT in BPR.
3. Business modeling is a forerunner of BPR, ERP implementation, etc. Explain the
significance of business modeling in ERP.
4. Considerable risks are involved in ERP implementation due to its complexity and
time constraints. What are the factors to be considered for successful
implementation of ERP? Explain the various steps involved.
5. ERP enables the organization to optimize and organize different qualifiers and
order-winners to gain a competitive advantage in the market. How can an
organization use ERP as a competitive advantage to compete with others?
6. Garg, Vinod Kumar and N K Venkitakrishnan. Enterprise Resource Planning:
Concepts and Practice. New Delhi: Prentice-Hall of India Private Limited, 2002.
7. Sadagopan, S. ERP: A Managerial Perspective. New Delhi: Tata McGraw Hill
Publishing Company Limited, 1999.
<http://www.projectperfect.com.au/info_erp_imp.php>
9. ABCs of ERP
<http://www.cio.com/research/erp/edit/erpbasics.html>
10. ERP
<http://www.erpfans.com/erpfans/erpdefinition/erp001.html>
<http://searchopensource.techtarget.com/originalContent/0,289142,sid39_gci110
0450,00.html>
Operations Control
46
1. (c) Business process reengineering
Business reengineering involves a fundamental rethinking and radical redesigning
of business processes to achieve dramatic improvements in critical, contemporary
measures of performance such as cost, quality, service, and speed. It advocates a
complete overhaul of the existing systems and processes in an organization in
order to increase productivity, reduce costs, and improve business practices.
2. (b) It transforms knowledge and information-based productivity into labor
and machinery-based productivity.
Business process reengineering advocates a complete overhaul of the existing
systems and processes in an organization in order to increase productivity, reduce
costs, and improve business practices. It transforms labor and machinery-based
productivity into knowledge and information-based productivity.
3. (b) IBM was the first company to develop and maintain ERP software.
The history of ERP can be traced back to 1972 when five employees of IBM left
the company and established SAP (Systems, Application, and Products in Data
Processing) in Germany. SAP was the first company to develop and maintain
ERP software. The development of ERP can be traced back to the concepts of
MRP and MRP II.
4. (d) Business process
Business process is defined as a set of logically related tasks performed to
achieve a defined business outcome. Strategies are broad, long-term plans,
conceived to achieve business objectives and are developed at the corporate,
business and functional levels. An activity is an element of work performed
during the course of a project. A business model is a representation of various
business systems and processes, and their interconnections and interdependencies.
To carryout successful ERP implementation, the members of the steering
committee should be able to understand business redesign and integration. The
steering team should be trained in process mapping and reengineering
methodology and it should be fully involved in the process redesign so that it can
guide the team members (implementation team) properly.
6. (b) To provide an overview of operations without focusing on processes and
systems
The purpose of business modeling is to provide a general overview of the
operations of a business without going into the technical details of processes and
systems. It defines the activities performed and workflow structure in a broad
manner.
7. (d) Market structure
A good business model should be comprehensible, coherent and complete. It
should define clearly the different systems and subsystems of a business. A
business model is developed on the basis of the organization's goals, objectives
and strategic plans. The market structure is external to the organization and is one
of the many factors that helps decide on the organization's goals, objectives and
strategic plans.
47
8. (d) Steering committee
The key activity of the steering committee is to monitor the ERP implementation
process continuously in order to identify deviations, cost overruns, resource
requirements etc., during ERP implementation.
9. (b) i and ii
Information gathered from mapping and gap analysis is used for customization of
the ERP package. The other two options are not basic requirements for
customizing an ERP package.
10. (b) i, ii, iv
Integration of data across departments helps in better connectivity and smooth
flow of information. It reduces data redundancy and ensures availability of right
information to the concerned department or personnel.
11. (a) To assess the readiness of the organization to accept change
Defining corporate needs before ERP implementation helps the organization to
assess its readiness to change. Implementing an ERP system involves the
redefinition of the roles of different functional departments and the authority and
responsibility of individuals throughout the organization. Hence, organizations
have to adapt to these changes as quickly as possible.
12. (b) To assess the implications of the changes
Even though an organization may be willing to adapt to changes, it may not be
able to assess the implications of the changes. Hence, it must undergo a brief
business process redesign exercise before actual implementation.
13. (b) Product range
Product range implies all the products that are offered by an organization. HDFC
Bank offers a wide range of products like deposits, loans, bank accounts, NRI
products, insurance products, investment products like mutual funds, pension
plans, etc.
14. (c) Set up tough quality targets
Tough quality targets can be set up if the organization uses quality as the order
winner. Further, when quality is given more importance, price of the product
shoots up as quality never comes cheap.
15. (b) Qualifiers, order-winners
Qualifiers are the most basic attributes that an organization must possess before
any customer decides to deal with it. They provide the initial impetus to
customers to deal with an organization. But to close a deal, organizations must
have order-winners, which could be price advantage, quality, etc.
Qualifiers provide the initial impetus to customers to deal with an organization.
Organizations have order-winners to close a deal. Some of the order-winners and
qualifiers for organizations are price, product range, delivery speed, and delivery
reliability.
Unit 27
Supply Chain Management
Structure
1. Introduction
2. Objectives
3. Business Drivers in Supply Chain Management
4. Principles of Supply Chain Management
5. Forces Shaping Supply Chain Management
6. Supply Chain Management Framework
7. Customer Focus in Supply Chain Management
8. Electronic Supply Chain Management
9. Summary
10. Glossary
1. Introduction
In the last section of the previous unit, we have discussed how enterprise resource
planning helps organizations gain competitive advantage. We have learnt that
enterprise resource planning enables the organization to optimize and organize
different qualifiers and order-winners to gain a competitive advantage in the market.
In this unit, we will discuss supply chain management.
A supply chain is the network covering various stages in the process of providing
products or services to customers. The supply chain network includes manufacturers,
suppliers, transporters, warehouses, distributors, retailers, etc. Supply Chain
Management (SCM) integrates procurement, operations, and logistics to provide value
added products or services to customers.
This unit will explain the business drivers in supply chain management. We will
discuss the principles of supply chain management, and the forces shaping supply
chain management. We shall then move on to discuss the supply chain management
framework, and the customer focus in supply chain management. Finally, we would
discuss electronic supply chain management.
2. Objectives
discuss the business drivers in supply chain management.
explain the principles of supply chain management.
determine the forces shaping supply chain management.
evaluate the supply chain management framework.
assess customer focus in supply chain management.
define electronic supply chain management.
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3. Business Drivers in Supply Chain Management
SCM is one of the key focus areas for organizations to reduce costs and enhance the
efficiency of the production process. The supply chain performance is driven by four
key drivers:
Inventory Inventory includes raw materials, work-in-progress materials, and
finished goods in the supply chain. Inventory decisions influence the supply chain.
Transportation Organizations need to take proper transportation decisions. If it uses
air transport, the responsiveness increases while the cost efficiency decreases due to
high air transport costs. Similarly, in case of land or sea transport, its cost efficiency
increases but responsiveness decreases.
Facilities Facilities located closer to the customer enhance responsiveness but lead
to high maintenance costs. Alternatively, organizations can have fewer warehouses
that cater to different markets. This reduces maintenance costs but adversely affects
their responsiveness.
Information Though a quality aspect, information is a key driver affecting the
supply chain performance and also the performance of other drivers.
Check Your Progress
1. What is the relationship between the location of a facility and the supply chain
performance of the firm?
a. Facilities close to the target market improve the performance of the supply chain
b. Facilities away from target markets improve the performance of the supply chain
c. Facilities close to target markets worsen the performance of the supply chain
d. The location of a facility and supply chain efficiency of a firm are in no way
related
2. Which of the following is not considered a member of a supply chain?
a. Manufacturer
b. Supplier
c. Distributor
d. Customer
3. Identify from the following the key drivers driving the supply chain performance.
i. Inventory
ii. Transportation
iii. Facilities
iv. Information
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4. Which of the following statement is true regarding the key drivers driving supply
chain performance?
a. Facilities located closer to the customer enhance responsiveness, but leads to low
maintenance costs.
b. Inventory that includes raw materials, work-in-progress materials and finished
goods influence the supply chain.
c. In case of land or sea transport, the cost efficiency decreases but responsiveness
increases.
d. In case of air transport, the responsiveness decreases while the cost efficiency
increases due to high air transport costs.
4. Principles of Supply Chain Management
The principles of SCM allow organizations to maintain a balance between customers
expectations and their own objectives.
Segment Customers Based on Service Needs Organizations have to segment
markets based on the specific needs of their customers. After segmenting,
organizations can develop a supply chain plan that considers the specific requirements
of different segments.
Customize the Logistics Network Companies usually design logistics systems
either to meet average service requirements of all customers or to satisfy the toughest
requirements of a single customer. However, both these approaches lead to poor
resource utilization. Hence, organizations customize their logistics network so that
they can supply items to customers based on their specific requirements.
Plan Based on Market Demand Conventionally, each department in an organization
develops demand forecasts independently for the same set of products and they differ
drastically thus making the supply chain inefficient. A company should therefore ensure
that every link in the supply chain is involved in collaborative forecasting.
Enhance Ability to Meet Customer Requirements Manufacturers can gain a
competitive advantage if they reduce the lead-time along the supply chain and the
time for converting raw material to finished product and provide products based on
the requirements of specific customers.
Improve Relationships with the Suppliers By maintaining strong and long-term
relationships with their suppliers, organizations can derive significant cost advantages.
To improve supplier satisfaction, organizations should have clear and mutually
understood rules of relationship. Organizations should show commitment for long-
term profitability and success of suppliers. This commitment would require suppliers
involvement in new product development and improvements in current products or
services. But focus on discounts to increase short-term profits will hamper
development and maintenance of long-term relationships with suppliers.
Have a Supply Chain-Wide Technology Strategy Organizations should replace
inflexible and poorly integrated systems with enterprise-wide systems. Fragmented
systems capture data but cannot translate it into business intelligence that enhances the
capability of business operations. Therefore, an IT system should integrate three kinds
of capabilities: in the short term, it should be able to handle day-today transactions, so
that demand and supply are aligned to a certain extent by the sharing of information;
in the medium term, it should help in planning and decision-making and effective
resource allocation through a master production schedule; and in the long term, it
should provide top managers with tools for strategic analysis.
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Devise a Complete Supply Chain Performance Measure Organizations should
develop a broad system to measure the overall performance of the supply chain
system instead of narrow performance measures.
5. Forces Shaping Supply Chain Management
The effectiveness of SCM is influenced by various business and economic forces:
Consumer Demand Customers expectations regarding quality, speed of service,
choice, and price have notably increased. Firms aim to meet these expectations by
providing cheaper products within the least possible time. All these objectives are
fulfilled by SCM.
Globalization Organizations can benefit from the competitive advantages of other
economies. For example, US and European companies have outsourced their
operations to Asian or Latin American countries and gained significant advantages.
Competition Technological advancements, increased globalization, easy access to
information, etc., has increased competition in every business. Improvements in
information flow and transportation, small companies are able to compete with bigger
players globally.
Information and Communication The information explosion brought about by
improved communications systems has supported the supply chain decisions and has
resulted in the worldwide expansion of supply chain activities.
Government Regulation Regulations and policies framed by governments of other
countries have a direct effect on the organizations supply chain decisions.
International trade organizations like the WTO and other regional trade agreements
have tried to bring about consistent regulations in all countries.
Environment Supply chain decisions are influenced by a growing concern for the
environment and government regulations to protect the environment.
Activity: Villa Inc. is a 15-year-old consumer goods manufacturing company. For
a decade, the company was successful in the consumer goods industry, but the last
five years saw it facing a downturn. It was unable to maintain profitability and
market share due to the increased competition and volatile business environment.
The management of Villa has therefore decided to restructure its supply chain in
order to enhance its operational efficiency. Do you think the companys decision to
restructure its supply chain is justified? How can revamping of SCM practices help
the company in enhancing its operational efficiency and in gaining profitability and
lost market share?
Answer:
Operations Control
52
Check Your Progress
5. If an organization follows the principles of supply chain management, it can
attain a balance between customers expectations and growth and profitability
objectives. Which of the following is not a principle of supply chain
management?
a. Quality and performance management
b. Customize the logistics network
c. Enhance ability to meet customer requirements
d. Have a supply chain-wide technology strategy
6. Which of the following statements about designing of a logistics network in a
supply chain is incorrect?
a. Firms design a logistic network to meet average requirements of all customers
b. Firms design a logistic network to meet even the toughest requirements of a
single customer
c. Firms never custom design a logistic network to meet the individual requirements
of customers
d. Firms design a logistic network so that some amount of customization is built in
to meet the requirements of customers
7. The health and well-being of suppliers is critical for organizations, which largely
depend on suppliers for their requirements. Which of the following hampers
development and maintenance of long-term relationships with suppliers?
a. Show commitment for long-term profitability of suppliers
b. Lay down mutually understood rules for building a long-term relationship
c. Strive for heavy discounts to improve the organizations short-term profitability
d. All of the above
8. Identify the statement that does not hold true regarding the principles of supply
chain management.
a. Organizations have to segment markets based on the specific needs of their
customers.
b. Companies usually design logistics systems either to meet average service
requirements of all customers or to satisfy the toughest requirements of a single
customer.
c. Each department in an organization develops demand forecasts independently for
the same set of products and they differ drastically thus making the supply chain
inefficient.
d. Manufacturers can gain competitive advantage if they increase the lead-time
along the supply chain and the time for converting raw material to finished
product.
9. Which of the following statement is not correct regarding the forces shaping
supply chain management?
a. Customers expectations regarding quality, speed of service, choice, and price
have notably increased.
b. Technological advancements, increased globalization, easy access to information,
etc., has increased competition in every business.
53
c. The information explosion brought about by improved communication systems
has supported the supply chain decisions and has resulted in the worldwide
expansion of supply chain activities.
d. Regulations and policies framed by the governments of other countries have an
indirect effect on the organizations supply chain decisions.
6. Supply Chain Management Framework
The SCM framework is based on a functional model of the SCM system. It is a
development tool that assists in the development of a well-integrated SCM system in
an organization. The framework consists of several components that define key
functions, processes, and best practices. Organizational behaviors like SCM enablers
support the organizations overall performance.
6.1. The Seven SCM Components
SCM components represent business processes and practices. Following are the seven
SCM components:
SCM leadership This component provides a direction to the SCM system. It is
constituted by managers from the different functional areas. The overall performance
of the SCM system depends on the interaction between these functional heads and the
senior management.
SCM strategy The SCM strategy forms an outline for supply chain operations that
support and are consistent with the manufacturing and marketing objectives of the
organization.
Operational planning This component defines the operational requirements for
maintaining a supply chain which are specified in terms of tasks, resource
requirements, and measurements.
Business relationship management Organizations and supply chain partners are
dependent on each other. It is imperative to have a favorable environment that
facilitates communication and negotiation between the organization and its supply
chain partners. The relationship can be improved by having long-term contracts, and
by using inputs from different levels of management and supply chain partners in the
communication and decision making processes.
Order-to-delivery process The order-to-delivery process defines how effectively
an organization can direct the flow of products from the suppliers to the company. It
includes processes like order releases, receiving, inspection of incoming material,
accounts payable, and materials handling. The order-to-delivery process can be used
to evaluate suppliers performance on the basis of criteria like on-time delivery, cost,
defects, lead time, flexibility in scheduled time, etc.
Quality and performance management This component is concerned with the
initiatives that organizations and suppliers take to improve and maintain quality
standards. The quality and performance component helps identify the quality defects
in suppliers products, and facilitates cooperation between suppliers and the
manufacturer to improve the quality.
Human resources management This component deals with the training of
personnel to improve their skills, knowledge, and attitudes to enhance the supply
chain performance.
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54
6.2. The Six SCM Enablers
The SCM enablers are a group of carefully conceived and defined behaviors and
approaches that allow, encourage, and reinforce a firms commitment to high
performance SCM practices. The following are the SCM enablers:
Alignment Alignment refers to matching the corporate and business unit goals. It is
a key organizational behavior within the SCM system and includes consistency in
processes, actions, and decisions across the business units to support the SCM
processes. For better alignment, the company leadership should set goals, objectives,
and strategies that support successful supplier relationships.
Customer-supplier focus The customer-supplier focus aims to plan the
organizations processes in such a way that they are able to understand and react to
customer requirements quickly. To improve suppliers satisfaction, organizations
should have clear and mutually understood and agreed rules of relationship and
should show commitment for their suppliers long-term profitability and success.
Design Design is the feature of products, processes, systems, and services that
ensures their successful functioning. It is a comprehensive process, which, after
considering feedback from customers and suppliers, defines the overall external and
internal requirements to the organization.
Measurement Measurement is a tool that organizations use to quantify information
about inputs, outputs, and the performance dimensions of products, processes, and
services. It evaluates the performance of different business processes, and of supplier
activities in terms of delivery performance, quality of material supplied, etc.
Participation/involvement Stakeholders must be involved in the decision-making
process to ensure the success of products, processes, systems, and services.
Organizational efficiency and performance can be improved by utilizing the available
resources in terms of talents and energies of employees and external stakeholders.
Periodic review Continuous improvement is based on the periodic review of all the
business processes, programs, and systems. These reviews indicate the difference
between the expected performance and the actual performance and the reasons for the
deviations.
Activity: Paradise Inc., a retailing company, has decided to make efficient use of
the SCM system that it recently developed, in order to increase its profits, market
share, and competitive position. It has appointed Sheetal, an SCM consultant, to
assist the company in the process. Sheetal has suggested that the company go in for
supply chain integration. The company, which is not aware of the significance of
supply chain integration, has requested Sheetal to explain in detail about it. Help
Sheetal in the process. Do you think Sheetals suggestion of integrating the supply
chain functions is a better option for the company? What are the key issues to be
considered by Paradise to integrate its supply chain functions?
Answer:
55
Check Your Progress
10. Order-to-delivery process is an SCM component. It can be used to evaluate the
performance of a _________ on the basis of on-time delivery, costs, defects, etc.
a. Production manager
b. Supplier
c. Purchase manager
d. Distributor
11. Every organization takes steps to maintain certain standards in terms of quality.
Which of the following components of SCM is not concerned with these
initiatives?
i. Human resources management
ii. Order-to-delivery process
iii. Business relationship management
iv. Quality and performance management
a. i and ii
b. i, ii, iii
c. ii, iii, iv
d. i, iii, iv
12. Measurement is an SCM enabler. How are measurements helpful in supply
chain management?
i. They provide information about inputs, outputs, performance etc.
ii. They are used to evaluate the performance of business processes
iii. They provide insights into suppliers performance in terms of delivery
performance, quality of material supplied etc
iv. They ensure periodic evaluation of the performance of processes, programs and
systems that support continuous improvement
a. i and ii
b. i, ii and iv
c. ii, iii, iv
d. i, ii, iii
13. ____________ is an SCM enabler that refers to matching the corporate and
business unit goals. It is a key organizational behavior within the SCM system
and includes consistency in processes, actions and decisions across the business
units to support the SCM processes.
a. Design
b. Alignment
c. Measurement
d. Periodic review
14. Identify the statements that hold true regarding design, an SCM enabler.
i. It includes consistency in processes, actions, and decisions across the business
units to support the SCM processes.
ii. It is the feature of products, processes, systems and services that ensures their
successful functioning.
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56
iii. It is a tool that organizations use to quantify information about inputs, outputs and
the performance dimensions of products, processes and services.
iv. It is a comprehensive process, which, after considering feedback from the
customers and suppliers, defines the overall external and internal requirements to
the organization.
a. Only i and ii
b. Only i and iii
c. Only ii and iv
d. Only iii and iv
7. Customer Focus in Supply Chain Management
The current competitive environment is the outcome of the convergence of various
forces on all supply chain members and to compete in it, organizations need to do
more than optimize their supply chain activities. These forces include the
development of new technologies, increase in communication capabilities, increasing
demand for better quality and customer services, and the demand for quick and
efficient response to market. Earlier, supply chain members who were away from the
end consumers stressed factors that directly affected their own immediate customer
and supplier. But now, they too need to focus on the end customers and see how these
forces affect their end customers. The key to survival depends on the supply chain
members focus on the demand side of the supply chain equation. From the corporate
perspective, end-use forces will influence the way things are done in the supply chain
and determine the best operational practices for meeting the requirements of the end
users. From the consumers perspective, end-use forces like technology and changing
lifestyles will help in determining the supply chain. Thus, customer focused analysis
influences the objectives and goals of supply chain activities. The efficacy of push
and pull strategies has always been debatable. Of late, the consumer provides both
the strategies in the demand-chain management process.
Demand-Chains: A Focus on End Users
Instead of building and operating a supply chain from manufacturer to market,
demand-chain leaders focus on developing alliances with those channel partners who
can meet customer requirements. The focus on end-users directed the attention of all
supply chain partners to the demand side of the supply chain equation and made them
rethink their roles in the supply chain. The roles and responsibilities of players in
todays emerging demand chains have changed compared to those in traditional
chains. In a demand chain, the products are developed based on consumer research
and information gathered by any of the supply chain partners and not necessarily by
the manufacturers. For example, retailers provide comprehensive information on
consumer spending patterns and preferences to the manufacturer and this information
helps in producing products with attributes that meet customer requirements.
Consumers are now interacting with different entities in the purchasing process.
Therefore, every member of the demand chain needs to monitor consumer needs and
wants. This knowledge makes it easier for all the members to identify the product and
packaging requirements and marketing opportunities, and to determine the need for
brand extension. The success of a product and the channel members depends on the
level of participation and coordination between the channel members from the time
the product is conceptualized to the time it is launched in the market. This is essential
if supply chains are to be transformed into demand chains.
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Broad Trends and Misconceptions
While developing a demand chain, channel partners should be aware of the broad
demand trends in consumer markets based on demographics, lifestyle, and other social
factors. For example, the overall size of the average family has shrunk due to a fall in
the birth rate in industrialized nations, thus bringing down the number of new
consumers. Also, the workforce size has contracted due to an increase in automation.
These changes influence the way in which consumers purchase goods and where they
purchase them. The failure to accept these changes leads to two general
misconceptions about the working of the demand chain.
Misconception # 1 Customers will always buy from retailers. Consumers are
actively looking for new sources from which to obtain products and services. In this
process, to get value for money, they are prepared to buy products and services from
any0020channel member who can provide them with quality products, timely
delivery, and a reasonable price.
Misconception # 2 Business-to-business companies or industrial organizations
need to monitor only their customers. In industrial organizations, solving customers
problems sometimes means solving your customers customers problems. All
customer/industrial demand for products or services across the supply chain is derived
from end-user demand. Industrial customers will not order more parts if consumers
are not buying their end products.
Creating the Demand Chains of the Future
Demand chains are intended to bring together channel members to delight customers
and solve their problems by
Gathering and analyzing information about consumers, their problems, and their
needs.
Identifying and choosing the right channel partners.
Developing a system for information sharing among channel partners.
Developing products and services, which are capable of solving customers problems.
Choosing the most optimal transportation and distribution methods.
Check Your Progress
15. Which of the following supply chain members traditionally assumed the role of
monitoring consumer preferences?
a. Retailer
b. Wholesaler
c. Distributor
d. Manufacture
16. Which of the following are common misconceptions about the working of the
demand chain?
i. All customers buy from retailers
ii. Industrial marketers should focus on client preferences and not end users
iii. All members of the supply chain should work in unison to improve profitability
iv. To improve supply chain efficiency it is necessary to have a supply chain-wide
technology strategy
a. Only i
b. i and iv
c. i and ii
d. i, iii and iv
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58
17. Demand chains help in bringing together channel members by delighting
customers and solving problems. Which of the following strategies are used by
demand chains to solve problems?
i. Gather and analyze information about consumers, their problems, and their needs.
ii. Identify and choose the right channel partners.
iii. Develop a system for information sharing among channel partners.
iv. Develop products and services, which are capable of solving customers
problems.
18. The current competitive environment is the outcome of the convergence of
various forces on all supply chain members. Which of the following are those
forces?
i. Development of new technologies
ii. Increase in communication capabilities
iii. Demand for quick and efficient response to market
iv. Increasing demand for better quality and customer services
Information technology has become a part of SCM. Electronic SCM or ESCM is
business-to-business integration through the Internet.
ESCM Advantages
ESCM has many advantages including timely order-processing, improved inventory
tracking and management, improved accuracy in order fulfillment, support for JIT
manufacturing, etc.
Cost saving Organizations can gain huge cost savings by integrating the different
supply chain levels. The communication cost and time is greatly reduced with the help
of internet.
Reduction in inventory levels ESCM covers the suppliers activities, and provides
instant information to them about the status of inventory levels.
Reduction in procurement costs ESCM helps supply chain partners communicate
through the Internet. Communication through Internet is quicker and cost effective. A
company can reduce procurement costs significantly by providing its suppliers with
instant access to information regarding inventory and procurement.
Reduction in cycle time ESCM ensures that organizations get timely and accurate
forecasts regarding product or service demand. This allows proper production
planning based on actual requirements, resulting in reduction of cycle time for
production activities and stock-out costs.
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ESCM Implementation
The following activities should be undertaken for improving ESCM implementation:
Understand and evaluate the level of integration within the organization.
Determine the number of suppliers who have a direct influence over the products or
services that are delivered to the customers, across the entire supply chain.
Divide suppliers into different categories: first tier, second tier, and so on.
Define the customer base in term of sales, profitability, size, etc.
Improve the information infrastructure within the organization to accommodate
ESCM requirements.
Constitute a team with representation from various functions within the organization
and representatives from suppliers and customers to plan and carry out the
implementation.
Identify leaders who are capable of guiding the implementation process competently.
Issues Relating to ESCM
ESCM allows effective sharing of information like forecasts and orders among the
supply chain partners. Utilizing customer and supplier related data through Internet
technologies results in a virtual corporation that aids the direct flow of information
between various supply chain partners. To enhance the efficiency of ESCM, the
organization should deal with the following issues:
Security issues As information is shared or exchanged over the Internet, the
organization has to ensure that the right person accesses it. This can be done by
encrypting the data to make it secure and allowing supply chain members to view
only the information which is relevant to them.
Changes to existing business processes An electronic supply chain significantly
transforms a business process. The changes arise in the way companies deal with each
other. Channel partners should be willing to share information regarding inventory
levels, production schedules, forecasts, promotion plans, etc. A culture of openness
and trust should be developed between all the channel partners.
Activity: Ganesha Ltd. is a diversified company engaged in construction, financial
services, fertilizers, and retailing businesses spread over different countries. The
company has been facing challenges because of its business being diversified and
staggered. The company has therefore decided to streamline its operations,
restructure its supplier network, and improve the efficiency of its supply chain. It
has decided to give more importance to the use of information technology in its
supply chain. Do you think the company was right in its decision to use IT in
making its operations efficient? What do you think will be the role played by
suppliers in enhancing the efficiency of the supply chain? How can an efficient
supply chain help a company like Ganesha Inc to compete strongly in the market?
Answer:
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60
Example: IKEAs Supply Chain Management
IKEA, the Swedish furniture retailer, was founded in 1943. The company had been
expanding globally and gaining a huge market share. Its success was built around
selling low-priced products (which included furniture, accessories, bathroom, and
kitchen furniture) at retail stores worldwide. IKEA had about 12,000 products, with
each store carrying about 10,000 products, depending on its size. By 2003-2004,
the company had 201 stores in 30 countries. It sourced raw materials and other
components from 1,600 suppliers in 55 countries.
Trading was done through the local purchasing offices of the company which were
located in 33 countries. IKEA had to change its supply chain from time-to-time to
meet the market and technological changes. The company planned to change its
supply chain strategy by cutting down on suppliers and concentrating on those
located in low-cost countries. To ensure a smooth and flawless transition, the
company needed the best tools. It also had to be able to resolve problems as
quickly as possible. However, it realized that to benefit from this, it would have to
put up with longer lead times. Longer lead times would in turn affect the
companys ability to adjust quickly to changes and put extra pressure on the entire
supply chain network operation. To solve these problems, the company sought the
help of Manugistics Group, Inc., which provided supply chain management
software and solutions to its clients.
IKEA began to work with Manugistics in 2001. It used Manugistics Demand
Management Solutions on all of its products worldwide. IKEA laid down a number
of objectives for Manugistics like developing a sales planning methodology and
tools that guaranteed reasonable forecasts. These forecasts were used for planning
supplier, warehouse, and transportation capacities. Manugistics developed a
capacity planning tactic and tool which reduced the risk involved in the disparity
between supply and demand and helped the company to gain cost savings. A
coordinated global and regional supply planning system helped the company in
coordinating and consolidating the sales capacity and distribution planning which
were linked directly to the replenishment. This also helped IKEA to consider all the
inventories and to have a visible supply chain in the order management process.
The use of Manugistics helped in improving the forecast accuracy of the company,
augmented the visibility in the sales patterns of the IKEA products, improved the
planner experience and productivity through exception-based management, enabled
the consolidation of the supplier base with a focus on low-cost countries, and
increased the overall supply chain visibility and efficiency.
Adapted from IKEA: Revamping Supply Chain Strategy with Manugistics,
http://www.manu.com/documents/collateral/1092_0106_IKEA_client%20profile.pdf
Check Your Progress
19. How does electronic supply chain management cut procurement costs?
a. By transporting goods quickly
b. By enabling customers to directly order products
c. By reducing communication costs
d. By providing suppliers instant access to information
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20. Electronic supply chain management has many benefits, but together with the
benefits, there are issues that must be addressed to improve the efficiency of
ESCM. Which of the following can be considered the most sensitive issue?
a. Information security
b. Order taking
c. Order delivery
d. Customer information
21. Arrange the following steps in electronic supply chain management
implementation in the correct sequence.
i. Understand and evaluate the level of integration within the organization.
ii. Determine the number of suppliers who have direct influence over the products or
services delivered to customers across the entire supply chain.
iii. Divide suppliers into different categories: first tier, second tier and so on.
iv. Define customer base in term of sales, profitability, size, etc.
v. Improve information infrastructure within the organization to accommodate
ESCM requirements.
vi. Constitute a team with representation from various functions within the
organization and representatives from suppliers and customers to plan and
implement.
vii. Identify leaders who are capable of guiding the implementation process
competently.
a. iv, iii, ii, v, vi, vii. i
b. i, ii, iii, iv, v, vi, vii
c. iv, v, vi, vii, i, ii, iii
d. i, ii, iii, iv, vii, vi, v
22. Which of the following is not correct regarding the advantages of an electronic
supply chain management?
a. Reduction in inventory levels
b. Increased cycle time
c. Improved accuracy in order fulfillment
d. Timely order-processing
9. Summary
A supply chain consists of suppliers, manufacturers, distributors, and retailers whose
combined efforts result in production, selling, and delivery of products and services.
The objectives of SCM are to reduce operation costs, improve coordination between
channel partners, reduce lead time, improve the reliability of the delivery system, etc.
The key drivers of SCM that determine the overall competitiveness and
responsiveness of the organization relate to inventory, transportation, facilities and
information.
The complete supply chain is made up of many channel partners and many processes.
These processes can be viewed from two perspectives: the cycle view and the
push/pull view.
SCM encompasses several activities and partners. The forces which are responsible
for making the supply chain effective are consumer demand, globalization and so on.
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62
The supply chain enablers which determine its performance are alignment,
measurement, participation and involvement, customer-supplier focus, design, and
periodic review.
The scope of SCM has increased significantly of late. For many big enterprises,
supply chain activities span countries or continents.
10. Glossary
Supply chain management components: The supply chain management
components are leadership, strategy, operational planning, business relationship
management, order-to-delivery process, quality and performance management, and
human resources management.
Supply chain management enablers: The supply chain management enablers are
alignment, customer-supplier focus, design, measurement, participation/involvement,
and periodic review.
Supply chain management framework: It is a development tool that assists in the
development of a well-integrated supply chain management system in an
organization. The framework consists of several components that define key
functions, processes, and best practices.
Supply chain management: It integrates procurement, operations, and logistics to
provide value added products or services to customers.
Supply chain: A network covering various stages in the process of providing
products or services to customers. It includes manufacturers, suppliers, transporters,
warehouses, distributors, retailers, etc.
1. Supply Chain Management (SCM) is one of the key focus areas for organizations
to reduce costs and enhance the efficiency of the production process. What is
SCM? What are the key drivers of supply chain performance?
2. The principles of SCM allow organizations to maintain a balance between
customers expectations and their own objectives. What are the principles of
SCM? Explain the forces shaping supply chain management.
3. The SCM framework consists of several components that define key functions,
processes, and best practices. Explain in detail about the supply chain
management framework.
4. As new areas of competition have emerged in the supply chain, organizations are
now competing on flexibility, speed, and productivity, and focusing on meeting
consumer demand. Why is customer focus important in supply chain
management?
5. Organizations are integrating their supply chains through the use of information
technology. Explain the importance of Electronic SCM (ESCM) in this context.
6. ESCM allows effective sharing of information like forecasts and orders among
the supply chain partners. Explain the activities that should be undertaken and
issues to be considered to improve the efficiency of ESCM.
1. Chopra, Sunil and Peter Meindl. Supply Chain Management: Strategy, Planning
and Operation. Fourth Indian Reprint. Delhi: Pearson Education, Inc. 2003.
63
7. ABCs of Supply Chain Management
<http://www.cio.com/research/scm/edit/012202_scm.html>
8. Introduction to Supply Chain Management
<http://logistics.about.com/od/supplychainintroduction/a/into_scm.htm>
9. Supply Chain Management
<http://mba.tuck.dartmouth.edu/pages/faculty/dave.pyke/case_studies/supply_cha
in_or_ms.pdf>
10. Supply Chain Management
<http://en.wikipedia.org/wiki/Supply_chain_management>
<http://faculty.ksu.edu.sa/nizarhussain/Documents/Electronic%20Supply%20Cha
in%20Management-%20Some%20latest%20issues%20and%20Practices.pdf>
12. Web-based Supply Chain Management
<http://www.engr.sjsu.edu/fayad/designfest/SupplyChain_02.pdf>
1. (a) Facilities close to the target market improve the performance of the
supply chain
The capacity and location of a facility has a significant effect on the performance of
the supply chain. More facilities close to the customer may improve supply chain
effectiveness although cost of maintenance of so many facilities will be high.
2. (d) Customer
Supply chain members include manufacturers, suppliers, distributors,
wholesalers, retailers, logistic service providers, etc. Customers are the basis for
all supply chain activities. Supply chain members strive hard to meet customer
demand for products they deal with.
SCM is one of the key focus areas for organizations to reduce costs and enhance
the efficiency of the production process. The supply chain performance is driven
by four key drivers inventory, transportation, facilities, and information.
4. (b) Inventory that includes raw materials, work-in-progress materials, and
finished goods influence the supply chain.
All the statements are false regarding the key drivers driving supply chain
performance, except statement (b). Setting up facilities closer to the customers
enhances responsiveness but leads to high maintenance costs. For instance,
facilities such as warehouses need to be set up closer to the customers to suit their
requirements. However, maintenance of these facilities from time-to-time leads to
incurrence of high costs. Alternatively, companies can opt for fewer warehouses.
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64
Though these reduce the maintenance costs, they adversely affect the
responsiveness. In case of land or sea transport, its cost efficiency increases but
responsiveness decreases. In case of air transport, the responsiveness increases
while the cost efficiency decreases due to high air transport costs.
5. (a) Quality and performance management
Quality and performance management is a component of SCM and not
considered a principle of SCM. All other options mentioned are principles of
supply chain management.
6. (c) Firms never custom design a logistic network to meet the individual
requirements of customers
Companies usually design logistics systems either to meet average service
requirements of all customers or to satisfy the toughest requirements of a single
customer. However, both these approaches lead to poor resource utilization.
Hence, a certain amount of customization is built into the network to meet
specific requirements of customers.
7. (c) Strive for heavy discounts to improve the organizations short-term
profitability
To improve supplier satisfaction, organizations should have clear and mutually
understood rules of relationship. Organizations should show commitment for
long-term profitability and success of suppliers. This commitment would require
suppliers involvement in new product development and improvements in current
products or services. But focus on discounts to increase short-term profits will
hamper development and maintenance of long-term relationships with suppliers.
8. (d) Manufacturers can gain competitive advantage if they increase the lead-
time along the supply chain and the time for converting raw material to
finished product.
All the statements are true regarding the principles of supply chain management,
except statement (d). Manufacturers can gain competitive advantage if they
reduce the lead-time along the supply chain and the time for converting raw
material to finished product and provide products based on the requirements of
specific customers.
9. (d) Regulations and policies framed by governments of other countries have
an indirect effect on the organizations supply chain decisions.
All the statements are true regarding the forces shaping supply chain
management, except statement (d). An organizations supply chain decisions have
to consider the regulations and policies of other countries as well. Trade barriers,
duties and other such trade related decisions are in the hands of the governments
of various countries. These rules and regulations directly affect the functioning of
supply chain entities.
10. (b) Supplier
The order-to-delivery process can be used to evaluate suppliers performance on
the basis of criteria like on-time delivery, cost, defects, lead time, and flexibility
in scheduled time.
11. (b) i, ii, iii
The quality and performance component is related to initiatives that organizations
and suppliers take towards improving and maintaining quality standards. It helps
identify quality defects in supplier products and facilitates cooperation between
suppliers and the manufacturer to improve the quality of items supplied.
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12. (d) i, ii, iii
Measurements provide information on inputs, outputs, performance of business
processes, suppliers performance, etc. The latter can be measured using metrics
like on-time delivery performance, quality, etc. Periodic evaluation of
performance of processes, programs and systems is associated with periodic
review, another SCM enabler.
13. (d) Alignment
Alignment refers to matching the corporate and business unit goals. It is a key
organizational behavior within the SCM system and includes consistency in
processes, actions and decisions across the business units to support the SCM
processes. For better alignment, the company leadership should set goals,
objectives and strategies that support successful supplier relationships.
Options ii and iv refer to design. Option i refers to alignment and option iii refers
to measurement, both SCM enablers.
15. (a) Retailer
Traditionally, retailers have been the closest to consumers. Owing to this
proximity, retailers assume the role of monitoring consumer preferences. But the
use of the Internet and direct sales are changing all that. Consumers are now
interacting with different entities in the purchasing process.
16. (c) i and ii
There are two common misconceptions about the working of the demand chain.
One is that all consumers buy from retailers. This can be true in most cases but
many consumers are shifting to other channel members who deliver products at
the right time and at reasonable prices. The second misconception is that
industrial marketers should monitor only their customers and need not bother
about end-users. They should not ignore the fact that the demand for their
products is based on end-users.
Demand chains are intended to bring together channel members to satisfy
customers and solve their problems by gathering and analyzing information about
consumers, their problems, and their needs; identifying and choosing the right
channel partners; developing a system for information sharing among channel
partners; developing products and services, which are capable of solving
customers problems; and choosing the most optimal transportation and
distribution methods.
The current competitive environment is the outcome of the convergence of
various forces on all supply chain members and to compete in it, organizations
need to do more than optimize their supply chain activities. These forces include
the development of new technologies, increase in communication capabilities,
increasing demand for better quality and customer services, and the demand for
quick and efficient response to market.
19. (c) By reducing communication costs
ESCM helps supply chain partners communicate through the Internet.
Communication through Internet is quicker and cost effective. As the supplier can
access information regarding inventory and procurement automatically, the
purchasing department can lessen its involvement in minor transactions and focus
on high value activities like vendor selection and sourcing. The other two options
are not related to procurement.
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20. (a) Information security
Security of information is the most sensitive issue when information is shared or
exchanged over the Internet. An organization has to ensure that the rightful
recipient views the information. All other options are some types of information
shared over the Internet between supply chain partners.
21. (b) i, ii, iii, iv, v, vi, vii
To improve ESCM implementation, the following activities should be
undertaken:
1) Understand and evaluate the level of integration within the organization, 2)
Determine the number of suppliers with direct influence over products or services
delivered to customers across the entire supply chain, 3) Divide suppliers into
different categories: first tier, second tier and so on, 4) Define customer base in
term of sales, profitability, size, etc., 5) Improve information infrastructure
within the organization to accommodate ESCM requirements, 6) Constitute a
team with representation from various functions within the organization and
representatives from suppliers and customers to plan and carry out
implementation, 7) Identify leaders capable of guiding the implementation
process competently.
22. (b) Increased cycle time
Electronic supply chain management (ESCM) has many advantages including
timely order-processing, improved inventory tracking and management, improved
accuracy in order fulfillment and support for JIT manufacturing. The other
advantages of ESCM include savings in cost, reduction in inventory levels,
reduction in procurement costs and reduction in cycle time.
Unit 28
Just-In-Time (JIT) Manufacturing System
Structure
1. Introduction
2. Objectives
3. The Concept of the JIT System
4. Advantages of JIT Systems
5. Characteristics of JIT Systems
6. Summary
7. Glossary
1. Introduction
In the last section of the previous unit, we have discussed electronic supply chain
management (ESCM). We have learnt that ESCM offers many advantages such as
timely order-processing, improved inventory tracking and management, and improved
accuracy in order fulfillment to organizations. In this unit, we will discuss the Just-In-
Time (JIT) manufacturing system.
The JIT manufacturing system is a planning system for manufacturing processes that
helps in achieving high-volume production using the minimal inventories. The system
eliminates the inventory of raw materials, work in progress, and finished goods by
making them available as and when required. The items are picked up by the worker
and fed directly into the production process. The finished goods are produced only at
the time they are required for sale. The implementation of the JIT system requires
complete transformation of methods of designing products and services, assigning
responsibilities to workers, and organizing work.
This unit will introduce you to the concept of the JIT system. We shall then move on
to discuss the advantages of JIT systems. Finally, we would discuss the characteristics
of JIT systems.
2. Objectives
explain the concept of the JIT system.
discuss the advantages of JIT systems.
evaluate the characteristics of JIT systems.
3. The Concept of the JIT System
The JIT concept states: nothing is produced until it is required. According to the JIT
system, the finished goods are assembled just before they are sold, the sub-assemblies
are made just before the products are assembled and the components are fabricated
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68
just before the sub-assemblies are made. Here, the work-in-process inventory is
always kept at a low level, thus reducing the production lead times. The firms should
achieve and maintain high performance levels in all their operational areas to facilitate
the smooth flow of materials in the JIT systems. The JIT system involves the active
participation, involvement, and cooperation of all its employees. The JIT
manufacturing system is based on the concept of continuous improvement, which
includes the two mutually supporting components of people involvement and total
quality control.
People Involvement
The HRM component plays a vital role in the implementation of the JIT
manufacturing system. The successful implementation of a JIT program requires
teamwork, discipline, and supplier involvement.
Teamwork: Teamwork involves activities like suggestion programs, and quality
circle programs, which enable employees to actively participate. Suggestion programs
are conducted to encourage the employees to give their ideas on how to improve a
process. In quality circles, people working in similar types of operations meet at
regular intervals and discuss ways of improving the quality of their processes.
Discipline: Firms use the creativity of workers along with their teamwork and
discipline to produce good quality products and services.
Supplier Involvement: JIT firms maintain fewer suppliers, but they are more than
one. Firms can allow suppliers to participate in design review and to suggest new
designs and methods for improving product quality or productivity. JIT firms enter
into contracts with their suppliers instead of inviting competitive bids from a set of
suppliers. The contract should be beneficial for both the supplier as well as the firm.
The JIT firm can share its production plans and schedules with its suppliers so that
they can plan their business and capacity requirements beforehand. Linear production
schedules relate to the development of production schedules with uniform workloads.
The suppliers should tailor their schedules to the JIT firms needs as they contribute to
the improvement of the firms manufacturing operations. The maintenance of linear
production schedules requires the identification and elimination of production
bottlenecks, a balance in the production system, and a reduction in set-up time.
Total Quality Control
A firm can produce high quality products only through the combined efforts of all the
departments including the purchase department, quality control department, and
personnel department. The concept of immediate customer helps the firms to
achieve the required quality levels.
Concept of Immediate Customer
A JIT firm uses the concept of immediate customer where each worker in the firm
considers the next worker who continues the production process as the customer.
Therefore, it is the responsibility of the worker to ensure that the product is processed
to meet specifications and quality requirements before passing it on to the next
worker. Only items of acceptable quality are delivered to the immediate customer. In
case a worker delivers a defective item or an improperly finished item to his/her
immediate customer, the worker who identifies the defect is authorized to stop the
process and take necessary actions thereafter.
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Example: Ford
The Model T developed by Henry Ford consisted of about 10,000 parts of motors,
transmissions, and other components. The production of the company increased
significantly from 1914 to 1916. Ford was continuously expanding his existing
facilities and building newer ones to aid the flow, storage, and handling of
materials from its large number of suppliers. He believed that figures were facts
and never relied on expert opinion. To maintain the companys production rate, he
carried an inventory worth $ 60 million. Ford called the system speeding up the
turnover, which was innovative and instructive and used it to begin backward
integration of the firm. Ford outsourced 50% of his supplies. Additionally, in order
to ensure continuous flow of manufacturing, Ford acquired iron ore fields, coal
mines, a railroad, coal and ore boats, timberlands, stamping mills, and foundries.
By effectively planning and coordinating the input of materials, Ford was able to
reduce the manufacturing cycle time and the inventory carrying costs. Within 14
days, raw materials were sourced, transformed into automobiles, and were sent to
the dealers.
Prior to World War II, Ford and GM dominated the Japanese market. The Japanese
were proficient in reverse engineering. Post war, Toyota wanted to become
competitive and looked to the US. In the 1950s, Taiichi Ohno, a mechanical
engineer and manager for Toyota, studied and redesigned the techniques used by
Ford into just-in-time inventory. Ohno observed that while some workers
overproduced and created inventory, others were idle waiting for parts. This
resulted in the creation of Kanban, in which tags accompanied each part or batch of
work in process. The tags alerted the workers about what needed to be done. For
example, when a part or container of parts was used in the production process, the
tag was returned to the supplier, suggesting the need to restock. As each work
station required parts, the card would move backward from site to site and then
forward with the resupply. In an ideal situation, the inventory would be zero, with
each part arriving just when it was needed.
Adapted from, Daniel A. Wren, Just-in-Time Inventory, September 1999,
http://www.destinationkm.com/articles/default.asp?articleID=165
Activity: Great Automobiles Inc is an automobile manufacturing company. The
company has decided to adopt the JIT manufacturing system. The company is
under the impression that JIT involves assembling finished goods just before they
are sold. The operations manager decides to explain to the company the importance
of people and quality control in the JIT manufacturing system. Assist him in the
process. In what way do you think people play a role in the JIT system and who are
the people involved in the system?
Answer:
Operations Control
70
Check Your Progress
1. Which of the following are essential conditions for a JIT system to be successful?
i. Teamwork
ii. Discipline
iii. Supplier involvement
a. Only i and ii
b. Only i and iii
c. Only ii and iii
d. i, ii, and iii
2. Nothing is produced until it is required is a fact practiced in which concept?
a. Make-to-stock process
b. Materials requirement planning
c. Just-in-time manufacturing
d. Inventory management
3. JIT adopts the concept of immediate customer to increase product quality and
improve customer service. What does the term immediate customer signify?
a. Every worker in the JIT firm is considered a customer
b. A person outside the firm who buys its products for use or consumption
c. Each worker in the firm considers the next worker in the production line as a
customer
d. Each worker is fully responsible for a task and inspect his or her own work
4. Which of the following is not a characteristic of JIT system?
a. The JIT firm shares production plans and schedules with suppliers
b. The JIT firm can provide assistance to suppliers to improve quality and
productivity
c. The JIT firm invites suppliers to participate in product design and suggests
changes and/or improvements
d. The JIT firm always maintains only one supplier for each type of material
4. Advantages of JIT Systems
The advantages of JIT systems to firms are increased utilization of machinery
and equipment, reduced investment in inventory, improvement in the quality of
product or service, reduction in space requirements of the firm, reduction in
production cycle time, zero inventory storage and maintenance costs, closer
relationship with suppliers, reduction in formal paper work, and higher
involvement of employees as they are responsible for producing good quality
goods.
The advantages of JIT systems to suppliers are long-term guaranteed contract for
supply of materials, steady and continuous demand for their materials, less
expenditure on promotional activities, and timely payment for materials supplied.
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Activity: Sweekar is a small chocolate manufacturing company. In order to
increase its production capacity, the company decides to change its manufacturing
system and expand its operations. It seeks the advice of a consultant who suggests
that the company go leaner and adopt JIT. The management is surprised to learn
that lean manufacturing and JIT can be applied to a small company. The consultant
explains to the company about JIT and lean manufacturing and how they are
helpful for any company. Help the consultant in convincing Sweekar by
highlighting the importance of JIT and lean manufacturing in general and
explaining how they help companies compete successfully in global markets.
Answer:
5. Characteristics of JIT Systems
The proper implementation of the JIT principles helps in producing products and
services at the quality and price demanded by customers. The following are the
characteristics of a JIT system:
Uniform Workstation Loads
By using the JIT system, firms can maintain uniform work-loads at the workstations.
For example, Toyota plans to produce 24,000 cars in the current month. By carrying
out the production for five days per week, the company can produce 1200 cars each
day. By carrying out production in two shifts a day, the company can produce 600
cars per shift. In this way, the JIT system helps in maintaining uniform workloads at
each work center.
Small Lot Sizes
In a JIT manufacturing system, firms maintain inventory in the smallest possible lot
sizes. This is done to reduce the cycle inventory, cut lead times, and achieve a uniform
workload. Smaller lots have a lower waiting time in the production process when
compared to the larger lots.
Closer Supplier Ties
JIT firms should maintain long-term relationships with their suppliers as they are
responsible for providing the timely delivery of good quality inventory. The
relationship should be profitable for both the suppliers and the firm. Both the parties
should work toward the betterment of each other while abiding to the terms of the
contract.
Maintenance of High Quality
In the JIT system, quality control begins from the source where the workers are
encouraged to maintain the quality of work. The production process is stopped
immediately when a quality problem is identified and is continued only after the
problem has been sorted out.
Operations Control
72
Quick and Economic Set Ups
Generally, firms manufacture their products in large lots leading to a lower number of
machine set-ups. Firms using the JIT system experience a larger number of set-ups as
they produce in small lots. JIT firms, therefore, need quick and inexpensive set-ups in
order to minimize the disadvantages of having more set-ups. JIT firms engage
specialists and consultants to train their workers to reduce set-up times. The following
is the procedure to reduce set-up times:
1. Analyze existing set-up procedures: The existing set-up procedure is recorded
on videotapes and the management collects information from its employees
relating to the execution of these set-up procedures. The procedures are then
analyzed to determine ways to improve them.
2. Separation of internal and external set-up activities: External set-up activities
are those that can be performed without stopping the current production process.
The set-up process can be improved by separating external set-up activities from
internal set-up activities and then developing a plan to perform the external
activities while the production process is in progress. Thus, the time is saved on
the production process.
3. Convert internal set-up activities into external set-up activities: The
management of the firm should then try to convert its internal set-up activities
into external activities by changing work methods, adding work aids, or by
purchasing duplicate sets of tools or equipment. The following are some
procedures that would enable conversion of internal set-up activities into external
set-up activities:
a) Heating: Instead of heating materials before beginning a production process as a
part of the internal set-up, materials can be preheated outside the set-up so that the
actual heating activity can be finished in less time.
b) Cleaning: Workers can replace contaminated equipment with a clean set to
continue the production process while the contaminated equipment is cleaned
externally.
c) Streamline work: Set-up times can be reduced by simplifying the internal
activities and by streamlining the work in a firm. For example, a set of tools can
be provided to each work center so that workers need not wait for a standard tool
required while another process is going on.
d) Flexible facilities and multi-skilled workforce
JIT production systems are advantageous for firms that produce the same product
constantly. As the production process is repetitive in nature, the movement of
materials can be reduced by placing the equipment in cells (a cell is a grouping of
several types of machines in which each machine repeatedly performs a single
operation) instead of keeping them in functional departments. Such flexible facilities
reduce the need for materials handling equipment and in turn the material-handling
costs, and improve the speed of production, thereby allowing quicker deliveries. In a
JIT production system, the entire workforce is trained continuously at regular intervals
to develop a variety of skills to perform any function the firm requires. Firms can
develop flexible workforces through cross-training in which a worker is trained to
perform more than one operation rather than being limited to the single operation
assigned to him. Cross-training of the workforce and establishing U-form cells makes
the production process more flexible. Arranging facilities in U-form and processing
production in small lot sizes makes it easy for the firm to identify defects that occur at
any stage in the production process.
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Preventive Maintenance
In order to reduce the occurrence of defects, firms should carry out preventive
maintenance. In preventive maintenance, the parts that are likely to produce defects
are replaced, rather than the defects that arise during production being repaired.
Workers are given the responsibility of maintaining their machinery and equipment
and are also trained to solve or repair common problems. The following are the
important principles and actions that improve equipment maintenance:
Design simple equipment and standardize replacement parts.
Collect information about the frequency and causes of failure of machines.
Replace worn out parts of the equipment, after periodic checks.
Purchase all spare parts that are necessary during repair work.
Continuous Improvement
In a JIT system, firms adopt continuous improvement in quality and productivity by
identifying areas that require improvement. Problems are detected before they occur and
are solved in the minimum possible time, to ensure smooth flow of work. For
manufacturing operations, the percentage of scrap can be reduced by following better
work methods and training employees. A proper master production schedule and
flexible workforce can be developed to eliminate the capacity imbalances.
Manufacturing operations can be improved on a continuous basis through the complete
involvement of employees and the management. For service operations, the process of
continuous improvement aims at reducing the number of people involved in providing
the service, without affecting the quality and rate of service. JIT is a powerful tool for
reducing the firms inventory and improving productivity. However, implementation of
JIT principles is difficult as barriers in the form of workers resistance to change,
difficulty in accomplishing zero lead-time, zero safety stock, and zero idle time have to
be overcome. Support and commitment from the top management and extensive
employee training lead to the successful implementation of JIT.
Activity: Safety Inc is a manufacturing company using the JIT manufacturing system
of production. The company realized that it was not successful in implementing the
system and therefore, appointed a consultant to find out the reason. The consultant
found that the company had failed to implement the system because of lack of
flexibility in production. He further explained the reasons for failure in implementing
the JIT system by companies like Safety Inc. What do you think are the factors that
contribute to successful implementation of the JIT system?
Answer:
Check Your Progress
5. How are workers in a JIT firm different from that of a non-JIT firm?
i. JIT workers are trained continuously
ii. JIT workers are trained to perform multiple jobs
iii. JIT workers are specialized in a particular operation
Operations Control
74
a. Only i
b. i and iii
c. i and ii
d. i, ii and iii
6. Having quick and economic set-ups is a characteristic of a JIT system. Firms
adopt a procedure to reduce set-up times. Arrange the steps in the correct
sequence.
i. Analyze existing set-up procedures
ii. Separation of internal and external set-up activities
iii. Convert internal set-up activities into external set-up activities
a. i, ii, iii
b. ii, iii, i
c. i, iii, ii
d. iii, i, ii
7. Which of the following is a feature of the JIT strategy related to production?
a. Produce in small lots
b. Every worker is responsible to the immediate customer (worker)
c. Continuous improvement
d. Customer satisfaction
8. Which one of the following is not a result of implementing JIT systems?
a. Small lot sizes
b. Varying workstation loads
c. Quick and economic set-ups
d. Preventive maintenance
9. Which of the following is not a characteristic of the JIT system?
a. Uniform workstation loads
b. Large lot sizes
c. Quick and economic set-ups
d. Flexible facilities
10. Firms that practice JIT production systems require reliable suppliers. Therefore,
JIT firms maintain long-term business relationships with a few selected suppliers.
Which of the following is true about a supplier relationship under the JIT system?
a. The JIT firm derives more mileage than the supplier from the relationship in the
long run
b. The supplier derives more mileage from the relationship
c. The relationship should be profitable to both the firm and the supplier
d. The supplier need not stick to the terms of supply under the contract
11. Quick and economic set-ups is a characteristic of a JIT system. What does this
signify?
i. Lesser inventory
ii. Smaller production lot size
iii. Higher number of set-ups
iv. Higher costs
75
a. i, ii, and iii
b. ii, iii, and iv
c. i, iii, and iv
6. Summary
The JIT manufacturing system achieves high-volume production using minimal
inventories.
In the JIT system, inventory is always kept at a low level, thus reducing the
production lead times.
Firms can maintain consistent quality of products and processes by coordinating the
various production processes.
Successful implementation of a JIT program requires teamwork, discipline, and
supplier involvement.
The JIT manufacturing system is based on the concept of continuous improvement
which includes the two mutually supporting components of people involvement and
total quality control.
The JIT system entails uniform workstation loads, small lot sizes, closer supplier ties,
maintenance of high quality, quick and economic set-ups, flexible facilities, and
multi-skilled workforce, preventive maintenance, and continuous improvement.
7. Glossary
Concept of immediate customer: A firm following the just-in-time manufacturing
system uses this concept where each worker in the firm considers the next worker
who continues the production process as the customer.
Just-In-Time system: It states: nothing is produced until it is required. The finished
goods are assembled just before they are sold, the sub-assemblies are made just before
the products are assembled and the components are fabricated just before the sub-
assemblies are made.
1. The JIT concept states: nothing is produced until it is required. Substantiate.
2. A JIT system contributes to improving the productivity and profitability of a firm.
How can firms adopting the JIT technique and their suppliers benefit from the JIT
system?
3. The JIT system minimizes the firms idle resources, aims at the continuous
improvement of a process, and ensures the desired quality of the end-product or
service. Describe the characteristics of the JIT system in detail.
Operations Control
76
6. Risks of being Just-In-Time
<http://www.inventorymanagementreview.org/2005/10/the_risks_of_be.html>
7. Just-In-Time Inventory Management Strategy & Lean Manufacturing
<http://www.academicmind.com/unpublishedpapers/business/operationsmanage
ment/2005-04-000aaf-just-in-time-inventory-management.html>
8. Just-In-Time Manufacturing
<http://www.maaw.info/ABKYBook/ABKYChapter6.htm#7.%20JIT%20Manufa
cturing>
9. Just-In-Time
<http://www.maaw.info/Chapter8.htm>
10. Traditional Costing, ABC, JIT
<http://www.maaw.info/TradABCJIT.htm>
11. JIT, TPS, and Lean Manufacturing
<http://www.strategosinc.com/just_in_time.htm>
Teamwork, discipline, and supplier involvement are considered important
elements for successful implementation of the JIT system in an organization.
2. (c) Just-in-time manufacturing
The Just-in-time concept states that 'nothing is produced until it is required.' The
practice of JIT aims at assembling finished products just before they are sold,
sub-assembling just before products are assembled and fabricating components
just before sub-assemblies are done.
3. (c) Each worker in the firm considers the next worker in the production line
as a customer
In a JIT firm each worker considers his/her next worker in a production line as
his/her customer. This is because the work done by him/her passes to the next
worker for further processing.
4. (d) The JIT firm always maintains only one supplier for each type of
material
JIT firms maintain fewer suppliers, but they are more than one. JIT firms
normally share their production plans and schedules with suppliers to enhance
their understanding of the production and supply the material at the right time.
They also help suppliers with their expertise and suggest ways to improve quality
and productivity. This will help firms improve the quality of end products. When
the firms plan to introduce new products, they also take suggestions from
suppliers regarding product design and types of materials that can be used to
improve quality as well as profitability.
77
5. (c) i and ii
In a JIT production system, workers must be capable of performing more than
one operation. Hence, the entire workforce is trained continuously (at regular
intervals) to develop a variety of skills to perform any function the firm requires.
A worker is trained to perform several operations rather than being limited to a
single assigned operation.
6. (a) i, ii, iii
The successful implementation of a JIT system is greatly dependent on its ability
to reduce set-up times. JIT firms engage specialists and consultants to train
workers to reduce set-up times. Firms adopt the following steps to reduce set-up
times: 1) Analyze existing set-up procedures, 2) Separation of internal and
external set-up activities and 3) Convert internal set-up activities into external set-
up activities.
7. (a) Produce in small lots
Traditionally, firms manufacture products in large lots, resulting in a lower
number of machine set-ups. But JIT manufacturing firms undergo a larger
number of set-ups as they produce in small lots.
8. (b) Varying workstation loads
Just-in-time manufacturing helps firms maintain uniform loads at workstations.
Some of the characteristics of a JIT system are uniform workstation loads, small
lot sizes, closer supplier ties, maintenance of high quality, quick and economic
setups, flexible facilities and multi-skilled workforce, preventive maintenance,
and continuous improvement.
9. (b) Large lot sizes
Firms that follow JIT type of manufacturing system maintain inventory in the
smallest possible lot sizes. This is required as small lot sizes reduce cycle
inventory (the excess of inventory, above the safety stock, that is carried between
two orders), cut lead times and also help in achieving a uniform workload. JIT
manufacturing systems follow uniform workstation loads where material is fed to
the workstation uniformly and uniform output is produced across different
workstations. Besides, these firms have flexible facilities and quick and economic
set-ups.
10. (c) The relationship should be profitable to both the firm and the supplier
Under the JIT system, the relationship should be profitable to both the supplier
and the JIT firm in the long run. Hence, the JIT firm and the supplier should work
towards the betterment of each other by abiding to the terms of the contract.
11. (a) i, ii and iii
Traditionally, firms manufacture products in large lots, resulting in a lower
number of machine set-ups. But JIT manufacturing firms undergo a larger
number of set-ups as they produce in small lots. Therefore, JIT manufacturing
firms require quick and inexpensive setups to minimize the disadvantages of
having more number of set-ups and higher costs.
Unit 29
Productivity and Quality Management
Structure
1. Introduction
2. Objectives
3. Productivity
4. Strategic Role of Quality
5. Role of Inspection in Quality Control
7. Statistical Concepts in Quality Control
8. Acceptance Plans
9. Computers in Quality Control
10. Concept of TQM
11. Summary
12. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the characteristics of Just-In-
Time (JIT) manufacturing systems. We have learnt that proper implementation of the
JIT concept helps in producing products and services at the quality and price demanded
by customers. In this unit, we will discuss productivity and quality management.
Performance can be split into qualitative and quantitative performance. Productivity is
the measure of quantitative performance of an organization. It is the output produced
using a given set of inputs. Productivity provides a good measure of performance at the
national, industry, or individual business level. Walter Stewhart marked the beginning of
the quality movement by developing the first process control chart in 1920. Quality,
which was not the top priority in organizations initially, began gaining importance with
the growing competition and more demanding consumers. Quality control begins from
the time raw materials are procured based on appropriate specifications.
This unit will introduce you to productivity, and the strategic role played by quality.
We will discuss the vital role played by inspection in quality control, and then study
the cost of quality. We shall then move on to discuss the statistical concepts in quality
control, and about acceptance plans. Finally, we would discuss the use of computers
in quality control, and the concept of total quality management.
2. Objectives
define productivity.
assess the strategic role of quality.
explain the role of inspection in quality control.
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determine the cost of quality.
analyze the statistical concepts in quality control.
define acceptance plans.
discuss the role played by computers in quality control.
reproduce the concepts of total quality management (TQM).
3. Productivity
Productivity is the ratio of the output produced to that of the inputs consumed. Hence,
it is a measure of the efficiency of the firm in terms of products produced. For
instance, the number of motor cycles produced per day is a typical measure of
productivity. Productivity helps the operations managers to control the production
process and match it with that of the market demand. Productivity is calculated by the
formula:
Input
Output
= ty Productivi .
Inputs: All the factors that are used in the production process of a product are
considered the inputs of that product. Inputs can be viewed in terms of costs, tangible
and intangible assets etc, and can be measured in different units. Typical tangible
production inputs include quantity of material used, number of workers employed,
number of man hours consumed, amount of power consumed, etc. Intangible inputs
include training, leadership skills, workers knowledge, etc.
Outputs: Inputs are converted into output through production process. Output can be
quantified in terms of number of units produced, number of customers serviced, etc.
Common examples include 50 million tons of cement, 4000 telephone units, etc.
Output in service organizations can also be intangible like customer satisfaction,
customer delight etc.
Components of Productivity
Productivity can be improved in many ways such as by procuring quality raw material
at the lowest possible cost, adopting an optimal mix of production factors, and training
the workers. These different factors/components independently influence the
productivity in different ways. The components can be categorized to include price
efficiency, allocative efficiency, technical efficiency, and scale efficiency.
Factors Affecting Productivity
Productivity is one of the important performance indicators of an organization.
Increased productivity enhances the image of the organization and is one of the key
factors that affect the competitiveness of the organization. Some of the factors
affecting productivity of an organization are listed as follows.
Bottlenecks in the form of poor layout designs, slow processing equipment, and
inventory shortages can reduce the productivity of an organization.
Shortage of skilled manpower and lack of training on advanced technologies can also
reduce productivity.
Poor scheduling methods lead to more waiting time in the production process. More
waiting time leads to increased cycle time and reduced productivity.
Strikes and worker agitations also cause break in production that in turn affects the
productivity of the organization.
Operations Control
80
Measuring Productivity
Productivity can be measured in relation to a single factor (single factor productivity), a
combination of factors (multifactor productivity), or all the factors taken together (total
productivity). Single factor productivity implies productivity is measured considering
only a single factor, say labor or raw material. Multifactor productivity implies two or
more factors are considered to measure productivity. When all the factors of production
are used to measure productivity, then it is termed total productivity.
Goods and/or services produced (output)
Labor productivity =
Labor hours/man hours spent (output)
Multifactor productivity =
Quantity of raw material and components used
Total productivity =
[Labor + capital + energy + technology + materials] (inputs)
Activity: Tarun Motor Works is a small scale unit manufacturing 0.5hp motors. It
has 10 workers in the workshop and they work for 8 hrs a day. Every motor uses
2kg of copper wire and 6 components. If five motors are manufactured daily on an
average, (a) what is the labor productivity? (b) What is the multifactor productivity
of the usage of copper wire and components?
Answer:
Measuring knowledge workers productivity: It is difficult to measure the
productivity when intangible and qualitative factors like knowledge of the workers,
leadership skills etc, are involved. The quality of knowledge workers output cannot
be immediately determined in many cases. For instance, a strategic decision taken by
a top level manager can take a few years to bear fruit. Hence, until the output is not
quantified, productivity cannot be measured. Further, when the knowledge workers
provide their services to other organizational units it becomes difficult to quantify
their contribution. For example, if a sales managers knowledge is used in the
development of company forecast, it is difficult to quantify the extent of involvement
of the sales manager in the development of the forecast.
Measuring productivity of service organizations: Intangibility in services makes it
difficult to produce tangible results. This in turn further affects the ability of the
service organizations to measure the productivity. To overcome this difficulty, the
service organizations make use of indirect means to measure productivity. For
instance, many service organizations use time sheets to measure the amount of time
spent by the employees on each task. This helps them estimate the time spent by the
employee(s) on servicing a single customer. Time sheets are helpful in both routine
service activities like that of a call center executive outbound) and customized service
81
offerings like in health clubs, restaurants, counseling etc. Usually productivity in
service organizations is measured in terms of number of tasks performed, or number
of customers serviced in a given period of time.
Check Your Progress
1. Identify from the following, the factors that affect the productivity of an
organization.
i. Bottlenecks in the form of poor layout designs and slow processing equipment.
ii. Shortage of skilled manpower and lack of training on advanced technologies.
iii. Poor scheduling methods leading to more waiting time in the production process.
iv. Strikes and worker agitations causing break in production.
2. _____________ is a measure of the efficiency of the firm in terms of products
produced, and can be calculated as the ratio of the output produced to that of the
inputs consumed.
a. Quality
b. Scheduling
c. Productivity
d. Reengineering
3. All the statements given below are true regarding productivity, except:
i. Productivity can be measured in relation to a single factor, a combination of
factors, or all the factors taken together.
ii. When two or more factors of production are considered to measure productivity,
it is called as total productivity.
iii. It is very easy to measure the productivity when intangible and qualitative factors
like knowledge of the workers and leadership skills are involved.
iv. Generally, productivity in service organizations is measured in terms of number
of tasks performed, or number of customers serviced in a given period of time.
a. Only i and ii
b. Only i and iv
c. Only ii and iii
d. Only iii and iv
4. Quality control is an important function that helps increase customer satisfaction.
At which of the following stages does quality control begin?
a. Procurement of raw material
b. Start of production
c. Finished goods inventory
d. Dispatch to customers
5. Bottlenecks in the production process can hamper productivity. Which among the
following cannot be an example of a bottleneck that can hamper productivity?
a. Layout
b. Slow processing equipment
c. Proper scheduling
d. Inventory shortage
Operations Control
82
6. Which of the following can be a measure of output associated with productivity
in service organizations?
a. Number of calls made by a telemarketer
b. Number of complaints received by a call center
c. Amount of time spent in counseling a student
d. Number of cars serviced in a period
4. Strategic Role of Quality
Until recently, quality was considered as a defensive function which helped in
developing new markets and increasing market share. The basic purpose of quality
control was then to reduce the number of customer complaints. It was therefore
dependent on inspection rather than on prevention. However, of late, companies have
begun to realize the importance of using quality as an offensive strategic weapon. A
company can compete on the quality functions such as performance (a car could be
compared on performance characteristics such as acceleration, mileage, and speed),
features of the product, reliability (the probability of a products failure within a
specified time period), conformance (ability of the product and its individual
components to meet the established standards), durability (the operational life of a
product), serviceability (It is the readiness of the product to be serviced back to the
operational mode), aesthetics and perceived quality (customers perception about the
quality of a product).
5. Role of Inspection in Quality Control
As the number of items being inspected increases, the inspection cost increases while
the cost of undetected faults decreases. At a particular point, there is an optimal trade-
off between the inspection cost and the cost of undetected faults, and at this point, the
total quality control cost will be the minimum. Costs incurred for personnel training,
supervision of inspectors, inspection facilities, conducting tests, etc. come under
inspection costs whereas the costs of undetected faults include customer complaints,
loss of goodwill, product replacement cost, etc. The output for most of the product and
services cannot be inspected as it would be uneconomical and in cases where
destructive testing is done, it would be impossible. The efficiency of the inspections
could be enhanced by carrying them out.
1. After operations that are most likely to produce faulty items,
2. Before costly operations commence,
3. Before operations that can cover up defects take place,
4. Before undertaking assembly operations that cannot be undone, and
5. When the finished product is ready for delivery.
Activity: Skato Ltd is a company engaged in manufacturing different types of
skates and skate boards. The company recently set up a product development wing
to develop new kinds of products. The new product development team is planning
to come out with a new type of skates which will serve multiple purposes. Skanda
is the quality manager in the team. The team has been concentrating on developing
a good quality product that serves all the purposes for which it is meant. However,
it has neglected to consider the other aspects of the product such as durability,
serviceability, performance, and reliability. Skanda is in the process of explaining
to the team the importance of all these aspects in developing a new product. Assist
her in the process. Do you think a product (irrespective of price) should be
developed after considering the various quality aspects like those stated here?
Contd
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Contd
Answer:
Check Your Progress
7. A company can compete on different quality functions. Which of the following is
not a function of quality?
a. Performance
b. Features
c. Reliability
d. Warranty
8. At one point cost of inspection and cost of undetected faults is optimum. What
does this statement signify?
a. The cost of inspection is high
b. The cost of undetected faults is high
c. The total cost of quality control is minimal
d. The average cost of quality control is minimal
9. At one point, there is an optimal trade-off between the cost of inspection and the
cost of an undetected fault. At this point, the cost of total quality control is
minimal. Which of the following is not an inspection cost?
a. Cost of training personnel
b. Loss of goodwill
c. Supervision of inspectors
d. Cost of inspection facilities
10. Match the following quality functions with their respective descriptions.
i. Reliability
ii. Conformance
iii. Perceived quality
p. Ability of the product and its individual components to meet the established
standards
q. Customers views about the quality of a product
r. Probability of a products failure within a specified time period
a. i/r, ii/q, iii/p
b. i/r, ii/p, iii/q
c. i/q, ii/p, iii/r
d. i/q, ii/r, iii/p
Operations Control
84
The cost of quality is the total of the cost of prevention (Companies incur prevention
costs to prevent defective goods and services from being manufactured or delivered to
the consumers), the cost of detection/appraisal (costs associated with the evaluation of
quality and the performance of products and machines), and the cost of failure (costs
that occur in non-conforming and non-performing products). The costs of failure are
divided into external and internal failure costs. Internal failure costs are incurred when
defects are found before the products are delivered to the consumers and they can be
eliminated if the defects are minimized or eliminated within the system. These costs
are incurred due to scrap, repair, retesting of repaired products, downtime, losses due
to process variability, disposal of defective items, etc. External failure costs are
incurred when the defects are found after the products are delivered to the consumers.
These costs include cost of returned material, warranty charges, field survey costs,
legal expenses due to lawsuits, loss of sales, cost of concessions, etc.
Activity: Edmond, the quality manager of a manufacturing company, is calculating
the cost of quality of a new product that has been recently developed. His
subordinate Rupert, a newcomer, is assisting him in the process. Rupert observed
that Edmond has taken into account the prevention costs, the appraisal costs, and
the failure costs to arrive at the cost of quality. He is wondering how to arrive at the
cost of quality, which is intangible in nature. Can you explain to him the
importance of quality, and the way it can be calculated and the different types of
costs involved in the process?
Answer:
7. Statistical Concepts in Quality Control
Statistical techniques are used in identifying variations in the process which could
affect the quality of the final product or service.
Control Charts
Control charts are used for monitoring quality and are easy to develop, analyze, and
understand. Different measurement criteria are plotted on a chart with a central line
representing the mean value and two control limits above and below the central value.
The process is said to be in control if the noted variable and attribute values fall
between the control limits. If the values fall outside the control limits, then the process
is said to be out of control, and remedial actions have to be taken to correct the
differences.
Essential Steps in Starting the Control Chart
Steps for establishing the basic procedures for a quality control program:
1. Select the quality characteristics that are to be controlled (including the limits of
variations).
2. Analyze the production process to determine the kind and location of the probable
causes of irregularities.
85
3. Determine how the inspection data is to be collected and recorded.
4. Choose the statistical measures that are to be used in the chart.
5. Select a control chart to ensure that the control limits calculated are correct for the
data. The selection depends on the format of the data being collected, which can
be either in the variables or attributes format. The selected variables refer to the
measurable characteristics of a product or service such as length, weight,
thickness, etc. In the attributes format, the items inspected are classified as
conforming or non-conforming.
Control Charts for Variables: These charts are used for maintaining quality
standards for a process by evaluating measurable product or service variables like
thickness, length, tensile strength, and queue waiting time. These charts are used for
evaluating the mean and variability of the process distribution. The X-Chart and the
R-Chart are types of control charts for variables. The X-Chart is used to find the
central tendency of the inspected samples while R-Chart displays the variability of the
process. Both X-Chart and R-Chart are used simultaneously to get a meaningful
analysis. The upper and lower control limits for X-chart are given by the equations
UCL = x + A
2
R and LCL = x A
2
R
Control limits for R-chart is given by the formula
UCL=D
3
R
and LCL= D
4
R
Control Charts for Attributes: In these charts, a measurable variable like weight,
length, width, etc. is used in the inspection process. After inspection, the items are
identified as defective or non-defective if the quality characteristics are not quantifiable.
The C-Chart and the P-Chart are the types of control charts for attributes. P-Chart is
used to find the proportion of defective items in a given sample while C-Chart is used to
find the total number of defects in an item when the item has multiple defects.
Check Your Progress
11. Control charts are used extensively to monitor quality. Suppose some individual
parts measured are below the lower control limit. What does this clearly indicate?
a. The process is out of control and the cause should be established
b. The process is in control
c. The process is within established control limits with natural causes of variation
d. The process is outside established control limits with only natural causes of variation
12. The cost of quality can be divided into different categories. Evaluating quality and
performance of products and machinery is associated with which type of costs?
a. Prevention costs
b. Failure costs
c. Appraisal costs
d. Both a & b
13. Failure costs, which are a type of quality costs, can be divided into internal and
external failure costs. Which of the following is not an internal cost?
a. Scrap costs
b. Downtime costs
c. Retesting costs
d. Cost of returned products
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86
14. Control charts are used extensively to monitor quality. They can be categorized
under control charts for variables and control charts for attributes. Which of the
following come under the former?
i. X-chart
ii. R-chart
iii. P-chart
iv. C-chart
a. i & ii
b. ii & iii
c. i & iii
d. ii & iv
15. Which of the following control charts is used to determine the proportion of
defective items in a selected sample?
a. X-chart
b. R-chart
c. P-chart
d. C-chart
16. Companies incur ___________ costs to avoid defective goods and services from
being manufactured or delivered to the consumers.
a. Failure
b. Detection
c. Appraisal
d. Prevention
Exercise
A. Small boxes of peanuts are labeled net weight 250 gm. To construct control
charts, random samples of 4 boxes were weighed. You can assume the value of
D
3
as 2.11 for the sample. Based on observations given in the table below,
determine the upper control limit for the R-chart.
Sample Mean Weight (X) Range (R)
1 240 30
2 260 20
3 250 20
4 270 30
5 240 60
TOTAL 1260 160
8. Acceptance Plans
Acceptance plans are used for verifying the quality of raw material inputs, parts and
components, and finished goods. A manager can accept or reject a lot based on these
plans. If a lot is accepted, it is placed in the inventory for use whereas if it is rejected,
it is returned to the supplier. If the lot of finished goods is accepted, it is sent to the
87
consumers and if it is rejected, it is put through 100% inspections and the defective
items are replaced by non-defective items. The main criterion for acceptance plans is
to accept or reject a sample. For attributes, what is the maximum percentage of
defectives that can be found in a sample and still be accepted? For variables, what is
the largest and the smallest sample mean and sample range? Given here is acceptance
sampling based on average outgoing quality and operating characteristics.
Average Outgoing Quality (AOQ) Curve
Average Outgoing Quality (AOQ) Curve: The AOQ indicates the average defects in
a lot that is assumed to have been inspected completely with all the defects or
defective items having been removed or replaced. When the number of defects or non-
conforming units in a lot is not too much, it means the AOQ (proportion of non-
conforming units in the released lot) is less. The probability of rejecting lots increases
with an increase in the proportion of defective items in the lot. These rejected lots are
put to 100% inspection. The AOQ level is enhanced as more lots are put through
100% inspection. The maximum AOQ for any acceptance plan is the Average
Outgoing Quality Limit (AOQL), which indicates the point at which the AOQ reaches
the critical level. Any lot with the AOQ value of more than AOQL must not be sold to
the final customers. Figure shows the AOQ curve characteristics when AOQ is plotted
against percent defective. At the beginning, the curve takes an upward trend as there is
an increase in the number of defective units, which increases the AOQ for the
sampling plan. Point P is the maximum level for AOQ. The entire lot is rejected and
every item in the lot is inspected, if the percent defectives exceed the critical point P.
As the inspection increases, the defectives in the outgoing lot decrease, thereby
improving the AOQ.
Operating Characteristics (OC) Curve: An inspection of all the items in a lot is not
practical or feasible. By drawing a random sample, one can make an inference about
the quality of all items in the lot though it reveals only the quality of the items present
in the sample. The OC curve shows how well an acceptance plan differentiates
between good and bad lots. Assume that a good lot does not have more than 1%
defectives. This is called the Acceptable Quality Level (AQL). If there are only 1% of
actual defectives, the probability of accepting the lot will be 95% and the probability
of rejecting the lot will be 5%. The probability of rejecting the lot at AQL is called a
producers risk or Type I error. In a sampling plan, there is always a risk that a good
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88
lot will be rejected, which is the producers risk. The consumer also faces a risk.
Assume that a bad lot has 5% or more defectives. This is called the Lot Tolerance
Percent Defective (LTPD). The probability of accepting a lot with this percent of
defectives is the consumers risk or Type II error. Acceptance plans generally do not
have large sample sizes because their inspection costs are higher and therefore while
designing them they make a trade-off. Acceptance plans are designed with sample
sizes that offer a balance between inspection costs and the cost of undetected defects.
OC curves are not used for making day-to-day decisions about accepting or rejecting
lots. Acceptance plans are used for ascertaining whether raw materials, purchased
parts, and finished goods meet prescribed quality standards and based on these plans,
operations managers can either accept or reject a lot.
Check Your Progress
17. ___________ are used for verifying the quality of raw material inputs, parts and
components and finished goods.
a. Attributes
b. Acceptance plans
c. Control charts for attributes
d. Control charts for variables
18. Identify the statement that does not hold true regarding acceptance plans.
a. Acceptance plans are used for verifying the quality of raw material inputs, parts
and components and finished goods.
b. The main criterion for acceptance plans is to accept or reject a sample.
c. If a lot is accepted, it is returned to the supplier for use.
d. If the lot of finished goods is rejected, it is put through 100% inspection and the
defective items are replaced by non-defective items.
19. What is the condition in which a customer runs the risk of accepting a lot with has
5% or more defectives?
a. Cost of prevention
b. Type I error
c. Type II error
d. Cost of detection
20. What explains how well an acceptance plan differentiates between good lots and
bad lots?
a. AOQ
b. OC curve
c. Lot Tolerance Percent Defective
d. Acceptable Quality Level
9. Computers in Quality Control
Computer programs provide timely and relevant information regarding the quality of
output. The time between product inspection at various stages and posting of
information on control charts can be reduced as control charts can be prepared quickly
using computers. Computer programs are used for making lot acceptance decisions.
89
These programs set the conditions for acceptance, receive sample measurements, and
recommend an acceptance decision. The lead time can be minimized, and materials
can be moved into production quickly.
10. Concept of TQM
improvement through the involvement of every individual in the organization. TQM is
different from traditional quality control methods. Where the former suggests that it is
the responsibility of everyone to maintain quality standards, the latter restricts quality
maintenance to the quality personnel and manufacturing departments. Basically,
quality meant products meeting the specifications and any defects in them were
attributed to the manufacturing department. However, the fact that the performance of
the manufacturing department was dependent upon the performance of other
departments (like the purchase department), etc. was not taken into consideration. The
TQM philosophy takes a broader view and fixes the responsibility of quality control
on everyone, where the aim of the entire organization is to satisfy the customer. In
TQM, customers are divided into external customers and internal customers. External
customers are those who use the goods and services offered by the company and
internal customers are the employees of the organization. The TQM philosophy states
that each department in the organization should treat the other departments as its
customers. TQM uses various tools and techniques like Kaizen, Continuous
Improvement, Quality Circles, Quality Improvement Teams (QITs), Total
Productivity Management, etc. whose main focus is on team building and empowering
employees.
Activity: Collin International Ltd. is a sports goods manufacturing company. The
management of the company realized that its quality management initiatives were
not helping the company achieve its target of zero defects in its products. The
company thought that the manufacturing department was faulty in the process and
therefore began to warn them. The head of operations observed that the company
needed to implement TQM, as the quality management was restricted only to the
manufacturing department of the company and not to the entire company. The head
of operations is trying to convince the management of Collin about the need to
implement TQM throughout the company. Assist him in the process.
Answer:
TQM Principles
The following are the principles of TQM that organizations ought to practice to
survive in the highly competitive world.
Systematic improvement: TQM as a philosophy involves systematic improvement of
all the processes and systems in the organization irrespective of the functions and
departments.
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90
Customer focused: Under TQM, customer needs and requirements are identified and
evaluated first and then requisite products are developed to suit those needs. This
leads to increased customer satisfaction and delight.
Continuous improvement: Quality in TQM concept is not an end in itself, but is seen
as a continuous process of improvement. Continuous quality improvement makes the
organization more dynamic and a learning organization. A learning organization
always strives to satisfy its customers in better ways.
Problem prevention: The concept of TQM always emphasizes on preventing a
problem rather than finding ways to solve it after it has erupted. Thus TQM concept is
a proactive approach to problem solving (problem prevention).
Universal responsibility: The TQM concept emphasizes that every employee in the
organization is responsible for the implementation of quality and its improvement.
Designing quality products: The quality of the end product is very much dependent
on the design of the product. Hence quality improvement in designing of products is
emphasized in TQM.
According to Genichi Taguchi, the three important aspects of design quality are meeting
customer requirements, capability of process, and standardization to improve quality.
Check Your Progress
21. Universal responsibility is one of the principles of TQM. Identify the statement
that best represents and underlines the spirit of this principle.
a. Top management is responsible for the quality of products entering the market.
b. Production department is responsible for product quality.
c. Every employee at every level in the organization is responsible for quality.
d. Emphasis is on continuous improvement in process, skill sets, systems, or
operations.
22. Under TQM, every department in an organization should treat every other
department as its _________.
a. Producer
b. Customer
c. Distributors
d. Supplier
23. All the statements given below are true regarding total quality management, except:
a. It is a philosophy that seeks organization-wide improvement through the
involvement of every individual in the organization.
b. It restricts quality maintenance to quality personnel and manufacturing departments.
c. It takes a broader view and fixes the responsibility of quality control on everyone,
where the aim of the entire organization is to satisfy the customer.
d. It states that each department in the organization should treat the other
departments as its customers.
24. Which of the following is not a principle of total quality management?
a. Systematic improvement
b. Focus on customers
c. Continuous improvement
d. Top management responsibility
91
25. Identify from the following, the important aspects of design quality as proposed
by Genichi Taguchi.
i. Capability of process
ii. Meeting customer requirements
iii. Customizing the logistics network
iv. Standardization to improve quality
11. Summary
Productivity is an important performance indicator and measures the efficiency of
production process in a firm.
Productivity can be measured by considering a single factor (single factor
productivity) like raw material or multiple factors like raw material, components,
labor, etc (multiple factor productivity). Total productivity measures the productivity
by considering all the factors of production.
Measuring the productivity of knowledge workers and service organizations is
difficult as they involve many intangible components.
Operations managers have begun to pursue quality standards in products and services
to satisfy the demands of the consumers for good quality goods and services.
Quality control begins from the time raw materials are procured based on appropriate
specifications.
A company can compete on the quality functions of performance, features, reliability,
conformance, durability, serviceability, aesthetics, and perceived quality.
The cost of quality is the total of the cost of prevention, the cost of detection/appraisal,
and the cost of failure.
Prevention costs are incurred by a company to prevent defective goods and services
from being manufactured or delivered to the consumers.
Detection/appraisal costs are associated with the evaluation of quality and
performance of products and machines.
Failure costs occur in non-conforming and non-performing products and are divided
into external and internal failure costs.
Control charts are used for monitoring quality and are easy to develop, analyze, and
understand. There are two types of control charts control charts for variables and
control charts for attributes.
X-Charts illustrate the central tendency of a sample, R-Charts illustrate the variability
of a process, P-charts identify the proportion of defects in a given sample and C-
Charts identify the number of defects in a sample item when the item has multiple
defects.
Acceptance plans are used for verifying the quality of raw material inputs, parts, and
components, and finished goods.
Operations Control
92
The quality of products and processes can be improved by using computer-based
systems like robots, flexible manufacturing systems, automated assembly systems,
numerically controlled machines, etc.
improvement through the involvement of every individual in the organization.
TQM uses various tools and techniques like Kaizen, Continuous Improvement,
Quality Circles, Quality Improvement Teams (QITs), Total Productivity
Management, etc.
The principles of TQM have been instrumental in implementing the concept in
organizations and improving the quality across every sphere of the organization.
12. Glossary
Acceptance plans: These are used for verifying the quality of raw material inputs,
parts and components, and finished goods. A manager can accept or reject a lot based
on these plans.
Control charts for attributes: In these charts, a measurable variable like weight,
length, width, etc. is used in the inspection process. After inspection, the items are
identified as defective or non-defective if the quality characteristics are not
quantifiable.
Control charts for variables: These charts are used for maintaining quality standards
for a process by evaluating measurable product or service variables like thickness,
length, tensile strength, and queue waiting time.
Control charts: These are used for monitoring quality and are easy to develop,
analyze, and understand. Different measurement criteria are plotted on a chart with a
central line representing the mean value and two control limits above and below the
central value. The process is said to be in control if the noted variable and attribute
values fall between the control limits. If the values fall outside the control limits, then
the process is said to be out of control, and remedial actions have to be taken to
correct the differences.
Cost of detection/appraisal: Costs associated with the evaluation of quality and the
performance of products and machines.
Cost of failure: Costs that occur in non-conforming and non-performing products.
Cost of prevention: Costs incurred to prevent defective goods and services from
being manufactured or delivered to the consumers.
Cost of quality: The total of the cost of prevention, cost of detection/appraisal, and
the cost of failure.
External failure costs: Costs incurred when the defects are found after the products
are delivered to the customer.
Internal failure costs: Costs incurred when defects are found before the products are
delivered to the consumers and they can be eliminated if the defects are minimized or
eliminated within the system.
Multifactor productivity: Productivity is measured considering two or more factors.
Productivity: It is a measure of the efficiency of the firm in terms of products
produced. It is calculated as the ratio of the output produced to that of the inputs
consumed.
Single factor productivity: Productivity is measured considering only a single factor,
say labor or raw material.
93
Total productivity: Productivity is measured considering all the factors of
production.
Total Quality Management: A philosophy that seeks organization-wide
improvement through the involvement of every individual in the organization. It
suggests that it is the responsibility of everyone to maintain quality standards.
1. What is productivity and what factors affect productivity in an organization?
Explain how productivity measurement varies in manufacturing and service
organizations.
2. Quality control begins from the time raw materials are procured based on
appropriate specifications. Explain the importance and role played by quality
control in business organizations.
3. Companies have been using quality as an offensive strategic weapon against their
competitors. Explain the different quality functions or dimensions which can be
used by a company to gain an advantage over its competitors.
4. Inspection plays a vital role in quality control. Explain the role of inspection in
quality control. What do you mean by the cost of quality?
5. Statistical techniques are used in identifying variations in the process which could
affect the quality of the final product or service. Describe the various statistical
concepts involved in quality control. Also explain in detail the procedure for
implementing a quality control program.
6. A manager can accept or reject a lot based on acceptance plans. What are
acceptance plans? Explain in detail about the Average Outgoing Quality (AOQ)
curve and Operating Characteristics (OC) curve.
7. Computer systems and databases are used in various quality control programs.
How are computers useful in quality control?
8. Total Quality Management (TQM) is a philosophy that seeks organization-wide
improvement through the involvement of every individual in the organization.
Explain the concept of Total Quality Management (TQM) in detail.
<http://home.att.net/~iso9k1/tqm/tqm.html#Total%20Quality%20Management%
20(TQM)>
<http://www.johnstark.com/fwtqm.html>
8. Quality Control Charts
<http://www.statsoft.com/textbook/stquacon.html>
Operations Control
94
9. Quality Control
<http://www.itl.nist.gov/div898/handbook/pmc/section1/pmc11.htm>
10. Productivity and Sustainability
<http://indianexpress.com/story/6214.html>
Some of the factors that affect productivity in organizations are (a) bottlenecks in
the form of poor layout designs, slow processing equipment and inventory
shortages; (b) shortage of skilled manpower and lack of training on advanced
technologies; (c) poor scheduling methods leading to more waiting time in the
production process; and (d) strikes and worker agitations that cause break in
production.
2. (c) Productivity
Productivity is the ratio of the output produced to that of the inputs consumed.
Hence, it is a measure of the efficiency of the firm in terms of products produced.
Productivity helps the operations managers to control the production process and
match it with that of the market demand.
Productivity can be measured in relation to a single factor (single factor
productivity), a combination of factors (multifactor productivity), or all the
factors taken together (total productivity). Multifactor productivity implies two or
more factors are considered to measure productivity. When all the factors of
production are used to measure productivity, then it is termed as total
productivity. Productivity is difficult to measure when intangible and qualitative
factors like knowledge of the workers and leadership skills are involved.
4. (a) Procurement of raw material
Quality control begins as early as procurement of raw materials. Raw materials
have to be procured with the right specifications and in the right quantity. This is
part of preventive control.
5. (c) Proper scheduling
Layout, slow processing equipment and inventory shortages can reduce
productivity. But, proper scheduling helps the operations mangers increase
productivity.
6. (d) Number of cars serviced in a period
Options - (a), (b), and (c) are inputs to calculate productivity in service
organizations, while option (d) is an output.
7. (d) Warranty
All the options are functions of quality except warranty, which is an external
failure cost, due to poor quality of product.
8. (c) The total cost of quality control is minimal
An optimal trade-off between the cost of inspection and the cost of undetected
faults exists when the cost of total quality control is minimal.
9. (b) Loss of goodwill
The cost of undetected faults includes customer complaints, loss of goodwill,
product replacement cost, product liability suits, product recall programs and
returned products.
95
A company can compete on the quality functions such as performance (a car
could be compared on performance characteristics such as acceleration, mileage
and speed), features of the product, reliability (the probability of a products
failure within a specified time period), conformance (ability of the product and its
individual components to meet the established standards), durability (the
operational life of a product), serviceability. (It is the readiness of the product to
be serviced back to the operational mode), aesthetics and perceived quality
(customers perception about the quality of a product).
11. (a) The process is out of control and the cause should be established
If the values fall outside the control limits then the process is considered out of
control. Remedial action has to be taken to rectify these discrepancies.
12. (c) Appraisal costs
Detection or appraisal costs are costs associated with evaluating the quality and
performance of products and machines. These include inward materials
inspection, tests and inspection throughout the transformation process, equipment
maintenance, etc.
13. (d) Cost of returned products
Cost of returned products is an example of external costs. Internal costs include
scrap, repair, retesting of repaired products, downtime, loss due to process
variability and disposition of defective items.
14. (a) i and ii
Quality control charts can be broadly classified into control charts for variables
and control charts for attributes. Control charts for variables include X-Chart and
R-Chart.
15. (c) P-chart
P-chart and C-chart fall under control charts for attributes. P-chart determines the
proportion of defects in a given sample while C-chart is used to determine the
total number of defects in a product.
16. (d) Prevention
The cost of quality is the total of the cost of prevention (costs incurred to prevent
defective goods and services from being manufactured or delivered to the
consumers), the cost of detection/appraisal (costs associated with the evaluation
of quality and the performance of products and machines), and the cost of failure
(costs that occur in non-conforming and non-performing products).
17. (b) Acceptance plans
Acceptance plans are used for verifying the quality of raw material inputs, parts
and components and finished goods. A manager can accept or reject a lot based
on these plans.
18. (c) If a lot is accepted, it is returned to the supplier for use.
Acceptance plans are used for verifying the quality of raw material inputs, parts
and components, and finished goods. A manager can accept or reject a lot based
on these plans. If a lot is accepted, it is placed in the inventory for use whereas if
it is rejected, it is returned to the supplier. If the lot of finished goods is accepted,
it is sent to the consumers and if it is rejected, it is put through 100% inspections
and the defective items are replaced by non-defective items.
Operations Control
96
19. (c) Type II error
The probability of accepting a lot with 5% or more defectives is the consumers
risk or Type II error.
20. (b) OC curve
The operating characteristics (OC) curve is an important feature of acceptance
plans. It shows how well an acceptance plan differentiates between good and bad
lots. The OC curve is used to determine the limit of average outgoing quality.
21. (c) Every employee at every level in the organization is responsible for
quality
Maintaining quality is not just a prerogative of top management or the quality
inspection department but every employee at every level. Quality responsibilities
result in employees being more committed, motivated and creative in performing
assigned tasks.
22. (b) Customer
TQM believes that each department should treat other departments as its
customers.
23. (b) It restricts quality maintenance to quality personnel and manufacturing
departments.
All the options are true regarding total quality management (TQM), except
statement (b). TQM is different from traditional quality control methods. While
the traditional quality control methods restrict quality maintenance to the quality
personnel and manufacturing departments, TQM suggests that it is the
responsibility of everyone to maintain quality standards.
24. (d) Top management responsibility
The principles of total quality management are systematic improvement; focus on
customers, continuous improvement, problem prevention, universal
responsibility, and designing of quality products. The TQM concept emphasizes
on universal responsibility, rather than responsibility of the top management. It
states that every employee in the organization is responsible for the
implementation of quality and its improvement.
According to Genichi Taguchi, the three important aspects of design quality are
meeting customer requirements, capability of process, and standardization to
improve quality. Customizing the logistics network is a principle of supply chain
management.
A. 67.52
Upper Control Limit =D
3
R
, Lower Control Limit = D
4
R
.
D
3
and D
4
are constants whose values are based on the sample size.
R = R/n = 160/5 =32
UCL = D
3
R = 2.11 32 = 67.52
Unit 30
Facilities and Maintenance Management
Structure
1. Introduction
2. Objectives
3. Facilities Management
4. Necessity of Maintenance Management
5. Types of Maintenance
6. Economics of Maintenance
7. Evaluation of Preventive Maintenance Policies
8. Modern Approaches to Preventive Maintenance
9. Recent Trends in Maintenance
10. Summary
11. Glossary
1. Introduction
In the last section of the previous unit, we have discussed the concept of total quality
management (TQM). We have learnt that the TQM philosophy seeks organization-
wide improvement through the involvement of every individual in the organization. In
this unit, we will discuss facilities and maintenance management.
Managing the facilities of an organization has gained in importance over the years. It
has grown from being a secondary function handled by a manager in the personnel
department to a major function similar to human resources management, financial
management etc. Facilities management is either done in-house or outsourced to
external agencies. Maintenance management helps in curtailing the effects of factors
like wear and tear, aging, and misuse in machines, and in extending the operational
life of the equipment. Through proper maintenance, organizations can retain the
productivity of their equipment, increase the operational life of the equipment, reduce
the number of breakdowns, minimize losses, and maintain safe working conditions by
reducing the probability of accidents. Maintenance also helps in developing a reliable
and high quality production system. Organizations tend to ignore the importance of
proper and timely maintenance as it is a non-core activity.
This unit will introduce you to facilities management, and explain the necessity of
maintenance management. We will discuss the various types of maintenance, and the
economics of maintenance. We shall then move on to discuss how to evaluate the
preventive maintenance policies, and the modern approaches to preventive
maintenance. Finally, we would discuss the recent trends in maintenance.
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98
2. Objectives
define facilities management.
explain the necessity of maintenance management.
classify the various types of maintenance.
discuss economies of maintenance.
evaluate preventive maintenance policies.
identify the modern approaches to preventive maintenance, and the recent trends in
maintenance.
3. Facilities Management
Facilities management can be defined as a field/profession, which integrates people,
process and technology with the work environment to enable the organization to
carryout its core business operations in the most efficient manner. The primary
objective of facilities management is to provide a clean and conducive work
environment and enable efficient and effective progress of the core functions of an
organization, be it manufacturing, distribution or research. Sometimes, organizations
outsource the facilities management function to ensure this focus in core competence.
Some of the activities under the purview of facilities management include
Housekeeping & janitorial services, Operations and maintenance services, Office
administration, reprographics & mail services, Landscaping and horticulture, Pest and
rodent control, Waste management, Energy conservation and management, and
Communication networks.
Functions of Facilities Manager
The facilities manager develops and executes strategies that are in line with the
organizational goals. The most important function of the facilities managers is to
manage the facilities economically. The following are the common functions of
facilities managers:
Conduct and participate in planning activities
Recruit the right people to perform facilities management jobs
Measure the work performance of the facilities management teams
Review the current techniques so as to reduce cost of operations
Develop and maintain a controlling center as a support to facilities management
department
Outsourcing of Facilities Management
Facilities management function is usually outsourced to third parties. The entire
facilities management function can be outsourced to a single operator or various
functions can be outsourced to different operators. A major reason to outsource
facilities management is to concentrate on the core business activities. The other
advantages of outsourcing include increase in the quality of work, flexibility of
operations, and reduced operation costs. Outsourcing is also done when special skills
are required to carry out certain facilities management activities like architectural
design, hazardous material removal, property appraisal, etc. Another popular reason to
outsource facilities management is to reduce the cost of operations. If organizations
99
feel that it is costly to handle certain operations in-house, then such operations are
outsourced to external agencies. This helps save operational and maintenance costs.
CMC Limited, an IT solutions company, provides facilities management services in
the field of IT infrastructure and maintenance. It installs and maintains the IT
infrastructure in its clients premises, which include Indian Railways, Indian Oil
Corporation, Kodak India, Bank of Baroda, Bombay Stock Exchange, etc.
Example: UDS Offers Total Facilities Management Solutions
Updater Services (UDS) provides world class facility management services for
companies in India. The portfolio of services includes house keeping, pest control,
waste management, mechanical and electrical maintenance, production support
services, staffing solutions etc. UDS offers these services individually or integrates
them to offer Total Facility Management Solutions to the client.
UDS classifies its facilities management services into soft services, hard services,
staffing solutions, and hospitality services.
Soft services: The soft services portfolio for facility maintenance and management
include Housekeeping & Janitorial Services, Garden & Lawn Maintenance, Pest
Control, Waste Management, Vendor Management, and Mail Room Services.
Hard Services: The hard services basically involve the maintenance management
activities. They include Mechanical & Electrical Services, HVAC (Operation &
Maintenance), Water Management & Plumbing, Energy/Safety Audits, Design
Erection & Installation, and Testing & Commissioning.
Staffing Solutions: UDS also carries out the staffing functions. It helps place a
wide variety of experienced skilled and semi skilled workforce at various client
locations. Personnel are provided for Production Support Services, Office
Administration Support, Help Desk Services, and Warehouse & Dispatch
Management.
Hospitality services: The hospitality services provided by UDS as part of its
Total Facility Management Solution include Guest House Management and
Catering Services.
Adapted from http://www.updaterservices.com/services/index.php
The costs and benefits involved are explored thoroughly by the organization before
outsourcing the facilities management function.
Costs associated with outsourcing: There are certain costs associated with
outsourcing the facilities management function. At times these costs may prove to be
a burden and hinder the expected savings from outsourcing, in addition to reducing
the quality of performance. Some of these costs are loss of control, decrease in
flexibility, decrease in staffing quality, decrease in workers availability, and increase
in other costs.
Benefits of outsourcing: It is commonly perceived that the benefits of outsourcing far
outwit the associated costs. Hence, many organizations world over prefer to outsource
their facilities to external agencies. Some of the benefits of outsourcing are reduced
costs, increased quality, focus on core competencies, and increase in flexibility.
Facilities Management and Maintenance
Maintenance of facilities is part of the facilities management services and it is the duty
of the facilities manager to oversee the maintenance activities of facilities. In large
organizations, a dedicated maintenance department would carry out the facilities
Operations Control
100
maintenance throughout the year. But in small organizations, the employees in the
departments themselves are expected to take up the additional responsibility of
maintenance. Activities under facilities maintenance include carrying out regular
preventive maintenance in the facilities, checking for safety in the work environment,
allocating budgets for upgrading the environment in the facilities, etc.
Check Your Progress
1. To provide a clean and conducive work environment and enable efficient and
effective progress of the core functions of an organization is an objective of
____________.
a. Quality management
b. Facilities management
c. Maintenance management
d. Inventory management
2. Despite several disadvantages, firms prefer to outsource facilities management
tasks. Which of the following does not support this statement?
a. Increases quality of work
b. Helps develop core competence
c. Increases flexibility
d. Increases operational costs
3. Which of the following are the functions of facilities managers?
i. Conduct and participate in planning activities
ii. Recruit right people to carry out facilities management jobs
iii. Measure the work performance of the facilities management teams
iv. Develop and maintain a controlling center as a support to facilities management
department
4. ___________ can be defined as a field/profession, which integrates people,
process, and technology with the work environment to enable the organization
carry out its core business operations in the most efficient manner.
c. Productivity management
d. Enterprise resource planning
5. Identify from the following the activities that fall under the purview of facilities
management.
i. Housekeeping services
ii. Energy management
iii. Communication networks
iv. Waste management
101
6. Proper maintenance helps organizations:
i. retain the productivity of their equipment.
ii. increase the operational life of the equipment.
iii. reduce the number of breakdowns and minimize losses.
iv. maintain safe working conditions by reducing the probability of accidents.
7. ______________ helps in curtailing the effects of factors like wear and tear,
aging, and misuse in machines and in extending the operational life of the
equipment.
c. Productivity management
d. Maintenance management
4. Necessity of Maintenance Management
Maintenance management ensures that systems are working at their optimum
efficiency by identifying and locating the source of the problem as early as possible
and taking preventive steps to avoid any breakdown. Timely inspection of facilities,
appropriate replacement policies for machines and their components, and proper care
during the designing and installation phases, all enhance the reliability of the
machines and the equipment. Maintenance management is important as the
breakdown or malfunctioning of a machine hinders the production process, affects the
quality of products, and results in idle time and accidents. Therefore, the maintenance
department plans and controls all the maintenance activities to keep the firms
machinery in optimal working condition. The goal of maintenance management is to
Maximize the availability (working time) of the firms assets for production purposes
Preserve the value of the firm's machinery and equipment by reducing the rate of
deterioration
Plan and schedule the maintenance work to anticipate and prevent machine failures
and breakdowns
Improve the quality of products and increase the firms productivity
Use maintenance personnel and equipment efficiently
Minimize or totally eliminate accidents by regular inspection and repairs
Effective maintenance management eliminates equipment errors, and improves the
operational capacity, economic lifetime, and salvage value of equipment. In essence,
the objective of maintenance management is to minimize loss of productive time,
increase the life of the assets, and ensure effective utilization of the assets.
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102
Activity: Michael is the operations manager of an engineering company. Realizing
that most of the productive working time is getting wasted due to frequent
maintenance problems and repairs of equipment in the factory, he approached the
management to tell them about the problems being encountered by the workers and
to request them for a maintenance management team in the company. He suggested
two alternatives to have a company-owned maintenance management team or to
outsource the maintenance management activities to original equipment
manufacturers (OEMs). However, the management considered this as an additional
cost and rejected both proposals. Michael began explaining to the management
about the benefits of maintenance management and preventive maintenance. Assist
him in the process of convincing the management about the importance of
maintenance management.
Answer:
Impact of Poor Maintenance
Poor or improper maintenance of the firms machines or equipment affects:
Production capacity As poorly maintained machines do not operate at optimum
efficiency.
Production costs Idle labor during breakdown, repair costs, increased material scrap,
lower productivity, etc., add to the production costs.
Quality of a product - Poorly maintained machines affect the quality of the end-
products.
Safety - Poorly maintained facilities are prone to accidents and usually compromise
the safety of the workers.
Areas of Maintenance
The major areas of maintenance in a firm are mechanical, civil and electrical
maintenance. Mechanical maintenance involves the maintenance of the firms
machines and equipment, such as boilers, furnaces, compressors, transport vehicles,
etc. Civil maintenance includes building construction and its maintenance,
maintenance of service facilities (like water filters, air conditioning, plumbing, etc),
drainage systems, fire fighting equipment, security systems, and waste disposal.
Electrical maintenance involves maintenance of electrical and electronic equipment
such as generators, motors, electrical installations, lighting, telephone systems, etc. A
plumber maintains water supply pipes, an electrician takes care of lighting equipment,
housekeepers are responsible for cleanliness of buildings and instrumentation
personnel maintain and service routers.
Activity: Jesse International is a financial services company based in San Francisco.
A year ago, the employees of the company were facing health problems. One of
the senior managers identified that the water filters in the company were not
being properly maintained and the air-conditioners were not being serviced regularly.
Contd
103
Contd
He reported this to the management. The management immediately took steps to
service the water filters and air-conditioners. The situation became normal.
However, the same situation came up again and this time, the senior manager
requested the management to set up a maintenance team to take care of the service
facilities. The management refused to consider this, stating that maintenance was
necessary for manufacturing companies, not for service companies. The senior
manager is trying to convince the top management of the company about areas of
maintenance in any company irrespective of the nature of business being carried
out. Assist him in the process.
Answer:
Check Your Progress
8. Which of the following is not a goal of maintenance management?
a. Minimizing the availability of the firms assets for production purposes
b. Improving the quality of products and increasing the firms productivity
c. Using maintenance personnel and equipment efficiently
d. Preserving the value of a firms machinery and reducing deterioration
9. Maintenance of air conditioners is an example of which type of maintenance?
a. Mechanical maintenance
b. Civil maintenance
c. Electrical maintenance
d. All of the above
10. If a 5hp motor is a critical component in the manufacture of a certain product in a
large organization, its maintenance is given utmost importance. Who would
appropriately undertake maintenance of such equipment?
a. Machine mechanic
b. Plumber
c. Electrician
d. Supervisor
11. Match the following personnel with their respective maintenance responsibilities.
i. Plumbing personnel
ii. Electrical personnel
iii. Housekeeping personnel
iv. Instrumentation personnel
p. Lighting equipment
q. Electronic routers
r. Water supply pipes
s. Buildings
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104
a. i/p, ii/q, iii/r, iv/s
b. i/q, ii/p, iii/r, iv/s
c. i/r, ii/p, iii/s, iv/q
d. i/r, ii/q, iii/p, iv/s
12. Mr. Suresh Kumar was promoted as maintenance manager in Unicorn
Manufacturing. He was a design engineer in the same plant earlier. What benefits
can Kumar offer to Unicorn in his new position?
i. Focus on regular maintenance to improve productivity
ii. Help increase the life of assets and machinery
iii. Help preserve the value of equipment
iv. Minimize the salvage value of machinery
a. i and ii
b. iii and iv
c. i, ii, iii
d. i, ii, iii, iv
13. Which of the following is not an activity of maintenance management?
a. Improving efficiency of raw material purchase
b. Minimizing loss of productive time
c. Prolonging asset life
d. Effective utilization of assets
5. Types of Maintenance
All the activities that keep the production facilities and the equipment in operating
condition form a part of the maintenance operations. These activities are divided into
preventive maintenance, predictive maintenance, and remedial maintenance.
Preventive Maintenance
Preventive maintenance aims at servicing the machines regularly so that the
equipment functions satisfactorily under optimum load conditions without breakdown
or reduction in efficiency. Machines and equipment deteriorate with the passage of
time because of wear and tear, improper use, overloading, aging, etc. As a result, there
is a reduction in the production rate of the machine, quality of products manufactured,
operational life. Preventive maintenance activities are classified into periodic and
irregular maintenance activities.
Periodic maintenance activities: Periodic maintenance activities are conducted at
regular intervals. These activities are carried out on a weekly or monthly basis or on
the basis of machine usage, like, after every 36 hours of operation.
Irregular preventive maintenance activities: Irregular preventive maintenance
includes tasks like repairs, overhauls, and cleaning of spills, which are carried out
when the routine inspection of a machine reveals the need for servicing before the
next periodic preventive maintenance.
Predictive Maintenance
Predictive maintenance is a set of irregular preventive maintenance activities, which
detect probable future problems before they occur while the equipment is still
performing at a satisfactory level. It involves continuous monitoring of the vital
105
attributes of various systems. Steps are taken to rectify any malfunctions. Preventive
maintenance is time-based whereas predictive maintenance is condition-based.
Predictive maintenance identifies problems before they become responsible for
breakdowns, reduces the amount of unscheduled maintenance activities, reduces the
repair and service time as problem-solving is done beforehand, and does not interrupt
the normal production activities as maintenance can be scheduled when the equipment
in question is idle.
Example: Importance of Predictive Maintenance
Iowa-based Cargill Vitamin E Plant belonging to the Cargill Health & Food
Technologies was built in 1996. Since 2001, the plant has been carrying out a
predictive maintenance program which has helped it gain hundreds of thousands of
dollars in savings. Until 2000, reactive maintenance at the plant supported the
schedule based preventive maintenance. The plant followed the instructions given
by the manufacturer regarding taking care of the products and reacted to the
problems whenever they occurred.
Under predictive maintenance, production equipment which needed maintenance
was identified before it reached a point where its performance affected the quality
of the product or resulted in an unplanned shutdown. The success of predictive
maintenance depends on the information regarding the equipment condition in
order to take timely and corrective action. Information was obtained through
microprocessor-based field instruments which evaluated their own condition and
the condition of the associated equipment. These instruments also recorded
information regarding temperature, pressure, and flow data, which was required to
control the production processes.
Prior to this, engineers and technicians had to personally go into the plant to trace
an instrument and connect a handheld communicator to get the information. But
with the help of communication tools like HART and FOUNDATION Fieldbus,
and asset management software, they could directly communicate with 1500 smart
field instruments located at the distributed control system of the plant. Apart from
these, the plant also had digital valve controllers or smart positioners installed on
about 350 control values throughout the facility. AMS Suite: Intelligent Device
Manager Software helped in detaining huge amounts of analytical data generated
by these devices. All the information obtained from these devices was integrated
into a single database, arranged, processed, and presented on a PC without affecting
the control system inputs and output.
Using this, the technicians could perform all the functions like instrument
commissioning, configuration, and troubleshooting of potential problems which
were earlier performed with the help of a handheld communicator. When the
performance of the instruments began to decline, the information was provided to
them through Status Alerts. In addition, documentation was automatically done for
all maintenance activities. Through improved maintenance, the variability of the
process was reduced and this resulted in greater reliability. The plant was able to
prevent costly shutdowns by the daily monitoring of 1500 instruments and control
valves, and then scheduling maintenance on the basis of criticality of devices.
Adapted from Wade Howarth, Predictive Maintenance Saves Money, Improves Plant
Reliability, May 2004,
http://www.emersonprocess.com/home/library/articles/pharmprocess/pharmprocess0405_pred
maint.pdf
Operations Control
106
Remedial Maintenance
Remedial maintenance (or breakdown maintenance or corrective maintenance) is
carried out when a machine or equipment breaks down or is malfunctioning. Remedial
maintenance activities are reactive as they are performed only after a breakdown has
occurred, when equipment malfunctions (reduction in vibration, etc.) or operates at a
lower speed than desired, produces products of inferior quality. Once the equipment
breaks down or stops functioning, the maintenance department analyzes the problem,
identifies the causes, and then carries out the necessary repair work to get the
equipment back into operational mode as soon as possible. Some objectives of
remedial maintenance are to minimize production losses by getting the equipment
back into working condition as quickly as possible, to minimize investments in spare
parts and standby machines used when equipment is under repair, and to perform
appropriate maintenance based on the extent of problem.
Check Your Progress
14. Which of the following is not an objective of remedial maintenance?
a. To minimize production losses by getting equipment back into working condition
as quickly as possible
b. To minimize investments in spare parts and standby machines used when
equipment is under repair
c. To perform appropriate maintenance based on the extent of the problem
d. Regular monitoring of vital parameters of a machine
15. Preventive maintenance can be classified into periodic maintenance and irregular
maintenance. Irregular preventive maintenance does not include one of the following.
a. Repair
b. Overhaul
c. Reducing machine vibration
d. Tasks like cleaning up oil spills
16. Identify the distinct difference between preventive and predictive maintenance
a. Predictive maintenance is done after a machine breaks down while preventive
maintenance is done before a machine breaks down
b. Preventive maintenance is done after a machine breaks down while predictive
maintenance is done before a machine breaks down
c. Preventive maintenance involves regular servicing of equipment while predictive
maintenance involves monitoring equipment continuously
d. Preventive maintenance focuses on the past while predictive maintenance focuses
on the future
17. Krishna, a production worker detected some minor vibrations in a lathe machine
that is very sensitive to movement. What does this indicate?
i. The cutting precision will reduce
ii. Rate of production can go up
iii. Quality of product can come down
iv. The equipment needs maintenance
a. i, iii, iv
b. ii, iii, iv
c. i, ii, iii
d. i, ii, iii, iv
107
18. Periodic maintenance is associated with ______.
a. Preventive maintenance
b. Predictive maintenance
c. Remedial maintenance
d. Mechanical maintenance
19. What is the term used for the maintenance activity that attempts to detect
problems while the equipment is still performing at a satisfactory level?
a. Remedial maintenance
b. Predictive maintenance
c. Periodic maintenance
20. Remedial maintenance is termed reactive. What does this mean?
a. Remedial maintenance is taken up when machinery breaks down
b. Remedial maintenance is done to avoid breakdown
c. It occurs before purchase of new machinery
d. It is carried out regularly
6. Economics of Maintenance
Improper maintenance of equipment leads to high maintenance costs. Too little
preventive maintenance is risky and too much is uneconomical. Firms require some
level of preventive maintenance for the smooth functioning of the production process
and they have to take decisions on how much to spend on such activities. Product-
based organizations and highly automated production units emphasize preventive
maintenance and process-based organizations rely on remedial maintenance.
Interruptions due to equipment maintenance can be reduced by emphasizing
preventive maintenance, improving the capabilities of maintenance personnel through
appropriate training, etc. Operations managers aim to reduce the total maintenance
cost which is the sum of the preventive and remedial maintenance costs.
Activity: Val is the head of maintenance operations in a manufacturing company.
Along with a small team of maintenance specialists, he carries out the maintenance of
the machinery and equipment at the plant and at the headquarters. Val has a different
method of carrying out maintenance activities. He never waits for the machinery or
the equipment to break down. He continuously monitors the performance of the
machinery or the equipment and checks whether there is a possibility of it breaking
down in the future. Val and his team specialize in detecting problems while the
equipment is still performing at a satisfactory level. What type of maintenance is Val
and his team performing? Do you think this kind of maintenance is superior to
preventive maintenance? Give reasons for your answer.
Answer:
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108
7. Evaluation of Preventive Maintenance Policies
Organizations have to determine the exact level of preventive maintenance activities
required that will minimize the cost of breakdowns and repairs and also the
expenditure on preventive maintenance activities. They should also periodically check
whether the level of preventive maintenance activities being carried out is acceptable.
The following is the procedure used for the evaluation of preventive maintenance
activities.
Let N be the number of identical machines in a production unit, C
p
the average cost of
preventive maintenance, C
R
the cost of major remedial maintenance activities if the
machine is run till it breaks down, and P
i
the probability for the breakdown of the
machine in the i
th
period after undergoing maintenance.
Then, the Mean Time Between Failures (MTBF) is
MTBF =
n
1 i
i
iP ,
Where, n = maximum number of periods that a machine will go without failure
If the organization does not undertake any preventive maintenance activity, the
expected total cost per period will be
i
R
0) PM (at c
iP
N C
T
To evaluate the level of preventive maintenance activities, let us begin with the
calculation of the cost of routine preventive maintenance if machines are serviced
periodically.
TC (1) = C
p
.N + C
R
B
1
,
Where B
1
= number of machines that break down during the first period after service.
TC (1) = C
p
.N + C
R
.NP
1
,
Where TC (1) is the total cost, if machines are serviced every period.
By extending this analysis to consider repairing machines every two periods, the
number of machines expected to break down between servicing if the service is
performed every two periods (B
2
) is given as B
2
= N (P
1
+ P
2
) + B
1
P
1
Where B
1
P
1
is the number of machines expected to be repaired during the first period
and to break down in the second period. In the same way, for period t the number of
machines that may break down is given by B
t
= N (P
1
+ P
2
+ P
3
++ P
t
) + B
t-1
P
1
+ B
t-2
P
2
++ B
1
P
t-1
The total cost of t periods if machines are repaired every t periods is TC(t) = C
p
N +
C
R
B
t
And the average total cost per period is TC (t)/ t
8. Modern Approaches to Preventive Maintenance
In a JIT manufacturing system, in-process inventories and production lot sizes are
maintained at a lower level than in a traditional manufacturing system. Any
breakdown in a machine creates a shortfall of inputs for all subsequent workstations
and results in stoppage of the production process. Therefore, workers are made
responsible for conducting preventive maintenance to prevent breakdowns. They have
to go through a preventive maintenance checklist before beginning their shifts, inspect
their machines thoroughly, and adjust the machine components in case any errors are
109
detected. They must also closely monitor the performance of the machines while they
are in operation to detect or predict irregularities, so that problems can be corrected
before breakdowns occur. In case of major preventive maintenance, they should assist
maintenance specialists in the process.
9. Recent Trends in Maintenance
Technological changes have resulted in changes in the type of production
methodologies being adopted by organizations. Computer aided design, computer
aided manufacturing systems, and robotics have resulted in the development of
sophisticated electronic controls to monitor machine performance. These have
changed the way organizations handle their maintenance activities. Workers are also
given training for servicing and repairing sophisticated equipment. Maintenance
activities are being subcontracted by companies to external agencies called original
equipment manufacturers (OEMs). Computers are also being widely used in
maintenance management programs for scheduling maintenance activities, developing
maintenance cost reports, checking the status of inventory of spare parts, etc.
Check Your Progress.
21. Which of the following statements does not hold correct regarding the
economics of maintenance?
a. Improper maintenance of equipment leads to high maintenance costs.
b. Process-based organizations and highly automated production units emphasize
preventive maintenance and product-based organizations rely on remedial
maintenance.
c. Operations managers aim to reduce the total maintenance cost which is the sum
of the preventive and remedial maintenance costs.
d. Interruptions due to equipment maintenance can be reduced by emphasizing
preventive maintenance, improving the capabilities of maintenance personnel
through appropriate training, etc.
22. What is the difference between a JIT manufacturing system and a traditional
manufacturing system with respect to simple preventive maintenance?
i. Simple preventive maintenance is done by specialized maintenance staff
ii. Simple preventive maintenance is done by production workers
iii. Simple preventive maintenance is carried out at the beginning of every shift
iv. Shop floor workers should assist repair specialists in case of a major break-down
a. i and ii
b. i, ii, and iii
c. ii, iii, and iv
d. i, iii, and iv
Exercises
(Questions A to D)
A manufacturing plant has 25 machines of the same type. The probability of failure of
a machine depending on time lapsed (in months) after the last maintenance is given in
the following table. Answer the following four questions based on the given
information.
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110
1 2 3 4 5 6 7 8 9 10 11 12
0.04 0.04 0.05 0.05 0.06 0.06 0.10 0.10 0.10 0.10 0.15 0.15
A. What is the mean time between failures?
B. Calculate the probable number of break-downs per year for a machine.
C. What can be the probable number of break-downs per year for all machines in a
plant?
D. If the yearly cost of servicing a broken down machine is Rs.12000, what is the
average cost of repairs per machine per occasion?
(Question E to G)
The probability of failure after maintenance for a machine is given in the table below.
Answer the following three questions, based on the given information.
Months after maintenance 1 2 3 4 5
Probability of break-down 0.1 0.2 0.3 0.3 0.1
E. If there are 15 identical machines in the plant, what is the expected number of
break-downs between maintenance, if the maintenance is performed every two
months?
F. What is the expected number of break-downs between maintenance, if the
maintenance is performed every three months?
G. If the average cost of preventive maintenance is Rs.650 and that of remedial
maintenance per machine is 5500, calculate the average total cost of maintenance
per month, if the maintenance is performed every 3 months. Assume the number
of machines as 15.
10. Summary
Facilities management is taken up by organizations to provide optimum working
conditions that support the core operations and improve productivity.
Facilities management function is either performed in-house or outsourced to external
agencies who are specialists in the field. Organizations have to weigh all the possible
costs and benefits of outsourcing before making the move.
111
Maintenance management ensures that systems are working at their optimum
efficiency.
Poor or improper maintenance of the firms machines or equipment affects the
production capacity, production costs, quality of a product or a service, and the safety
of the workers.
The major areas of maintenance in an organization are mechanical maintenance, civil
maintenance, and electrical maintenance.
All the activities that keep the production facilities and the equipment in operating
condition form a part of the maintenance operations.
Organizations should determine the exact level of preventive maintenance activities
required that will minimize the cost of breakdowns and repairs.
Maintenance activities are being subcontracted by companies to external agencies
called original equipment manufacturers (OEMs).
Computers are also being widely used in maintenance management programs for
scheduling the maintenance activities, developing maintenance cost reports, etc.
11. Glossary
Civil maintenance: It includes building construction and its maintenance,
maintenance of service facilities, drainage systems, fire fighting equipment, security
systems, and waste disposal.
Electrical maintenance: It involves maintenance of electrical and electronic
equipment such as generators, motors, electrical installations, lighting, telephone
systems, etc.
Facilities management: A field/profession, which integrates people, process and
technology with the work environment to enable the organization to carryout its core
business operations in the most efficient manner.
Irregular preventive maintenance activities: These tasks like repairs, overhauls,
and cleaning of spills, which are carried out when the routine inspection of a machine
reveals the need for servicing before the next periodic preventive maintenance.
Mechanical maintenance: It involves the maintenance of the firms machines and
equipment, such as boilers, furnaces, compressors, transport vehicles, etc.
Periodic maintenance activities: These are conducted at regular intervals on a
weekly or monthly basis or on the basis of machine usage, like, after every 36 hours
of operation.
Predictive maintenance: It is a set of irregular preventive maintenance activities,
which detect probable future problems before they occur while the equipment is still
performing at a satisfactory level. It involves continuous monitoring of the vital
attributes of various systems.
Preventive maintenance: It aims at servicing the machines regularly so that the
equipment functions satisfactorily under optimum load conditions without breakdown
or reduction in efficiency.
Remedial maintenance (or breakdown maintenance or corrective maintenance):
It is carried out when a machine or equipment breaks down or is malfunctioning.
These activities are reactive as they are performed only after a breakdown has
occurred, when equipment malfunctions or operates at a lower speed than desired,
produces products of inferior quality.
Operations Control
112
1. What is facilities management? Why is it necessary for organizations to focus on
facilities management? Discuss the various services that come under facilities
management.
2. Many organizations today are showing increasing interest in outsourcing their
facilities management function to external agencies. Explain the reasons for this
development. Also explain the pros and cons associated with outsourcing the
facilities management function.
3. Maintenance management helps in curtailing the effects of factors like wear and
tear, aging, misuse in machines and in extending the operational life of the
equipment. What is maintenance management? Explain the necessity for
maintenance management.
4. Maintenance activities include all the activities that keep the production facilities
and the equipment in operating condition. What are the different types of
maintenance activities in an organization?
5. Organizations should periodically check whether the level of preventive
maintenance activities being carried out is acceptable or not. Explain the method
of evaluation of the preventive maintenance policies. Describe briefly the
transformations taking place in preventive maintenance.
6. Preventive Maintenance
<http://www.weibull.com/SystemRelWeb/preventive_maintenance.htm>
7. Operations and Maintenance
<http://www.idcon.com/article-opera1.htm>
8. Outsourcing
<http://en.wikipedia.org/wiki/Outsourcing>
9. Outsourcing
<http://www.sourcingmag.com/content/what_is_outsourcing.asp>
<http://www.wisegeek.com/what-is-preventive-maintenance.htm>
<http://en.wikipedia.org/wiki/Preventive_maintenance>
12. Remedial Maintenance
<http://www.pcmag.com/encyclopedia_term/0,2542,t=remedial+maintenance&i=
50395,00.asp>
113
1. (b) Facilities management
The primary objective of facilities management is to provide a clean and
conducive work environment and enable efficient and effective progress of the
core functions of an organization, be it manufacturing, distribution or research.
Maintenance management is a primary function associated with facilities
management.
2. (d) Increases operational costs
Advantages of outsourcing include increase in quality of work and flexibility of
operations, reduced operation costs and more focus on core competencies.
The common functions of a facilities manager are: (a) conduct and participate in
planning activities; (b) recruit the right people to perform facilities management
jobs; (c) measure the work performance of the facilities management teams; (d)
review the current techniques so as to reduce cost of operations; and (e) develop
and maintain a controlling center as a support to facilities management
department.
4. (b) Facilities management
Facilities management can be defined as a field/profession, which integrates
people, process and technology with the work environment to enable the
organization carryout its core business operations in the most efficient manner.
core functions of an organization.
core functions of an organization. Some of the activities under the purview of
facilities management include housekeeping & janitorial services, operations and
maintenance services, office administration, reprographics & mail services,
landscaping and horticulture, pest and rodent control, waste management, energy
conservation and management, and communication networks.
Through proper maintenance, organizations can retain the productivity of their
equipment, increase the operational life of the equipment, reduce the number of
breakdowns, minimize losses and maintain safe working conditions by reducing
the probability of accidents.
7. (d) Maintenance management
Maintenance helps in developing a reliable and high quality production system.
Maintenance management helps in curtailing the effects of factors like wear and
tear, aging, and misuse in machines and in extending the operational life of the
equipment. It helps in developing a reliable and high quality production system.
8. (a) Minimizing the availability of the firms assets for production purposes
One of the goals of maintenance management is to maximize (not minimize) the
availability of the firms assets for production.
Operations Control
114
9. (b) Civil maintenance
Civil maintenance includes building construction and maintenance, maintenance
of service facilities like water filters, air conditioning, plumbing, etc. Other
activities include maintaining drainage systems, fire fighting equipment, security
systems, waste disposal, etc.
10. (c) Electrician
As the 5hp motor is an electrical component, it has to be maintained and serviced
by a qualified electrician.
11. (c) i/r, ii/p, iii/s, iv/q
A plumber maintains water supply pipes, an electrician takes care of lighting
equipment, housekeepers are responsible for cleanliness of buildings and
instrumentation personnel maintain and service routers.
12. (c) i, ii, iii
Mr. Kumar can help improve productivity, increase the life of assets and
machinery, preserve equipment value and maximize the salvage value of
machinery.
13. (a) Improving efficiency of raw materials purchase
Improving the efficiency of raw materials purchase in an organization is not
associated with maintenance management. It is more related to materials
management.
14. (d) Regular monitoring of vital parameters of a machine
Predictive maintenance is concerned with inspecting vital signs of the machine
regularly to identify the health of the system. Some objectives of remedial
maintenance are to minimize production losses by getting the equipment back
into working condition as quickly as possible, to minimize investments in spare
parts and standby machines used when equipment is under repair, and to perform
appropriate maintenance based on the extent of problem.
15. (c) Reducing machine vibration
Reduction of machine vibrations does not come under irregular preventive
maintenance. It is a form of remedial maintenance.
16. (c) Preventive maintenance involves regular servicing of equipment while
predictive maintenance involves monitoring of equipment continuously
The objective of preventive maintenance is to service machines regularly so that
equipment functions satisfactorily under optimum load conditions without
breakdown or reduction in efficiency. Predictive maintenance involves
identification of possible problems before they occur. Options a & b are similar
for both types of maintenance operations.
17. (a) i, iii, iv
Any abnormal vibration in equipment indicates that it is not functioning properly
in terms of precision cutting. Quality and productivity can come down drastically.
The vibration also indicates that the equipment needs maintenance.
18. (a) Preventive maintenance
Periodic maintenance and irregular preventive maintenance fall under preventive
maintenance. Periodic maintenance activities are conducted at regular intervals,
i.e. weekly, monthly etc.
115
19. (b) Predictive maintenance
Predictive maintenance is taken up when problems or indications of problems are
detected in machinery and equipment. Problems do not mean that the equipment
is not functioning properly. But it indicates that such problems or indications can
cause breakdown of machinery in future if they are neglected.
20. (a) Remedial maintenance is taken up when machinery breaks down
Remedial maintenance is performed only when there is breakdown or failure of
machinery. So, it is reactive in nature. Preventive and predictive maintenance are
proactive in nature.
21. (b) Process-based organizations and highly automated production units
emphasize preventive maintenance and product-based organizations rely on
remedial maintenance.
Improper maintenance of equipment leads to high maintenance costs. Product-
based organizations and highly automated production units emphasize preventive
maintenance and process-based organizations rely on remedial maintenance.
22. (c) ii, iii and iv
Breakdown in a manufacturing plant adopting JIT system can create a shortage of
inputs for all workstations and can hamper the productivity seriously. Hence,
production workers are required to do simple preventive maintenance at the
beginning of every shift. And in case of major preventive maintenance, they
should assist maintenance specialists in the process.
A. 7.98 months
Mean time between failure = iP
i
= (1x0.04) + (2x0.04) + (3x0.05) + (4x0.05) + (5x0.06) + (6x0.06) + (7x0.10) +
(8x0.1) + (9x0.1) + (10x0.1) + (11x0.15) + (12x0.15)
= 0.04 + 0.08 + 0.15 + 0.20 + 0.30 + 0.36 + 0.7 + 0.8 + 0.9 + 1.0 + 1.65 + 1.80
= 7.98 months
B. 1.50
Number of break-downs per year = Number of months / mean time between
failures
= 12/7.98 = 1.50
C. 37.50
There are 25 machines in the plant.
Hence, the number of break-downs per year for 25 machines = 25 x 1.50
(number of break-downs per year for a machine). This is equal to 37.50
D. Rs.320
Average cost of repairs per machine per occasion = 12000/37.5 = Rs.320
E. 4.65
Given
N=15, t=2, P
1
=0.1, P
2
=0.2
Operations Control
116
B
1
= NP
1
where B
1
= number of break downs during the first month after service
= 15 x 0.1 = 1.5
B
2
= N(P
1
+ P
2
) + B
1
P
1
where B
2
= the number of break-downs expected
between servicing if the service is performed every two periods
= 15(0.1 + 0.2) + 1.5 x 0.1
= 4.5 + 0.15
= 4.65
Thus, the expected number of break-downs between servicing is 4.65
F. 9.765
Given N=15, t=3, P
1
=0.1, P
2
=0.2, P
3
=0.3
From the previous question, we know that B1=1.5 and B2=4.65
B
3
= N(P
1
+ P
2
+ P
3
) + B
2
P
1
+ B
1
P
2
= 15(0.1 + 0.2 + 0.3) + (4.65 x 0.1) + (1.5 x 0.2)
= 9 + 0.465 + 0.3
= 9.765
Thus, the expected number of breakdowns between servicing is 9.765
G. Rs.21152.50
Total cost of maintenance for every 3 months = C
P
x N + C
R
x B
t
Where C
P
is the cost of preventive maintenance and C
R
is the cost of remedial
maintenance.
TC = (650 x 15) + (5500 x 9.765)
= 9750 + 53707.5
= 63457.5
Average total cost of maintenance per month = TC/3 = 63457.5/3 = Rs.21152.5.
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