Process Interruptions:

Setup Costs, Buffer or Suffer, Quality, Variability

R4

February 6-8, 2013

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 1

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A little background

Powered by Koffee (PBK) is a new campus coffee store. PBK

uses 50 bags of whole bean coffee every month, and you may
assume that demand is perfectly steady throughout the year.
PBK has signed a year-long contract to purchase its coffee from
a local supplier, Phish Roasters, for a price of $25 per bag and
an $85 fixed cost for every delivery independent of the order
size. The holding cost due to storage is $1 per bag per month.
PBK managers figure their cost of capital is approximately 2
percent per month.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 2

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Questions

Q1. What is the optimal order size, in bags?

Q2. Given your answer in (a), how many times a year does PBK place orders?

Q3. Given your answer in (a), how many months of supply of coffee does PBK
have on average?
Q4. On average, how many dollars per month does PBK spend to hold coffee
(including cost of capital)?
Q5. Suppose Phish Roasters is offered a 3.5% discount off the regular price of
$25 if PBK purchased at least 500 bags at a time. If PBK took this deal, how
many bags should they order each time.
Q6. If PBK took the deal described in Q5, then what would be their annual total
costs (inventory holding, ordering and purchasing costs)?

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 3

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Solution to Q1

To find out the optimal order size, its just a matter of

plugging numbers into the EOQ formula:

2* K * R
h
Here, order cost (K) is $85, flow rate (R) is 50

bags/month and holding cost (h) is ($1 + 2% * $25) =

$1.50 per unit per month. The optimal order size is
75.3 bags.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 4

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Solution to Q2

Yearly demand is:

12 months/yr *50 bags/month = 600 bags/yr

PBK must place:

Order size = 75.3 bags/order

600/75.3 = 7.97 orders a year.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 5

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Solution to Q3

The average inventory is half of the order quantity and

hence 75.3/2 = 37.6 bags.

Because the monthly demand is 50 bags, the average

inventory can supply 37.6/50 =0.753 months (or about

3 weeks)

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 6

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Solution to Q4

Cost of holding one bag for one month:

$1 of storage plus
$25 * 2% = $0.50 cost of capital.
Because the average inventory is 37.6 bags, the

monthly total holding cost is 37.6 * ($1 + $0.50) =

$56.46/month

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 7

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Q5
Q5. Suppose Phish Roasters is offered a 3.5% discount off the regular price of $25
if PBK purchased at least 500 bags at a time. If PBK took this deal, how many
bags should they order each time.

Is it a good deal? Which one leads to lower total costs?

Total cost = C(Q) + unit costs

KR 1
= + h Q + Rc
Q 2
Purchasing costs
c is per-unit cost
Setup Holding

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 8

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Q5
Monthly costs:
KR 1
With no deal = + h Q + Rc
Q 2
85 50 75.3
=
75.3
+
2
( )
1 + 2% 25 + 50 25

= 56.46 + 56.46 + 1250

With deal = $1362.92
KR 1
= + h Q + Rc
Q 2
85 50 500
=
500
+
2
( )
1 + 2% 25 (1 0.035) + 50 25 (1 0.035)

= 8.50 + 370.63 + 1206.25

= $1585.28
OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 9
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Q5

Total monthly costs are higher when they take the deal!

If PBK ordered even more than 500, it only gets worse for the company (you can
verify this yourself).

Within the constraint of the question, however, we can suppose that the manager
is informed that PBKs CEO has already accepted this deal.

Since the question asks if PBK took this deal, the manager should minimize the
damage and order just 500.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 10

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Q6
Q6. If PBK took the deal described in Q5, then what would be their annual total
costs (inventory, ordering and purchasing costs)?
We multiply the monthly cost with the deal by 12 for annual cost:

Total cost
KR 1
= + h Q + Rc
Q 2
85 50 500
=
500
+
2
( )
1 + 2% 25 (1 0.035) + 50 25 (1 0.035)

= 8.50 + 370.63 + 1206.25 Purchasing (annual)

12 x 1206.25 = $14,475

Setup (annual) Holding (annual)

12 x 8.50 = $102 12 x 370.63 = $4,447.50
Grand Total Annual
$19,024.50

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 11

 Salt production on Vanuatu part 1

A salt production facility on the island of Vanuatu has one salt pan (pink
water in left photo) covering 6 acres.
The pan is flooded with sea water, and evaporation leaves the pan dry,
covered with sea salt and ready for harvesting
Evaporation of a pan takes 10 weeks.
Harvesting is done by bulldozers.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 12

 Salt production on Vanuatu part 2

A single bulldozer requires 3 days to harvest each acre of salt and this
facility has 2 of them.
Harvesting can occur any day during the week and clearly the pan cannot
be flooded during harvesting.
Each acre yields 1000 cubic meters of salt. After salt is harvested from a
pan, it is flooded with sea water to begin the process again.

How much salt can this facility produce per day?

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 13

 Salt production for a 6-acre pan

70 days 9 days

Evaporate Harvest

Evaporation takes 10 weeks = 70 days

Harvest takes 9 days per pan:
6 acres x 3 days per acre per bulldozer / 2 bulldozers = 9 days

There is no inventory between Evaporation and Harvest!

Hence, Evaporation cannot work at the same time as Harvest!

So it takes 70 + 9 = 79 days to produce one 6 acre pan.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 14
 Salt production per 6-acre pan per day

70 days 9 days

Evaporate Harvest

So 79 days produces 6 acres.

6 acres yields 6 x 1000 m3 = 6000 m3 of salt.
Hence, 6000 / 79 = 76.0 m3 per day per pan

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 15

 Salt production with an inventory buffer

70 days 9 days

Evaporate Harvest

If Evaporation and Harvest could work independently then evaluate

each capacity separately:
Evaporation:
6000 m3 / 70 days = 85.7 m3 / day
u

Harvest
6000 m3 / 9 days = 667 m3 / day
u

Evaporation would be the bottleneck and the process would

produce 85.7 m3 / day

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 16

 Bonus questions - Salt production on Vanuatu

How much salt could they produce if they have 7 salt pans, each 6 acres?

How much salt can they produce if they have 10 salt pans, each 6 acres?

How much salt can they produce if they have 2 salt pans, each 3 acres?
Why is this different than one 6 acre salt pan?

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 17

 Bonus - Salt production with 7 pans

70 days 9 days

Evaporate Harvest

Each pan produces 76.0 m3 per day

Assume there is never two pans ready to harvest at the same
time
Then they can produce 76 x 7 = 532 m3 per day
Check that the assumption holds
Harvesting 6 pans takes 6 x 9 = 54 days
Evaporating one pan takes 70 days
So after harvest pan 1, the bulldozers can harvest for 54 more
days and finish before they need to get back to pan 1
OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 18
 Bonus - Salt production with 10 pans

70 days 9 days

Evaporate Harvest

Harvest now is constraining

To Harvest 9 pans requires 9 x 9 = 81 days
So after pan 1 is harvested, it cannot be harvested again for
another 81 days, but it is ready for harvesting after 70 days.
So now the bulldozers work all of the time
Capacity = 6000 / 9 = 667 m3 per day

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 19

 Bonus: Salt production with two 3-acre pans

70 days 4.5 days

Evaporate Harvest

Now it takes 4.5 days to harvest 3 acres

3 acres yields 3 x 1000 m3 = 3000 m3 of salt.
Hence, 3000 / 74.5 = 40.27 m3 per day per pan
There are two 3-acre pans so total capacity is 2 x 40.27 = 80.5 m3
per day
This is higher than one 6-acre pan because one pan can be
evaporating while the other is being harvested.

OPIM 101, Spring 2013, Profs Cachon/Savin, R4 Slide 20