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Conestoga College Institute of Technology and Advanced Learning Kitchener, Ontario

Course No: OPER 3000

Section # 1

Course Name: Operations Management

Professor: Ravi Sharma

Case Study Assignment – Zhou Bicycle Company

Due Date: November 11th, 2016 Time: 2:00pm Submission Date: November 11th, 2016 Time: 2:00pm

Group #

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Dishonesty

Acknowledge that it is a breach of College Regulations to give or receive unauthorized and/or unacknowledged assistance on a graded piece of work

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Name (Print/Type) Student # Signature

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removed for privacy reasons

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Table of Contents Executive Summary ..................................................................................................................... 3

Zhou Bicycle Company’s Key Facts ......................................................................................... 4

Primary Issue ................................................................................................................................. 4

Qualitative Evaluation of Appropriate Models ................................................................... 4

Production Order Quantity Model (POQ ................................................................................... 4

Economic Order Quantity Model ............................................................................................... 5

Single Period Inventory Model ................................................................................................... 5

Fixed Period Systems ................................................................................................................... 5

Quality Discounts .......................................................................................................................... 6

Probabilistic Model + Safety Stock ............................................................................................. 6

ABC Model ..................................................................................................................................... 6

Qualitative Approach ................................................................................................................... 6

Assumptions.................................................................................................................................. 7

Quantitative Approach ............................................................................................................. 9

Implementation Plan ............................................................................................................... 10

Recommendations ..................................................................................................................... 11

Reverences ................................................................................................................................. 11

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Executive Summary

Zhou Bicycle Company (WILL BE REFERED TO AS ZHOU OR THE COMPANY) was

founded by Young – Ping Zhou in 1981 and to this day is located in Vancouver, British

Columbia. Zhou is a wholesale distributor of bicycles and individual parts while having their

retailors located within a 650-km radius of the firm’s distribution centre. Zhou has found that the

most popular bike they’ve encountered is the AirWing Model and thus for the purpose of this

report will be focused on the model’s projected figures for the year 2017 because currently the

case in BOOK on page 475 illustrates these components. Next up, the primary issue Zhou is facing will be addressed.

The primary issue Zhou has established is that they are lacking a back-order system and

as a result the company is experiencing inventory shortage which has led to a loss in sales and

revenue. This fault is considered a poor operations management handle on the company and it

is recommended Zhou reviews their logistics. Due to lacking a back-order system which

essentially provides the company with the inventory they require to meet demand, they also do

not carry an access amount of inventory in case of excess demand or faulty models. The

following section will overview the different possible solutions Zhou can incorporate to his company.

A vital step in understanding how to figure out the most efficient and smart solution for

Zhou’s company is to assess and understand all possible solutions. The following six methods

are possible solutions for the firm’s inventory problem that Zhou should consider in order to

bounce back from their fall and rise to the top: Production Order Quantity (POQ), Economic

Order Quantity (EOQ), Single – Period, Fixed – Period, Quantity Discounts, Probabilistic +

Safety Stock, and lastly the ABC model. In the section of Appropriate Models to consider on

page 447 in the report is described in depth with detail the different aspects, requirements, and

criteria associated per model. The next paragraph will shortly explain what model Zhou should

use as their solution.

To be able to revive the company and bring back its stance Zhou needs to consider

implementing the probabilistic + safety stock model to this company. This model essentially

incorporates the EOQ model in order to completely remove inventory shortage and in contract

create a surplus. The company’s main problem is that they are not able to meet required

demand and therefore are losing out on sales and revenue. At the same time the company is

ruining their cliental in public relations by creating a negative reputation of not being able to

meet demand. The next section focuses on the recommendations that Zhou should consider alongside the solution model.

In order to achieve success and greatness the firm should look into implementing a few

success features that will overview the company’s performance on an on-going basis. The

following are the recommendations that are thoroughly explained in the implementation plan of

the upcoming report. The company should consider having a documentation + historical data

plan, an increase to their service level currently at 95% to 99%, a computerized automated

system, and proper forecasting methods. If Zhou implements all solutions and

recommendations it is guaranteed that not only will the company be able to meet demands, they

will also be prepared for unexpected occurrences. The following report breaks down in detail to

explain Zhou’s background, their primary issue, possible solutions, recommendations, as well

as an implantation plan to bring success to the company.

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Zhou Bicycle Company’s Key Facts

Zhou Bicycle Company is a whole sale distributor of bikes as well as bicycle parts and is located in Vancouver which was founded by Young Ping Zhou in 1981. Zhou’s most

popular model that consumers seem to want is their AirWing model. All of Zhou’s retailers are within a 650-km radius of his distribution centre. Due to this, it is important for Zhou to have enough inventory to supply because if not his retailers are eager to

turn elsewhere to fulfil their inventory. The case on page 475 and reference book also mentions that when Zhou is out in inventory they do not have any sort of back order

system to re-stock inventory. This is where issues arise from retailers to Zhou. It is mentioned in the case that Zhou is responsible to place a re-order of inventory not vice versa from suppliers having to chase after Zhou. The shipment per order is at a cost of

$65 and is required a four-week delivery lead time in order for the bicycles to arrive at the same time. The company has a 1% carrying cost per month and is charged 60%

purchase price off of retail which results to $102: based on the retail price per model AirWing with a cost of $170. For the upcoming year, 2017 Zhou wishes to maintain a 95% service level. Zhou does not seem to understand the consequences of lacking

safety stock but yet understands that he needs to implement fast action to take care of the inventory shortage.

Primary Issue

As mentioned in the previous section, the case states that Zhou’s retailers do not mind going elsewhere as long as they have the product to fill orders. When and if Zhou does

not have the inventory to supply the company then they are losing sales and customers. Furthermore, it has been established that the biggest problem Zhou faces is the fact that they lack a back-order system. As a result, the company is experiencing inventory

shortage, which led to a loss in sales and revenue. A secondary issue is that due to their inventory shortage, revenue loss, and cliental loss, Zhou is also destroying their

public relations with potentials investors and associations.

Qualitative Evaluation of Appropriate Models

In order to assess and help Zhou discover the most appropriate way to handle his

situation he needs to be aware of all possible solutions and their meaning. The following will list the appropriate models to consider and briefly explain each of the models. Later in the report will be discussed which model has been selected to specifically solve

Zhou’s safety stock problem and accompanied with a full in-depth detailed explanation of why that model was selected.

Production Order Quantity Model (POQ) 1) Economic order quantity technique applied to production orders. Most useful in

the situation of when inventory constantly builds over time. i.e.: Excessive

Inventory

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POQ is a model that focuses and answers how much to produce and when. In this model, the materials produced are used immediately and hence lowering the holding

cost than the economic order quantity. This model is applicable only under two situations; when inventory continuously builds up over a period of time or after an order

has been placed or when unit are produced and sold together. Due to this, the daily production rate and the daily demand rate should be taken in to account. This model is useful when inventory continuously builds up over time.

Economic Order Quantity Model (EOQ) 2) EOQ is one of the most commonly used models and it assumes that the

materials or goods are shipped in bulk at a time. It is easy to use but it is based on some assumptions.

1. Expected demand has been forecasted and demand is independent

2. The production rate per day is known 3. The only variable costs of production and storage are the setup cost and holding cost

4. It is possible to avoid stock outs if the production begins at the right time.

Single-Period Inventory Model.

3) Ordering items that at the end of a given time frame have little to no residual value.

This model describes a situation in which one order is placed for a product and at the

end of the sales period; any remaining product has no value. For example seasonal goods and bakery goods. Items that are ordered daily or weekly cannot be held over and used as the inventory in the next sales period. This is because the exact demand

for these products are never known therefore the probability distribution related to demand has be considered. Assume that the bicycle company stocked and sold an

average mean of 200 bicycle during the summer season, then there is a 50% chance that the company will stock out and a 50% chance that bicycles would be left over because of the changes in seasons. Therefore, in order to determine the optimal

stocking policy before the season begins, the Zhou Company will need to know the standard deviation and consider 2 marginal cost (cost of shortage and cost of overage).

Fixed Period Systems 4) An ordering system that has the same order amount each and every time. Can

also be referred to as a consecutive order: a simple re-stock call and same order is provided with repeated figures.

For this model, the same fixed amount is added to inventory every time an order for an

item is placed. When inventory decreases to the reorder point, a new order for Q unit is placed. In order for this model to be effective, inventory must be continuously monitored

which requires a perpetual inventory system. This model also has several assumptions

Lead times are known and constant

Items are independent of one another

Ordering and holding cost are the only relevant cost.

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Quantity Discounts 5) A reduced value for items purchased in large quantities or in bulk. This model

uses the assumption that price goes down per larger order. To increase sales and encourage customers, many companies always like to offer

quantity discounts. A quantity discount is when a price is reduced based on the large quantity good a customer purchase. As quantity discounts goes up, the production cost reduces, due to this, holding cost increase because orders are larger.

Probabilistic Model + Safety Stock 6) A model has two components that create a whole.

The first component is that the model is constructed of an unknown variable. This variable can be solved by strategic probability value distribution. The second aspect to this model is the safety stock component. Essentially this looks at how much inventory

does a company have, how fast they remove their inventory, during stock removal: how much inventory can hold the company until it runs dry. The model mixes these factors

up and determines how much to establish as safety stock to have as extra inventory kept on hand in case of shortage or needed surplus stock.

ABC 7) ABC model is not able to be used in under any circumstance within Zhou’s case

because the case itself did not provide enough information.

Qualitative Approach – Explanation of the selected model

EOQ is one of the most commonly used models and it assumes that the materials or goods are shipped in bulk at a time. It is easy to use but it is based on some assumptions.

1. Expected demand has been forecasted and demand is independent 2. The production rate per day is known

3. The only variable costs of production and storage are the setup cost and holding cost 4. It is possible to avoid stock outs if the production begins at the right time. To determine the quantity to be ordered, EOQ uses the annul demand, cost per order

and carrying cost. The total of ordering and carrying cost is minimized when optimum quantity or economic quantity “Q” is ordered. The EOQ gives an answer to the quantity

that can be ordered.

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Q represents the amount of inventory ordered and an industry level can increase from

point 0 to Q units when an inventory arrives. The slope lines on the graph indicate that inventory drops systematically. Each time the inventory level reaches 0, a new order is

placed and received and inventory level again jumps to Q units. Therefore, EOQ can be an effective tool in inventory management to find optimum

quantity to be ordered. But, it cannot be adopted as one stop solution for total inventory management. Therefore, other techniques and methods need to be considered and

adopted along with EOQ which could help minimize storage and holding cost. Assumptions

A model that will be briefly touched upon, yet has been explained previously in the section of Qualitative Evaluation of appropriate models is the EOQ model. This model

incorporates and is in partnership with the probabilistic + safety stock model which Zhou Bicycle company is using to undergo a reformation in order to address and solve their current inventory shortage. The basic EOQ model is one of the three independent

demand models. Thus, due to its certain criteria and based off the readings in BOOK on page 447 it remains evident that the EOQ model in association with the probabilistic +

safety stock model is partnered with six presumed assumptions. The following are the six assumptions with respect to the EOQ model on the probabilistic + safety stock model.

1) Demand for an item is known, reasonably consistent, and independent of decisions for other items

2) Lead time is known + consistent 3) Instantaneous inventory receipts. I.e.: Order arrives in one batch all at once! 4) Quantity discounts are not possible

5) Only variable costs are ordering (set up) + carrying (holding) 6) Stock outs/shortages can be completely avoided if planned accordingly

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Quantitative Approach – Application of Model

The main goal Zhou wishes to accomplish is to reduce shortage and to have a surplus instead while minimizing total order and holding cost. Below is the demand for Awing

Model. Month 2015 2016 Forecast for 2017

January 6 7 8 February 12 14 15 March 24 27 31 April 46 53 59 May 75 86 97 June 47 54 60 July 30 34 39 August 18 21 24 September 13 15 16 October 12 13 15 November 22 25 28 December 38 42 47

Totals 343 391 439

1. Zhou is responsible to place re-order of inventory

2. Shipment takes 4 weeks from time order is placed

3. Ordering cost is $65

4. Purchase price paid by Zhou is 60% of retail

5. Retail /AirWing is $170

6. Carrying cost is 1% per month (12% per year)

7. Wish to maintain a 95% service level

Cost per bike= 170*0.60= $102

Holding cost= ($102)*1%*12% per year per bicycle =$12.24 per year/bicycle Service level= 95%

Z- Value= 1.65 Total demand per year= 439 units

Average demand per month= 439/12= 36.58 or 37bikes

EOQ= (Q*) Economic Order Quantity

=√2𝐷𝑆

𝐻

=√(2)(439)(65)

$12.24

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=68.28 𝑜𝑟 69 Units

Within each order, Zhou should only order 68 Awings from their manufacturer.

ROP =𝑑. ℓ + 𝑧𝜎𝑑ℓ𝑡

= (36.58) + (1.65) (25.67)

=36.58 + 42.35

=78.93 𝑜𝑟 79 Bicycles

SS = 𝑧𝜎𝑑ℓ𝑡

= (1.65) (25.67)

=42.35 𝑜𝑟 43 Bicycles

Total cost= ½ Q* (holding cost) + SS (holding cost) + Total demand/Q* (ordering cost) 68/2*12.24 42*12.24 439/68*65

= $416.16 =$514.08 =$419.63

Total Cost= 416.16+514.08+419.63 =$1349.87

Demand for AirWing Model

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15

31

59

97

60

39

24

16 15

28

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36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58 36.58

0

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120

Janua

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Febru

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Marc

hApril

May

June

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Septem

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Forecasted 2008

Average

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From the above graph, the blue line represents the average forecast demand for 2017 and the pink line represents the average demand. This indicates that demand for their

product peaks in the spring due to seasonal factors and safety stock prevents against higher than expected demand. Order periods are flexible in preparation for lower than

expected demand. Therefore the model must be adjusted throughout the year as demand changes.

Implementation Plan

In essence Zhou was losing sales, revenue, public relations, and most importantly experiencing inventory shortage. The following are strategic recommendations suggested specifically for Zhou Bicycle Company to implement within 2017 as well as

future logistics and operations. 1) Documentation + Historical Data

Having and maintaining a historical database is important to consider in case the company. This is useful in case anyone wishes to question or review an action that was executed. Documentation can help prevent fraud, losses, inaccurate information, and

reduce liability. Documentation can also show future projections, trends, and provide reference.

2) 95% service level or higher

A main concern when evaluating Zhou Bicycle Company is the fact that they wish to

peruse a 95% service level with its customers. The questionable factor is questioning why Zhou does not wish to peruse a 99% service level or as high as possible. The

company should aim to pursue and have the highest quality product and this can only be done by a 99% service level expectation. Zhou should consider switching their service level expectation.

3) Computerized pre-set system

Currently the human error Zhou is currently experiencing is due to having to manually count the units which resulted in uncertainty of the reorder point. A note pad system is frowned upon because it is favorable to human error. In contract, to move around the

previous errors this system will be there to help automatically because it will be pre-set to specifics of Zhou Bicycle company to determine ROP, EOQ, and price. An electronic

computerized system designated to journal keeping is recommended for Zhou Company because it implements six sigma to achieve four parts per million error. Systems such as excel are multi-useful and friendly in this situation.

4) Forecasting Methods

By having and maintaining a proper forecasting method to predict future business orders Zhou will be able to know the future rather than be surprised by its actions. The following methods should be considered when assessing and projecting future figures.

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Recommendations

Zhou can accomplish this by analyzing their yearly data, having a correct yet accurate forecasting plan, and implementing this strategically. Not only is Zhou saving money by

implementing safety stock but it also cost the company less money to hold the additional 43 bicycles up until the new 69 units of bikes arrive. As previously mentioned, Zhou is saving money by investing in a cheaper and lower risk situation of holding

safety stock. They are also not going to be running low or out as their issue was previously, which will re-build and secure cliental and public relations.

The company saves money by implementing the probabilistic model + safety stock because it has also been calculated and found that Zhou now only needs to order 7

times a year. The member in charge of safety stock requires proper training but yet is simple enough to be done by a co-op post-secondary student. With this computerized

system, it is recommended that twice a year the system needs to be reviewed to ensure minimum cost of plan implementation.

In conclusion The main issue that Zhou Bicycle Company was facing in their previous model was that

they were not holding any safety stock, they did not have a back-order policy instituted, and they were fully draining their funds and revenue for all orders they could not fill. They could not fill orders because they were not properly planning and forecasting and

thus their back orders went to other suppliers. By implementing safety stock as part of their inventory management, Zhou will be able to reduce the amount of stock outs that

they have and more accurately fill, complete, and exceed expectations of their 95% service level projected for the upcoming 2017 year. If Zhou takes into considerations all recommendations and strategically implements the success factors, they will be able to

redeem themselves, meet demand, and build core competencies and become a core competitor in the field.

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References

Second Canadian edition, Operations management text book