INTRODUCTION TO OPERATIONS RESEARCH

HISTORICAL BACKGROUND
Operations Research came into being as a discipline during World War II. The war involved
complicated and complex strategic and tactical problems whose solutions could not be found
from a single discipline or single individual. In order to prepare an adequate response and more
so against the growing menace of the German air power the British military invited groups of
individuals who were specialists in different disciplines such as mathematicians, surveyor’s
engineers, behavioral scientists and physical scientists. Theses specialists from different
disciplines formed special units within the military to assist military executives in solving
strategic tactical and technical military problems.
These scientists began an urgent series of experiments aimed at locating aircraft by sending out
radio waves from ground stations. This scheme came to be known as the radar system. Hence
they assisted the military executive establish two systems:
1. For detection and tracking enemy aircraft
2. For tracking and defending their aircrafts and directing them to enemy sites.
This work involved cooperation between scientists and military personnel so that the best tactical
operation of both equipment and men air and ground crews could be achieved.
The result of joint operation was a remarkable improvement and progress in dealing with
complex executive problems.
This new interdisciplinary scientific approach to problems solving came to be known as
operations research.
After the war the success of mixed team approach attracted the attention of many people and
organizations. Some of those who served with the OR team during the war moved into business,
industry, government and research institutions and began to spread word about the effectiveness
of the new discipline in solving complex executive type problems . Today every organization in
developed countries has staff applying OR techniques. It is assuming an increasing degree of
importance in theory and practice. The factors responsible for this development are:
1. Modern management problems are so complex but only systematic and scientific based
analysis can yield realistic solutions.
2. There are several types of quantitative models available for solving these complex
managerial problems.
3. High speed computers have made possible the application of quantitative models in
solving real life problems.

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DEFINITIONS OF OR
OR SOCIETY OF THE UK
According to this society, OR is the application of the method of science to complex problems in
the direction and management of large systems of men, machines, materials and money in
industry, business, government and defense.
OR SOCIETY OF USA
According to this society OR is concerned with scientifically deciding how best to design and
operate man machine systems usually requiring the allocation of the scarce resources.
CHURCHMAN, ACKOFF AND ARNOFF (1957)
According to these three OR can be characterized as the application of scientific methods
techniques and tools to problems involving the operation of a system so as to provide those in
control of the operation with optimum solutions to business problems. In simple words the
essential characteristics of OR include:

PHASES OF OR
The study of OR generally involves three phases:
1. Judgment phase- this consists of;
a) Determination of operations. An operation is a combination of different actions
dealing with resources forming a structure from which actions regarding an objective
are attained.
b) Establishing the objectives and values associated with the operation.
c) Determination of suitable measures of effectiveness. This tests the success of a
solution and determines if there is need for improving the method of operation or
whether to alter the solution.
d) Formulation of the problem relative to the objectives. Determine the type of problem
being studied its origin and causes.
2. Research phase: this phase includes:
a) Observation and data collection for better understanding of the problem
b) Formulation of relevant hypothesis and models
c) Analysis of available information and verification of the hypothesis using pre-
established measures of effectiveness and
d) Prediction and generalization of results and considerations of alternative methods.

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 3. Action phase; this consists of making recommendations for remedial action to those who
first posed the problem and those who control the problem operation directly. These
recommendations consist of a clear statement of the assumptions made, scope and
limitations of the information presented about the situation, alternative courses of action,
effects of each alternative as well as the preferred course of action.

LIMITATIONS OF OPERATIONS RESEARCH

1. OR relies heavily in use of mathematical models and these models don’t take into
account qualitative factors such as emotional factors which can be of real importance to
the problem being solved and studied. Moreover all influencing factors that can not be
quantified are not included in the mathematical model.
2. Being a relatively new field of study there is general resistance from organizations from
application of its techniques.
3. Some experts overtaken by its advantages may be tempted to turn a problem to fit a
technique that they know rather than take time to develop the relevant models for the
problem.
4. When the basic data are subjected to frequent changes, incorporating them in the OR
model may be costly.

EXERCISES
Question one
What is operations research? Account for the growing importance of operations Research in
Business.
Question two
Define operations research and give four examples. State their properties, advantages and
limitations.
Question three
State the phases of an operations study and their importance in solving problems.

LINEAR PROGRAMMING

Linear programming deals with optimization (maximization or minimization) of a function of

variables, known as objective function, subject to a set of linear equations or inequalities known
as constraints. The objective function may be profit, cost, production capacity, or any other

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measure of effectiveness which is obtained in the best possible or optimal manner. The
constraints may be imposed by different resources such as market demand, production process
and equipment, storage capacity, raw materials availability etc.

Generally speaking, linear programming can be used for optimization problems if the following
conditions are satisfied;

1. There must be a well-defined objective function which can be expressed as a linear

function of decision variables.
2. There must be constraints on the amount or extent of attainment of the objective and
these constraints must be capable of being expressed as linear equations or inequalities in
terms of variables.
3. There must be alternative courses of action eg a given product may be processed by two
different machines and the problem may be as to how much of the product to allocate to
which machine.
4. The decision variables should ne interrelated and non-negative. Nin negativity means
linear programming deals with real life situations for which negative quantities are
generally illogical.

FORMULATION OF LINEAR PROGRAMMING PROBLEMS

In order to formulate the LP problem, first define the variables of the problem establishing
the interrelationship between them and formulating the objective function and constraints. A
model which approximates as closely as possible to the given problem is then to be
developed.

EXAMPLE ONE

A firm produces three products. These products are processed on three different machines.
The time required to manufacture one unit of each of the three products and the daily
capacity of the three machines is given in the table below;

Time per unit (minutes)

Machine Machine capacity

(minutes per day)

Product 1 Product 2 Product 3

M1 2 3 2 440

M2 4 - 3 470

M3 2 5 - 430

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The profit per unit for products I, 2 and 3 is sh 4, sh 3 and sh 6 respectively.

Required

Formulate a linear programming model that will maximize daily profit.

SOLUTION

Let x1, x2 and x3 respectively be amounts of products 1, 2 and 3 produced daily

Objective function will be

Maximize Z= 4x1+ 3x2+6x3

Subject to constraints

2x1+ 3x2+2x3<440………………..( i)

4x1+ 0x2+3x3<470………………..(ii)

2x1+ 5x2+0x3<430……………….(iii)

EXAMPLE TWO

A person wants to decide the constituents of a diet which will fulfill his daily requirements of
proteins, fats and carbohydrates at the minimum cost. The choice is to be made from four
different types of food. The yields per unit of these foods are given in the table below;

Yield per unit

Food type Proteins Fats Carbohydrates Cost per unit ( sh)

1 3 2 6 45

2 4 2 4 40

3 8 7 7 85

4 6 5 4 65

Minimum 800 200 700

requirement

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 Required

Formulate a linear programming problem for the problem

SOLUTION

Let x1, x2, x3 and x4 respectively denote the number of units of food types 1,2,3 and 4
respectively.

Objective function will be

Minimize Z= 45x1+ 40x2+85x3+65x4

Subject to constraints

3x1+ 4x2+8x3+ 6x4> 800………………..( i)

2x1+ 2x2+7x3+ 5x4> 200………………..(ii)

6x1+ 4x2+7x3+ 4x4> 700……………….(iii)

THE SIMPLEX METHOD

The method was developed by Professor George B Dantzig in 1947. It can be used for solving
linear programming problems with a thousand decision variables and thousands of constraints
using a high speed computer. This is in contrast with the graphical approach which solves
problems with two decision variables.
The very basis of this method is that the optimal solution of linear programming problem which
has a feasible solution lies at one of the corner points of the feasible region. It therefore evaluates
only the corner points to find the optimal solution.
Basic simplex concepts
Slack variables; Slack variables denoted by s1 and s2 represent the unused capacity. For instance
considering the objective function; Max P=500A + 400B
3A + 4B + s1 = 18,000
10A + 4B + s2 = 40,000
Next the objective function is written in a homogeneous form. In order to do this, first s 1 and s2
are written as 0s1 and 0s2 as follows; P = 500A + 400B +0s1+0s2
Then the right hand side of the equation is moved to the left side as follows;

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P – 500A -400B – 0s1 -0s2 =0 or P – 500A -400B + 0s1 +0s2 =0
Now the whole model is as follows;
Row 1: P -500A – 400B + 0s1+0s2=0
Row 2: 3A +4B + 1s1 = 18,000
Row 3: 10A + 4B + 1s2= 40,000

BASIC AND NON BASIC VARIABLES

A basic variable can be zero or non zero. But its coefficient is +1. If a basic variable becomes
zero we call it degeneracy.
A non basic variable will definitely be equal to zero. Non basic variables may have any
coefficient in a solution but the variables themselves are always equal to zero.
All variables which are not basic variables are non basic variables. Finally the number of basic
variables equals to the number of constraints.
From the above example the basic variable and non basic variable are;

Basic variables Non basic variables

P A
S1 B
S2

Characteristics of basic variables

1. Basic variables have always a coefficient of +1
2. A basic variable occurs only once in a row
3. There is a basic variable in every row
4. A variable may be a basic variable at one corner point and become a non basic variable at
another corner point.

SOLVING MAXIMIZATION PROBLEMS BY SIMPLEX METHOD

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Any linear programming problem which aims at maximization of the objective function can be
solved by the simplex method if it satisfies the following conditions;
1. All constraints are of the form < ( equal to or less than)
2. The values on the right hand side of the constraints are positive or zero.
3. The decision variables can not take negative values i.e the model has a non negativity
constraint.
An equation which is not of form < variety, or has a negative value on the right hand side of
the constraint can be expressed in the < form.
EXAMPLE
Solve the following using simplex model
Maximize profit, Z = 20,000 XA + 15,000 XB
Subject to constraints
i) 10000 XA + 20000 XB < 20 000 (capital limitation year 0)

ii) 20000 XA + 10000 XB < 25 000 (capital limitation year 1)

i) 30000 XA + 0XB < 15,000 (capital limitation year 2)

ii) Xj > 0 (non-negativity) for all values of j

FIRST TABLEAU
Cj 20,000 15,000 0 0 0

CCB BASIS XA XB SI S1 S3 d Q

0 S1 1 2 1 0 0 2 2

0 S2 2 1 0 1 0 2.5 1.25

0 S3 (1) 0 0 0 1 0.5 0.5

Zj 0 0 0 0 0 0

Cj-Zj 20,000 15,000 0 0 0 0

Entering variable in row C j-Zj is variable with highest coefficient of unknown ie X A with a coefficient of
20,000.

Basic variable S3 is leaving variable with the least quotient of 0.5.

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Pivot element is 1 in brackets. Pivot equation is ;

XA XB S1 S2 S3 b

1 0 0 0 1 0.5

In second tableau, replace S3 with XA. Insert the pivot equation in place of S 3 together with the coefficient
of XA i.e 20,000 in basis.

S1 and S2 will now be the difference between original values in first tableau and the pivot equation.

SECOND TABLEAU

Cj 20,000 15,000 0 0 0

CCB BASIS XA XB SI S1 S3 d Q

0 S1 0 (2) 1 0 -1 1.5 1.25

0 S2 1 1 0 1 -1 2.0 2

20,000 XA 1 0 0 0 1 0.5

Zj 20,000 0 0 0 20,000 10,000

Cj-Zj 0 15,000 0 0 -20,000 0

Entering variable in Cj-Zj is variable with highest coefficient of unknown ie X B with a coefficient of
15,000.

Basic variable S1 is leaving variable with the least quotient of 1.25.

Pivot element is 1 in brackets. Pivot equation is ;

XA XB S1 S2 S3 b

0 1 0.5 0 -0.5 0.75

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In third tableau, replace S1 with XB. Insert the pivot equation in place of S 1 together with the coefficient of
XB i.e 15,000 in basis.

S2 will now be the difference between original values in first tableau and the pivot equation.

XA will remain as in the previous tableau since it does not have coefficient of X B which was eliminated
when XB was entering.

THIRD TABLEAU

Cj 20,000 15,000 0 0 0

CCB BASIS XA XB SI S1 S3 d

15,000 XB 0 1 0.5 0 -0.5 0.75

0 S2 2 0 -0.5 1 0.5 1.75

20,000 XA 1 0 0 0 1 0.5

Zj 20,000 15,000 7,500 0 12,500 21,250

Cj-Zj 0 0 -7,500 0 -12,500 0

CONCLUSION

Since the values in row Cj-Zj are all non positive ie negative or zero, optimality has been achieved.
XA=0.5,XB=0.75 and Z= 21,250.

CCB= Coefficient of current basic variable in objective function

CJ= Contribution per unit

ZJ= Joint contribution of all basic variables

EXAMPLE 2

Minimize Z= 6x1+3x2

Subject to;

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2x1+4x2 > 16

4x1+ 3x2 >24

x1,x2,x3 > 0

Solve using simplex model.

Solution

Rewrite

In standard form;

Z= 6x1+3x2 + 0S1 + 0S2

2x1+4x2 - S1 =16

4x1+ 3x2 –S2= 24

If x1=x2=0, S1 = -16 and S2 = -24.

Since basic variables should be non negative, introduce artificial variables A 1 and A2 each
with a large positive cost of M.
S variables now are surplus variables
Objective function;
Z= 6x1+3x2 + 0S1 + 0S2 + MA1 + MA2

2x1+4x2 - S1 + A1=16

4x1+ 3x2 –S2 + A2+ = 24

FIRST TABLEAU
Cj 6 3 0 0 M M

CCB BASIS X1 X2 S1 S2 A1 A2 b Q

M A1 2 (4) -1 0 1 0 16 4

M A2 4 3 0 -1 0 1 24 8

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 Zj 6M 7M -M -M M M 40M

Zj- Cj 6M-6 7M-3 -M -M 0 0

Entering variable is x2 since it has the highest positive Z j- Cj value. The leaving variable is A 1 with the
lowest quotient.

Pivot element is 4 in brackets. Pivot equation is;

X1 X2 S1 S2 A2 B

½ 1 -1/4 0 0 4

In second tableau, replace A 1 with X2. Insert the pivot equation in place of S 3 together with the coefficient
of X2 i.e 3 in basis.

A2 values will now be;

old row values−( pivot equation values x corresponding column pivot element )

X1 X2 S1 S2 A2 b

4 3 0 -1 1 24

1/2 1 -1/4 0 0 4 (X 3)
5/2 0 3/4 -1 1 12

SECOND TABLEAU
Cj 6 3 0 0 M

CCB BASIS X1 X2 S1 S2 A2 B Q

3 x2 1/2 1 -1/4 0 0 4 8

M A2 (5/2) 0 ¾ -1 1 12 24/5

Zj 5M/2+3/2 3 3M/4-3/4 -M M

Zj- Cj 5M/2-9/2 0 3M/4-3/4 -M 0

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Entering variable is x1 since it has the highest positive Z j- Cj value. The leaving variable is A 2 with the
lowest quotient.

Pivot element is 5/2 in brackets. Pivot equation is;

X1 X2 S1 S2 B

1 0 3/10 -2/5 24/5

In third tableau, replace A2 with X1. Insert the pivot equation in place of S 3 together with the coefficient of
X2 i.e 6 in basis.

X2 values will now be;

old row values−( pivot equation values x corresponding column pivot element )

X1 X2 S1 S2 b

1/2 1 -1/4 0 4

1 0 3/10 -2/5 24/5 (X1/2)

0 1 -2/5 1/5 8/5

THIRD TABLEAU
Cj 6 3 0 0

CCB BASIS X1 X2 S1 S2 b Q

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 3 x2 0 1 -2/5 1/5 8/5 -4

6 x1 1 0 (3/10) -2/5 24/5 16

Zj 6 3 3/5 -9/5 168/5

Zj- Cj 0 0 3/5 -9/5

Since we still have a positive value in Zj- Cj optimality has not been achieved.

Enter S1 and x1 will leave. The rule is, the leaving variable should be the variable with the smallest
positive value of Q ( quotient) or zero.

Pivot element is 3/10 in brackets. Pivot equation is;

X1 X2 S1 S2 B

10/3 0 1 -4/3 16

In fourth tableau, replace x1 with S1. Insert the pivot equation in place of x 1 together with the coefficient
of x1 i.e 0 in basis.

x2 values will now be;

old row values−( pivot equation values x corresponding column pivot element )

X1 X2 S1 S2 b

0 1 -2/5 1/5 8/5

10/3 0 1 -4/3 16 (X(-2/5)

4/3 1 0 -1/3 8

FOURTH TABLEAU
cj 6 3 0 0

CCB BASIS X1 X2 S1 S2 b

3 x2 4/3 1 0 -1/3 8
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 0 S1 10/3 0 1 -4/3 16

Zj 4 3 0 -1 24

Zj- Cj -2 0 0 -1

Since all the values are negative or zero and has no positive value, optimality has been achieved.

Conclusion;

x1=0,x2 =8, S1=16, Z= 24= total cost

THE TRANSPORTATION MODEL

This is a special type of linear programming problem whose objective is to minimize cost or
maximize contribution associated with transporting goods from various sources to various
destinations.

Transportation table

This is a table used to summarize data relating to the transportation problem as shown below.

SUPPLY

E F G

C11 C12 C13

A X1 X2 X3

S1

C21 C22 C23

B X4 X5 X6 S2

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 C31 C32 C33

C X7 X8 X9 S3

DEMAND

d1 d2 d3

C11 = cost in cell 11

C12 = cost in cell 12

Formulation of a linear programming problem;

Max/Min Z = C11X1+C12X2+C13X3+C21X4+C22X5+C23X6+C31X7+C32X8+C33X9

Such that;

X1+X2+X3 = S1

X4+X5+X6= S2

X7+X8+X9=S3

X1+X4+X7=d1

X2+X5+X8=d2

X3+X6+X9=d3

X1…………………..X9 > 0 Non negativity constraint

Balanced transportation problem

This is where the total supply is equal to total demand. If the problem is not balanced proceed
to generate the initial solution.
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Unbalanced transportation problem

This is where total supply is not equal to total demand. If unbalanced, balance it by introducing
a dummy demand or supply point to take care of the difference between demand and supply.
The cost of the dummy will be zero since it’s not real.

Example

The cost matrix of a transportation problem of Uwezo limited is as follows.

SUPPLY

A B C

P 10 20 5

Q 2 10 8 4

R 1 20 7 8

DEMAND

3 5 6

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Required

Formulate a linear programming problem to minimize cost and solve it.

Solution

Total supply = 9 + 4 + 8 = 21

Total demand = 3 + 5 + 6 = 14

Difference = 7

Create a dummy demand point of 7 units.

North West corner rule

Allocate from the North West corner point and ensure that supply and demand is satisfied
appropriately.

Tableau 1

SUPPLY

A B C D

10 20 5 0

P 3 5 - 1+ 9

2 10 8 0

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 Q 4 4

+ -

1 20 7 0

R 1 7 8

DEMAND

3 5 6 7 21

D = Dummy

Initial cost = 3 x 10 + 5 x 20 + 1 x 5+ 4 x 8 + 1 x 7 + 7 x 0 = 174

Test for degeneracy = R + C – 1 = Number of occupied cells

= 3 + 4 – 1 = 6 . This is non degenerate.

Stepping stone algorithm.

1. Compute the cost improvement indices of the unoccupied cells.

Assume that the occupied cells are stones and the unoccupied cells are full of water and
inside the water is a frog.

The frog steps on the stones either in a clockwise or anticlockwise position and it steps only on
stones that allow it to turn vertically or horizontally.

2. Trace the paths for all the unoccupied cells and then allocate a positive sign starting from
the point where the frog is and then alternate the signs appropriately.
3. Using the signs and the cost in each cell compute the cost improvement index for each
unoccupied cell.
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 Cell Cost improvement index

PD 0+7–5–0=2

QA 2 – 10 + 5 – 8 = - 11

QB 10 – 20 + 5 – 8 = - 13 *

RA 1 – 10 + 5 – 7 = - 11

RB = 20 – 20 + 5 – 7 = - 2

QD = 0–0+7–8=-1

Since some of the values obtained are negative the solution is not optimal.

Consider the loop with the most negative value. In this case loop QB. Identify the cell with
a lower negative allocation on that loop and use it to improve the other cells on that loop.

Tableau 2

SUPPLY

A B C D

10 20 5 0

P 3 1 5 9

- +

2 10 8 0

Q 4 4

20
 1 20 7 0

R + - 1 7 8

DEMAND

3 5 6 7 21

Total cost = 3 x 10 + 1 x 20 + 5 x 5 + 4 x 10 + 1 x 7 + 7 x 0 = 122

Cell Cost improvement index

PD 0+7–5–0=2

QA 2 + 10 – 10 – 10 = 2

QC 8 + 20 – 5 – 10 = 13

QD 0 – 0 + 7 – 5 + 20 – 10 = 12

RA = 1 – 7 + 5 – 10 = - 11 *

RB = 20 – 7 + 5 – 20 = - 2

Tableau 3

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 SUPPLY

A B C D

10 20 5 0

P 2 1 6 9

- +

2 10 8 0

Q 4 4

1 20 7 0

R 1 7 8

+ -

DEMAND

3 5 6 7 21

Cell Cost improvement index

PD 0 – 0 + 1 – 10 = - 9

QA 2 – 10 + 20– 10 = 2

QC 8 – 5 + 20 – 10 = 13

QD 0 – 0 + 1 – 10 + 20 – 10 = 1

RB = 20 – 20 + 10 – 1 = 9

RC = 7 – 5 + 10 – 1 = 11

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Tableau 4

SUPPLY

A B C D

10 20 5 0

P 1 6 2 9

2 10 8 0

Q 4 4

1 20 7 0

R 3 5 8

DEMAND

3 5 6 7 21

Cell Cost improvement index

PA 10 – 0 + 0 – 1 = 9

QA 2 – 10 + 20– 0 + 0 – 1 = 11

QC 8 – 5 + 20 – 10 = 13

QD 0 – 0 + 20 – 10 = 10

RB = 20 – 0 + 0 – 20 = 0

RC = 7–0+0–5=2
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 Solution is optimal

Total cost = 1 x 20 + 6 x 5 + 2 x 0 + 4 x 10 + 3 x 1 + 5 x 0 = 93

LEAST COST METHOD

In this case we first allocate the cells with the lowest cost and then proceed to the next cell with
the lowest cost and proceed in that way until full allocation is attained.

From the previous example the solution will be generated as follows.

Tableau one

SUPPLY

A B C D

10 20 5 0

P 1 6 2 9

2 10 8 0

Q 4 4

1 20 7 0

R 3 5 8

DEMAND

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 3 5 6 7 21

Total cost = 1 x 20 +6 x 5 +2 x 0 +4 x10 +3 x 1+ 5 x 0 = 93

Cell Cost improvement index

PA 10 – 0 + 0 – 1 = 9

QA 2 – 10 + 20– 0 + 0 – 1 = 11

QC 8 – 5 + 20 – 10 = 13

QD 0 – 0 + 20 – 10 = 10

RB = 20 – 0 + 0 – 20 = 0

RC = 7–0+0–5=2

Solution is optimal

However since there is a tie in cost of cell PB and RB the alternative solution is as follows;

Tableau one

SUPPLY

A B C D

10 20 5 0

P 6 3 9

25
 2 10 8 0

Q 4 4

1 20 7 0

R 3 1 4 8

DEMAND

3 5 6 7 21

Total cost = 6 x 5 + 3 x 0 + 4 x 10 + 3 x 1 + 1 x 20 + 4 x 0 = 93

Then we test for optimality by calculating the cost improvement index of the unoccupied cells
as follows;

Cell Cost improvement index

PA 10 – 0 + 0 – 1 = 9

PB 20 – 0 + 0– 20 = 0

QA 2 – 10 + 20 – 1 = 11

QC 8 – 10 + 20 – 0 + 0 – 5 = 13

QD = 0 – 0 + 20 – 10 = 10

RC = 7–0+0–5=2

Since no negative value is obtained an optimal solution has been attained.

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VOGELS APPROXIMATION METHOD

The following steps are used when solving a problem using vogels approximation method;

1. Construct the cost matrix

2. For each row and column calculate the difference between the two lowest cost
entries.
3. Select the row or column with the greatest difference and allocate the maximum
number of units to the cell with the lowest cost and move along that row or column
until its fully allocated. Then move to the next value with the highest difference and
repeat the same until all the cells have been fully allocated.
4. Then test for optimality and proceed as before.

Tableau one

SUPPLY ROW

A B C D DIFFERENCE

10 20 5 0

P 5

1 6 2 9

2 10 8 0

Q 2

4 4

1 20 7 0

R 1

3 5 8

DEMAND

3 5 6 7 21

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 COLUMN 1 10 3 0
DIFFERENCE

Total cost = 1 x 20 + 5 x 6 + 2 x 0 + 4 x 10 + 3 x 1 + 5 x 0 = 93

Then test for optimality as follows

Cell Cost improvement index

PA 10 – 0 + 0 – 1 = 9

QA 2 – 10 + 20– 0 + 0 – 1 = 11

QC 8 – 5 + 20 – 10 = 13

QD 0 – 0 + 20 – 10 = 10

RB = 20 – 0 + 0 – 20 = 0

RC = 7–0+0–5=2

Solution is therefore optimal.

THE MODIFIED DISTRIBUTION METHOD (MODI)

This is a modification of the stepping stone algorithm. The modification is in terms of the
computation of the cost improvement index.

The cost improvement index is based on 3 sets of equations as follows;

1. Let R1 = 0

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 2. For the occupied cells Ri + Ci = Cij
3. For the unoccupied cells
Cij* =Cij – Ri – Kj

4. The rest of the steps are the same as for the stepping stone algorithm.

The first tableau will then be generated as follows;

Tableau one

C1 = 10 C2 = 20 C3=5 C4= - 2 SUPPLY

A B C D

10 20 5 0

R1 = 0 P 3 5 1 9

2 10 8 0

R2 = 3 Q 4 4

1 20 7 0

R3=2 R 1 7 8

DEMAND

3 5 6 7 21

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Cij = cost in cell ij

For the occupied cells

Cell Cij =Cij + Ri

PA 10 = R1 + C1 10 = 0 + C1 , hence C1 = 10

PB 20 = R1 + C2 20 = 0 + C2 , hence C2 = 20

PC 5 = R 1 + C3 5 = 0 + C3 , hence C3 = 5

QC 8 = R 2 + C3 8 = R2 + 5 , hence R2 = 3

RC 7 = R 3 + C3 7 = R3 + 5 , hence R3 = 2

RD 0 = R 3 + C4 0 = 2 + C4 , hence C4 = - 2

For the unoccupied cells

CELL Cij* =Cij – Ri – Kj

PD 0 - R1 + C4 = 10 = 0 – 0 - - 2 = 2

QA 2 – R2 – C1 = 20 = 2- 3 – 10 = - 11

QB 10 – R2 – C2 = 10 – 3 – 20 = - 13

QD 0 – R 2 – C4 = 0 – 3 – - 2 = - 1

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RA 1 – R3 – C1 = 1 – 2 – 10 = - 11

RB 20 – R3 – C2 = 20 – 2 – 20 = - 2

Cij* = cost improvement index.

Then proceed as before.

ASSIGNMENT MODEL

The procedure for solving the assignment problem can be described as follows;

1. Set up the assignment table

2. Construct the row opportunity cost table. This is done by establishing the smallest number in each
row in the assignment table and subtracting it from every element in that row.

3. Set up the column opportunity cost table by finding the smallest number in each column from the
previous table in 2 above and subtracting it from each element in that column.

4. Make assignments where (0) denotes an assignment. Assign once in every row and column. If the
optimal solution is not achieved go to the next stage.

5. Draw the least number of lines to cover all the zeros. Identify the smallest number without a line
through it.

6. Subtract the smallest number from any number without a line through it while adding it to a
number at the point of intersection between two lines and leaving all the remaining numbers
which are cut by one line as before.

7. Then perform the allocations to determine if the optimum allocation is possible or not.

Example one

Consider the following initial assignment table:

1 2 3 4 Smallest row element

A 68 72 75 83 68

31
 B 56 60 58 63 56

C 38 40 35 45 35

D 47 42 40 45 40

Subtract the smallest element from each element in its row;

0 4 7 15

0 4 2 7

3 5 0 10

7 2 0 5

0 2 0 5 Smallest column element

Subtract the smallest element from each element in each column.

0 2 7 10

0 2 2 2

3 3 0 5

7 0 0 0

Make assignments where (0) denotes an assignment

(0) 2 7 10

0 2 2 2

3 3 (0) 5

7 (0) 0 0

We can only make 3 assignments hence optimal solution has not been achieved.

Draw the least number of lines to cover all the zeros.

32
 0 2 7 10

0 2 2 2

3 3 0 5

7 (0) 0 0

The smallest number without a line through it is 2. Deduct 2 from any number without a line
through it and add 2 to any number at the point of intersection of the two lines and leave all the
other remaining numbers which are cut by one line as before.
This will lead to:
0 0 7 8

0 0 2 0

3 1 0 3

9 0 2 0

Then allocate once for each row and column.

Allocation one
(0) 0 7 8

0 (0) 2 0

3 1 (0) 3

9 0 2 (0)

Alternative allocation two

0 (0) 7 8

(0) 0 2 0

3 1 (0) 3

9 0 2 (0)

33
Alternative allocation three
0 (0) 7 8

(0) 0 2 0

3 1 (0) 3

9 0 2 (0)

Minimum mileage can then be calculated from the original table.

Allocation one = 68+60+35+45=208 miles
Allocation two = 68+63+35+42=208 miles
Allocation three = 72+56+35+45=208 miles
Example two
The supervisor of a machine shop in ABC limited has four jobs which are to be processed though
a particular kind of machine. He has identified 4 machines which can be assigned for the
processing of the job. However all these machines differ in speed and time taken in processing.
The time estimate of processing the jobs on the designated machines is given below;
Jobs

Machines E F G H

A 15 20 19 17

B 21 21 20 17

C 16 16 14 17

D 20 18 16 15

The supervisor wants to assign the machines to the jobs so a s to minimize total processing time.

Solve the above assignment problem and show the optimal maximization allocation of the jobs to the
appropriate machines

Solution
Consider the following initial assignment table:

E F G H Smallest row element

34
 A 15 20 19 17 15

B 21 21 20 17 17

C 16 16 14 17 14

D 20 18 16 15 15

Subtract the smallest element from each element in its row;

0 5 4 2

4 4 3 0

2 2 0 3

5 3 1 0

0 2 0 0 Smallest column element

Subtract the smallest element from each element in each column.

0 3 4 2

4 2 3 0

2 0 0 3

5 1 1 0

Subtract the smallest element from each element in each column.

0 3 4 2

4 2 3 0

2 0 0 3

5 1 1 0

The smallest number without a line through it is 1. Deduct 1 from any number without a line
through it and add 1 to any number at the point of intersection of the two lines and leave all the
other remaining numbers which are cut by one line as before.
This will lead to:

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 0 3 4 3

3 1 2 0

2 0 0 4

4 0 0 0

ALLOCATION ONE
(0) 3 4 3

3 1 2 (0)

2 (0) 0 4

4 0 (0) 0

Total = 15+17+16+16=64 mins

ALLOCATION TWO
(0) 3 4 3

3 1 2 (0)

2 0 (0) 4

4 (0) 0 0

Total = 15+17+14+18=64 minutes

INVENTORY MANAGEMENT
INVENTORY MANAGEMENT
                             

36
Introduction
Every enterprise needs inventory for smooth running of its activities. It
serves as a link between production and distribution processes. There is,
generally, a time lag between the recognition of need and its fulfilment.
The greater the time – lag, the higher the requirements for inventory.
The investment in inventories constitutes the most significant part of
current assets/working capital in most of the undertakings. Thus, it is very
essential to have proper control and management of inventories. The
purpose of inventory management is to ensure availability of materials in
sufficient quantity as and when required and also to minimise investment in
inventories.
Meaning and Nature of inventory
In accounting language it may mean stock of finished goods only. In a
manufacturing concern, it may include raw materials, work in process and
stores, etc. Inventory includes the following things:
(a) Raw Material: Raw material form a major input into the
organisation. They are required to carry out production activities
uninterruptedly. The quantity of raw materials required will be determined
by the rate of consumption and the time required for replenishing the
supplies. The factors like the availability of raw materials and government
regulations etc. too affect the stock   of raw materials.
(b) Work in Progress: The work-in-progress is that stage of
stocks which are in between raw materials and finished goods. The raw
materials enter the process of manufacture but they are yet to attain a final
shape of finished goods. The quantum of work in progress depends upon the
time taken in the manufacturing process. The greater the time taken in
manufacturing, the more will be the amount of work in progress.
(c) Consumables: These are the materials which are needed to
smoothen the process of production. These materials do not directly enter
production but they act as catalysts, etc. Consumables may be classified
according to their consumption and criticality.
(d) Finished goods: These are the goods which are ready for the
consumers. The stock of finished goods provides a buffer between
production and market. The purpose of maintaining inventory is to ensure
proper supply of goods to customers.
(e) Spares: Spares also form a part of inventory. The consumption
pattern of raw materials, consumables, finished goods are different from
37
that of spares. The stocking policies of spares are different from industry to
industry. Some industries like transport will require more spares than the
other concerns. The costly spare parts like engines, maintenance spares etc.
are not discarded after use, rather they are kept in ready position for
further use.
Purpose/Benefits of Holding Inventors
There are three main purposes or motives of holding inventories:
(i) The Transaction Motive which facilitates continuous
production and timely execution of sales orders.
(ii) The  Precautionary Motive which necessitates the holding of
inventories for meeting the unpredictable changes in demand and
supplies of materials.
 (iii) The Speculative Motive which induces to keep inventories
for taking advantage of price fluctuations, saving in re-ordering
costs and quantity discounts, etc.
Risk and Costs of Holding Inventors
The holding of inventories involves blocking of a firm’s funds and
incurrence of capital and other costs. It also exposes the firm to certain
risks. The various costs and risks involved in holding inventories are as
below:
(i)                 Capital costs: Maintaining of inventories results in
blocking of the firm’s financial resources. The firm has, therefore,
to arrange for additional funds to meet the cost of inventories. The
funds may be arranged from own resources or from outsiders. But
in both cases, the firm incurs a cost. In the former case, there is an
opportunity cost of investment while in later case the firm has to
pay interest to outsiders.
(ii)               Cost of Ordering: The costs of ordering include the
cost of acquisition of inventories. It is the cost of preparation and
execution of an order, including cost of paper work and
communicating with supplier. There is always minimum cot involve
whenever an order for replenishment of good is placed. The total
annual cost of ordering is equal to cost per order multiplied by the
number of order placed in a year.
(iii)             Cost of Stock-outs: A stock out is a situation when the
firm is not having units of an item in store but there is demand for
38
 that either from the customers or the production department. The
stock out refer to demand for an item whose inventory level is
reduced to zero and insufficient level. There is always a cost of
stock out in the sense that the firm faces a situation of lost sales or
back orders. Stock out are quite often expensive.
(iv)             Storage and Handling Costs. Holding of inventories
also involves costs on storage as well as handling of materials. The
storage costs include the rental of the godown, insurance charge
etc.
(v)               Risk of Price Decline. There is always a risk of
reduction in the prices of inventories by the suppliers in holding
inventories. This may be due to increased market supplies,
competition or general depression in the market.
(vi)             Risk of Obsolescence. The inventories may become
obsolete due to improved technology, changes in requirements,
change in  customer’s tastes etc.
(vii)           Risk Deterioration in Quality: The quality of the
materials may also deteriorate while the inventories are kept in
stores.
Inventory Management
It is necessary for every management to give proper attention to
inventory management. A proper planning of purchasing, handling storing
and accounting should form a part of inventory management. An efficient
system of inventory management will determine (a) what to purchase (b)
how much to purchase (c) from where to purchase (d) where to store, etc.
There are conflicting interests of different departmental heads over
the issue of inventory. The finance manager will try to invest less in
inventory because for him it is an idle investment, whereas production
manager will emphasise to acquire more and more inventory as he does not
want any interruption in production due to shortage of inventory. The
purpose of inventory management is to keep the stocks in such a way that
neither there is over-stocking nor under-stocking. The over-stocking will
mean reduction of liquidity and starving of other production processes;
under-stocking, on the other hand, will result in stoppage of work. The
investments in inventory should be kept in reasonable limits.
Objects of Inventory Management

39
 The main objectives of inventory management are operational and
financial. The operational objectives mean that the materials and spares
should be available in sufficient quantity so that work is not disrupted for
want of inventory. The financial objective means that investments in
inventories should not remain idle and minimum working capital should be
locked in it. The following are the objectives of inventory management:
(1)   To ensure continuous supply of materials spares and finished goods
so that production should not suffer at any time and the customers
demand should also be met.
(2)   To avoid both over-stocking and under-stocking of inventory.
(3)   To keep material cost under control so that they contribute in
reducing cost of production and overall costs.
(4)   To minimise losses through deterioration, pilferage, wastages and
damages.
(5)   To ensure perpetual inventory control so that materials shown in
stock ledgers should be actually lying in the stores.
(6)   To ensure right quality goods at reasonable prices.
(7)   To maintain investments in inventories at the optimum level as
required by the operational and sales activities.
(8)   To eliminate duplication in ordering or replenishing stocks. This is
possible with help of  centralising purchases.
(9)   To facilitate furnishing of data for short term and long term
planning and control of inventory.
(10) To design proper organisation of inventory. A clear cut accountability
should be fixed at various levels of management.
Tools and Techniques of inventory Management
Effective Inventory management requires an effective control system for
inventories. A proper inventory control not only helps in solving the acute
problem of liquidity but also increases profits and causes substantial
reduction in the working capital of the concern. The following are the
important tools and techniques of inventory management and control:

1. Determination of Stock Levels.

2. Determination of Safety Stocks.
3.  Determination of Economic Order Quantity
40
4. A.B.C. Analysis
5. VED Analysis
6. Inventory Turnover Ratios
7. Aging Schedule of Inventories
8. Just in Time Inventory
1. Determination of Stock Levels
Carrying of too much and too little of inventories is detrimental to the
firm. If the inventory level is too little, the firm will face frequent stock-
outs involving heavy ordering cost and if the inventory level is too high it
will be unnecessary tie-up of capital. Therefore, an efficient inventory
management requires that a firm should maintain an optimum level of
inventory where inventory costs are the minimum and at the same time
there is not stock-out which may result in loss of sale or stoppage of
production. Various stock levels are discussed as such.
(a)   Minimum Level: This represents the quantity which must be
maintained in hand at all times. If stocks are less than the minimum
level then the work will stop due to shortage of materials. Following
factors are taken into account while fixing minimum stock level:
Lead Time: A purchasing firm requires some time to process the order
and time is also required by supplying firm to execute the order. The time
taken in processing the order and then executing it is known as lead time.
Rate of Consumption: It is the average consumption of materials in
the factory. The rate of consumption will be decided on the basis pas
experiences and production plans.
Nature of Material: The nature of material also affects the minimum
level. If material is required only against special orders of customer then
minimum stock will not be required for such materials.
Minimum stock level = Re-ordering level-(Normal
consumption
                     x Normal Re-order period).
(b) Re-ordering Level:   When the quantity of materials reaches at a
certain figure then fresh order is sent to get materials again. The order is
sent before the materials reach minimum stock level. Reordering level is
fixed between minimum and maximum level. The rate of consumption,
number of days required to replenish the stock and maximum quantity of
41
material required on any day are taken into account while fixing reordering
level.
Re-ordering Level = Maximum Consumption  x  Maximum
Re-order period.
(c) Maximum Level: It is the quantity of materials beyond which a firm
should not exceed its stocks. If the quantity exceeds maximum level limit
then it will be overstocking. A firm should avoid overstocking because it will
result in high material costs. 
Maximum Stock Level = Re-ordering Level+ Re-ordering
Quantity
     -(Minimum Consumption  x  Minimum
Re-ordering period).
(d) Danger Level: It is the level beyond which materials should not fall
in any case. If danger level arises then immediate steps should be taken to
replenish the stock even if more cost is incurred in arranging the materials.
If materials are not arranged immediately there is possibility of stoppage of
work.
Danger Level = Average Consumption  x  Maximum
reorder period
                                          for emergency purchases.
(e) Average Stock Level
The average stock level is calculated as such:
Average Stock level = Minimum Stock Level +½ of re-
order quantity
2. Determination of Safety Stocks
Safety stock is a buffer to meet some unanticipated increase in usage.
It fluctuates over a period of time. The demand for materials may fluctuate
and delivery of inventory may also be delayed and in such a situation the
firm can face a problem of stock-out. The stock-out can prove costly by
affecting the smooth working of the concern. In order to protect against the
stock out arising out of usage fluctuations, firms usually maintain some
margin of safety or safety stocks. Two costs are involved in the
determination of this stock i.e. opportunity cost of stock-outs and the
carrying costs. The stock out of raw materials cause production disruption
resulting in higher cost of production. Similarly, the stock out of finished
42
goods result into failure of firm in competition, as firm cannot provide
proper customer service. If a firm maintains low level of safety frequent
stock out will occur resulting in large opportunity coast. On the other hand
larger quantity of safety stock involves higher carrying costs.
3. Economic Order Quantity (EOQ)
A decision about how much to order has great significance in inventory
management. The quantity to be purchased should neither be small nor big
because costs of buying and carrying materials are very high. Economic
order quantity is the size of the lot to be purchased which is economically
viable. This is the quantity of materials which can be purchased at minimum
costs. Generally, economic order quantity is the point at which inventory
carrying costs are equal to order costs. In determining economic order
quantity it is assumed that cost of a managing inventory is made of solely of
two parts i.e. ordering costs and carrying costs.
(A)  Ordering Costs: These are costs that are associated with the
purchasing or ordering of materials. These costs include:
(1) Inspection costs of incoming materials.
(2) Cost of stationery, typing, postage, telephone charges etc.
(3) Expenses incurred on transportation of goods purchased.
These costs are also know as buying costs and will arise only when some
purchases are made.
(B) Carrying Costs: These are costs for holding the inventories.
These costs will not be incurred if inventories are not carried. These costs
include:
(1)    The cost of capital invested in inventories. An interest will be paid
on the amount of capital locked up in inventories.
(2)    Cost of storage which could have been used for other purposes.
(3)    Insurance Cost
(4)    Cost of spoilage in handling of materials
Assumptions of EOQ:   While calculating EOQ the following assumptions
are made.
1.       The supply of goods is satisfactory. The goods can be purchased
whenever these are needed.
2.       The quality to be purchased by the concern is certain.
43
 3.       The prices of goods are stable. It results to stabilise carrying
costs. 
Economic order quantity can be calculated with the help of the following
formula:
D
xCo
Ordering cost = Q                     
Q
xC
Holding cost = 2 c    
At EOQ these two costs are equal
Equating and solving for Q
2C o D
Q=
√ Cc
   
D = annual demand in units
Q = EOQ
CO= ordering cost per order
Cc = carrying cost per unit

Illustration 1:  The finance department of a Corporation provides the

following information:
(i)                 The carrying costs per unit of inventory 15% of
product cost
(ii)               The fixed costs per order are USD 300
(iii)             The number of units required is 1,000 per month.
i) Determine the economic order quantity (EOQ)
ii) Calculate total inventory cost.

Solution: The economic order quantity may be found as follow

44
 2C O D
i)
EOQ=
√ Cc
=
2 x 300 x 12 , 000
√ 9
=895 units

Cost formula calculation

Purchase No of units x cpu 12,000 x 60 = 720,000

Ordering cost D 12 ,000

x 300=4022
XCo
Q 895
Holding cost Q 895
XCc x 9=4028
2 2
Total cost 728,050

Example 2
Sales per week 18 units at a unit cost of sh 60
Ordering cost sh 45
Annual holding cost 25% of unit cost value
Required
a) EOQ
b) Total cost at EOQ
c) Total cost if lot sizes of 390 units are used
d) Total cost if lot sizes of 468 units are used

Solution
2C O D
i)
EOQ=
√ Cc
=
2 x 45 x 936
√
15
=units

ii)
45
 Lot size 390
Cost formula calculation
Purchase No of units x cpu 936 x 60 = 56,160

Ordering cost D 936

x 45=108
XCo
Q 390
Holding cost Q 390
XCc x15=
2 2 2925
Total cost 59,193

iii)

Lot size 568 units

Cost formula Calculation
Purchase No of units x cpu 936 x 60 = 56,160

Ordering cost D 936

x 45=90
XCo
Q 468
Holding cost Q 468
XCc x 15=4510
2 2 2925
Total cost 59,760

        
4. A-B-C Analysis
Under A-B-C analysis, the materials are divided into three categories
viz, A, B and C. Past experience has shown that almost 10 per cent of the

46
items contribute to 70 percent of value of consumption and this category is
called ‘A’ Category. About 20 per cent of value of consumption and this
category is called ‘A’ Category. About 20 per cent of the items contribute
about 20 per cent of value of consumption and this is known as category ‘B’
materials. Category ‘C’ covers about 70 per cent of items of materials which
contribute only 10 per cent of value of consumption. There may be some
variation in different organisations and an adjustment can be made in these
percentages.
The information is shown in the following diagram:

Class No. of Items (%) Value of Items

(%)
 A        10         70
 B        20         20
 C        70         10
 
A-B-C analysis helps to concentrate more efforts on category A since
greatest monetary advantage will come by controlling these items. An
attention should be paid in estimating requirements, purchasing,
maintaining safety stocks and properly storing of ‘A’ category materials.
These items are kept under a constant review so that substantial material
cost may be controlled. The control of ‘C’ items may be relaxed and these
stocks may be purchased for the year. A little more attention should be
given towards ‘B’ category items and their purchase should be undertaken a
quarterly or half-yearly intervals.
5. VED Analysis
The VED analysis is used generally for spare parts. The requirements
and urgency of spare parts is different from that of materials. A-B-C analysis
may not be properly used for spare parts. Spare parts are classified as Vital
(V), Essential (E) and Desirable (D) The vital spares are a must for running
the concern smoothly and these must be stored adequately. The non-
availability of vital spares will cause havoc in the concern. The E type of
spares are also necessary but their stocks may be kept at low figures. The
stocking of D type of spares may be avoided at times. If the lead time of
these spares is less, then stocking of these spares can be avoided.
6.

47