D ETERMINING LOT SIZES

Description

The objective of the decision ‘determining lot sizes’ is to find a balance between efficiency in the production process (as few setups as possible) and a minimum of cycle stock. The demand for small(er) batches leads to lower cycle stocks and therefore lower cost of capital and risk of obsolescence. The demand for production efficiency would lead to large batch sizes and thus an, on average, high cycle stock level. The efficiency in the production process increases, since more capacity is assigned to production and a minimum of capacity is assigned to setups. An additional advantage here is that the start- up losses (waste) are also decreased.

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A lot of research effort has been spent on research into the financial effect of the lot size determination. Lee and Nahmias (1993) estimate the number of papers appeared in journals concerning the single product inventory problems well into thousands. However, most of these models are concerned with the search for optimal solutions. Again, the decision support described here, only deals with the retrieval of the financial impact when determining a specific lot size.

Each batch (lot) is supposed to require a setup activity and invokes a start-up activity. The setup activity refers to an activity to change, e.g., a piece of machinery from one configuration to another. The start-up activity refers to the initial run aimed at fine-tuning the specified configuration. The setup activity usually requires capacity of, e.g., machinery, energy, equipment, or human labour. This demand for capacity could lead to acquisition of these resources, resulting in cash outflows. Reducing the number of setups would reduce the demand for these resources, and possibly reduce the outgoing cash flows. The start-up activity could result in so-called start-up losses. These losses consist of, e.g., material, energy, and capacity of machinery, equipment and human labour. Reducing the number of setups would result in a reduction of the start-up activities. In the time frame considered this could result in avoiding the losses mentioned, and thus avoiding possible outgoing cash flows. Of course, when the number of setups is increased the opposite effects could occur.

Other financial effects of the lot size decisions are related to the cycle stock, risk of obsolescence, and missed demand. These are discussed next.

The lot-size determines the cycle stock and thus the demand for storage capacity. The higher the average lot size is the higher the demand for this storage capacity. In the time period considered, the lot size could influence measures to expand / reduce storage capacity. The accompanying cash flows are thus avoidable. A second effect of the occurrence of cycle stock is related to the opportunity cost of capital. The opportunity cost of capital is related to all cash in and cash outflows. A decrease of the lot size would imply that on average the purchase of resources could be postponed as opposed to the situation with a higher lot size. This implies that in the first situation on average less capital is invested in the organisation. This effect is expressed by means of the opportunity cost of capital (see also Van der Veeken 1988 or Veltman and Van Donselaar 1993 regarding this financial consequence).

Functional requirements 37 The higher the cycle stock, the higher is the risk of obsolescence. The financial impact of obsolete stock could be either the additional outgoing cash flow resulting from the resources needed to re-produce this stock, a cash inflow due to the sale of this obsolete stock, or in situation of shortage, the missed cash inflow of missed sales. Additionally, the product that has become obsolete should be removed, resulting in outgoing cash flows. The final effect is related to the missed production capacity due to setups. If capacity cannot be expanded, this could lead to customer orders not fulfilled. This effect can be expressed as a missed cash inflow.

Requirements

Most requirements for this decision have already been discussed in the previous sub- sections. These requirements are related to the specification of the production processes within companies. The knowledge obtained here is the explicit recognition of recipes for setup and start-up activities. When a batch is actually planned, these types of activities could lead to purchase of resources.

Another type of requirements which has been discussed above is the insight in missed production (and thus sales) due to the setup, start-up activities and replenishment of stock that has become obsolete. The same difficulties apply here as with the order acceptance decision. Since the alternatives do not arrive simultaneously, insight must be given by a master plan.

A new requirement concerns information about the moments in time that resources are actually paid. These moments are used to determine opportunity cost of capital. Furthermore, information must be available concerning the risk of obsolescence, and information concerning the removal of obsolete stock. For some situations this could imply cash inflow due to the sale of this stock, in other situations cash outflow for the removal of this stock.

In Section 2.3, the requirement for recipes is generalised to ‘resource consumption’, ‘resource transition’, and ‘cash transition’. Again the opportunity effect of a decision is generalised to the requirement ‘context information’. The time-phased moments of cash flows are captured by the requirement ‘objectivity of accounting data’.

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