ISTANBUL TECHNICAL UNIVERSITY

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ISTANBUL TECHNICAL UNIVERSITY TURKISH
AIRLINES Operations Logistics Management in Air
Transportation Dr. David Gillen (University of
British Columbia) Dr. Benny Mantin (University
of Waterloo) June 9-14, 2014
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Logistics

• Learning Objectives
• Key components of logistics
• Order Processing, Inventory, Transportation,
  Sourcing, Warehousing, Materials Handling, and
  Packaging, integrated through a network of
  facilities (warehouses and distribution centers)
• Logistics is integral to a firms strategy
• Keys to managing logistics costs
• Inventory management
• Transportation management
• Supply Chain Flexibility and Synchronization

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What is logistics?

• Logistics is the design and administration of
  systems to control movement and spatial
  positioning of factor inputs (raw materials,
  labor, capital, energy) work-in-process, and
  finished inventories at the lowest total cost.
• Our focus will be on inventory management and
  transportation management

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The five functions of logistical work are
interrelated
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What do we know about Turkey

• 81 provinces
• Bordering countries Armenia, Azerbaijan,
  Bulgaria, Georgia, Greece, Iran, Iraq, Syria
• Population (January 2013) 74.6 million (18th
  largest in the world)
• Urbanization about 72
• Age structure 014 years (26.0) 1564 years
  (67.9) 65 and above (6.1)
• Nominal GDP (2012) US790.5b
• GDP per capita (US current prices) (2012) -
  US10,595.2
• GDP Composition Agriculture (9.1) Industry
  (27.9) Services (63.0)
• Public debt 40.4 of GDP
• Labor force (2012) 26.5 million

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Geographic Strength
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International Freight-Modal Split
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Growth in Logistics Activities
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Care in Comparing Logistics Costs
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(No Transcript)
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U.S. logistics cost, 1980-2010 in five year
intervals (B)
Year Nominal GDP (T) Inventory Cost Transportation Cost Administrative Cost Total Logistics Cost Logistics of GDP
1980 2.80 220 214 17 451 16.1
1985 4.22 227 274 20 521 12.3
1990 5.80 283 351 25 659 11.4
1995 7.40 302 441 30 773 10.4
2000 9.82 374 594 39 1007 10.3
2005 12.43 395 739 46 1180 9.5
2010 14.60 396 769 47 1212 8.3
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The cost of logistics
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Logistics Costs Canada-U.S. Comparison
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Logistics will continue its renaissance in the
future

• Information technologies will automate many of
  the traditionally manual logistical functions
• Automated port and rail operations
• RFID tagging of materials
• Advanced technologies for warehousing and
  inventory operations
• Removal of trade barriers will continue to expand
  global trade and logistics
• Outsourcing versus near-shoring
• Implications for airlines?

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Logistical value proposition-Manufacturing
Service Industries

• Logistical value proposition consists of a
  commitment to key customer expectations and
  requirements at a minimum cost
• The two elements of this value proposition are
  Service and Cost Minimization
• Firms must make appropriate tradeoffs between
  service and cost for each of their key customers

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Service benefits are created by logistical
performance in 3 areas

• Availability involves having inventory to
  consistently meet customer material or product
  requirements
• Operational performance deals with the time
  required to deliver a customers order
• Key metrics for this area involve delivery speed
  and consistency
• Service reliability involves the quality
  attributes of logistics
• Key to quality is accurate measurement of
  availability and operational performance over time

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Cost minimization using the total cost logistics
model
Traditional Cost Logistics Model
Total Cost Logistics Model

• Focused on achieving the lowest possible cost for
  each individual function of logistics
• For example, Transport the material the cheapest
  way possible
• Expected lowest cost based on decisions that were
  cheapest for individual functions
• Ignored the impact of cost decisions across
  logistics functions

• Focused on achieving the lowest total cost across
  each function of logistics
• A cost decision in one function should consider
  impact to costs of all other logistics functions
• For example, Transporting material the cheapest
  way is slower than other choices. This requires
  an increase in storage cost to hold the material
  longer
• Would it still be a lower cost to use the
  cheapest mode of transport?

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Different perspectives on cost minimization
Traditional Cost Logistics Model
Total Cost Logistics Model

• Minimize order processing cost
• Minimize inventory cost
• Minimize transportation cost
• Minimize warehousing, materials handling and
  packaging cost
• Minimize facility cost
• __________________________
• Lowest logistics cost

• Minimize (order processing inventory
  transportation warehousing, materials handling
  and packaging facility) cost
• _________________________
• Lowest total logistics cost

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Framework Total Logistics Cost Function
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Components of TLC
TLC (Q, r T, ST) RDi (UCTDi/365) (SDi/Q)
(QCI/2) rIC K(Di/Q) N(Z)S1
where TLC total logistics cost R
Transportation Rate per Unit between Origin and
Destination D Annual Demand for some good i U
Carrying Cost of In-transit Inventory C Value
per Unit T Transit Time of Transportation
Alternative S Fixed Ordering Cost per Order Q
Order Quantity I Carrying Cost of Warehoused
Inventory r Safety Stock K Stockout Cost per
Unit N(Z) Unit Loss Integral S1 Standard
Deviation of Demand During Transit Time ST
Standard Deviation of Demand During Lead Time
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How these Costs are Distributed
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Cost Conflicts Speed versus Service Reliability
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Other Cost Conflicts/Tradeoffs
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Transportation

• Transportation is the operational area that
  geographically moves and positions inventory
• There are three basic ways to satisfy
  transportation requirements
• Operate a private fleet of equipment
• Contract with dedicated transport specialists
• Engage carriers that provide different
  transportation services as needed on a per
  shipment basis

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Measuring Costs

• Cost Structure

• Accounting Costs

• Variable costs
• Material
• Manufacturing/production
• shipping
• Fixed costs
• Contracts
• Capital
• Manufacturing/production
• Ownership
• Purchase
• Acquisition
• Usage
• salvage
• Opportunity cost-forgone sales

• Costs vary with factor prices, productivity
  output
• Scale economies
• Scope economies
• Utilization economies
• Density economies
• Agglomeration economies
• Value of time/reliability

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Pricing

• Concept to Willingness to Pay
• Unit cost or average cost pricing
• Cost plus pricing
• Incremental cost pricing
• Differential Pricing (special case of Ramsey
  pricing)
• Non-linear pricing and two-part tariffs
• Bundling and unbundling

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The scope of integrated logistical operations
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Logistical integration requires achieving six
objectives simultaneously

• Responsiveness
• Variance reduction
• Inventory reduction
• Shipment consolidation
• Quality
• Life cycle support

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Example situations for flexible logistics
structure

• The customer-specified delivery facility might be
  near a point of equal logistics cost or equal
  delivery time from two different logistics
  facilities
• The size of a customers order creates improved
  logistical efficiency if serviced through an
  alternative channel arrangement
• Decision to use a selective inventory stocking
  strategy
• Agreements between firms to move selected
  shipments outside the established echeloned or
  direct arrangements
• Co-opatition (Cooperation Competition)

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Supply chain synchronization

• Supply chain synchronization is the operational
  integration of multiple firms across a supply
  chain
• Seeks to coordinate the flow of materials,
  products and information between supply chain
  partners to reduce duplication of effort
• Seeks to reengineer internal operations of
  individual firms to leverage overall supply chain
  capability

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The logistics performance cycle is the basic unit
of supply chain design and operational control

• The performance cycle represents elements of work
  necessary to complete the logistics related to
  customer accommodation, manufacturing or
  procurement
• A performance cycle consists of the following
  elements
• Nodes
• Links
• Inventory
• Base stock
• Safety stock
• Input and output requirements

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Performance cycle uncertainty

• Major objective of logistics in all areas is to
  reduce performance cycle uncertainty
• Operational variance is randomly introduced
  during the cycle through
• The structure of the performance cycle itself
• Operating conditions
• The quality of logistical operations

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Total time to complete the customer delivery
cycle is based on each task within the cycle
Figure 2.8 Performance Cycle Uncertainty
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Inventory managementthe Economic Order quantity
model

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• Knowing what you've got,
• Knowing what you need,
• Knowing what you can live without
• Thats inventory control.

Frank Wheeler, Revolutionary
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Inventory

• Definition The stock of any item or resource
  used in an organization

Raw Materials Component Parts
Work-In-Process
Replacement parts, tools supplies
Goods in transit to warehouses or customers
Finished Products
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Importance of Inventory2005 Fiscal Year
Wall Mart (Billion ) Wall Mart (Billion ) Boeing (Billion ) Boeing (Billion ) General Motors (Billion ) General Motors (Billion ) Dell (Billion ) Dell (Billion )
Cash Short-Term Investments 6.4 5.9 50.4 9.0
Account Receivable 2.6 5.2 180.7 5.4
Inventories 32.2 73.5 7.7 35 30.1 9.6 0.57 3.3
Other Current Assets 2.5 2.8 51.7 2.6
Total Current Assets 43.8 100 22 100 312.9 100 17.7 100
Other Assets 94.3 38.1 163.1 5.4
Total Assets 138.2 60 476.1 34.1
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Importance of Inventory Management

• ... by 1990 Wal-Mart was already winning an
  important technological war that other
  discounters did not seem to know was on.
  Wal-Mart has the most advanced inventory
  technology in the business and they have invested
  billions in it. (New York Times, Nov. 95)
• Kmart increased its inventories to 8.3 billions
  in the third quarter of 2001 with an expectation
  of more shoppers. But higher sales never
  materialized, leading to a disastrous holiday
  selling season. Kmart filed for bankruptcy on
  Jan. 22. (Business Week, Mar. 02)

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Importance of Inventory ManagementMore Recent
News

• SanDisk suspends production as inventories pile
  up for makers of computers, cell phones, and TVs
  (Business Week, Dec. 08)
• Natural-gas futures soared 15 Thursday after
  U.S. inventory data slightly eased concerns about
  the possibility of a storage glut (Wall Street
  Journal, Sept. 11, 09)
• Fruit growers were blessed with excellent weather
  this year. But that hasnt translated into a
  great year for the provinces cherry and
  blueberry growers, as a bumper crop has flooded
  the market and pushed down prices. (The Vancouver
  Sun, Aug. 09)
• The Ford assembly plant in Oakville and 3,000
  workers will remain idle this week because of a
  parts shortage from a supplier in India. (Toronto
  Star, Oct. 27, 09)

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Why should you hold inventory?
Predictable Variability
Seasonal Inventories
What are some of the inventories that you have?
Unpredictable Variability
Safety Stock
Economies of Scale
Cycle Stock
Why do you have these inventories?
Transportation times / Flow times
Pipeline Inventories
Other Strategic / Speculative / etc.
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Why should you not hold inventory?

• Inventory increases certain costs such as
• Carrying cost
• Cost of customer responsiveness
• Cost of diluted return on investment
• Large-lot quality cost
• Cost of production problems, etc.
• The Sea of Inventory
• Inventory hides problems

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Reducing waste The Sea of Inventory
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How much inventory should you hold?

• Trade-off 1

• Trade-off 2

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Inventory Costs
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Inventory Classification
A classification to help manage inventories better

• (The above percentages are approximate)

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Motivation ATM

• How much cash do you take out from ATM?
• Why not more or less?

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Economic Order Quantity (EOQ)

• The Economic Order Quantity (EOQ) balances

• Assumptions
• Known annual demand, constant demand rate
• No uncertainty

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Notation
D Annual Demand Rate
Q Lot or batch size
S Set-up cost per lot/batch, or average cost of processing/placing an order
C Unit cost
H Annual holding and storage cost per unit of average inventory
i Percent carrying cost (e.g., interest rate)
Usually, H iC.
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Cycle Stocks Tradeoff between fixed costs and
holding costs

• Profile of Inventory Level over Time

Q
Demand rate
Quantity on hand
Time
Receive order
Receive order
Receive order
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Example The South Face

• Some facts about The South Face retail shop

D Annual Demand Rate 1200 jackets/year
S Set-up cost per lot/batch, or average cost of processing/placing an order 2,000
C Unit cost 200 per jacket
i Percent carrying cost (e.g., interest rate) 25
Thus, H iC (0.25)(200) 50 per unit-year

• What order size (Q) would you recommend for The
  South Face?

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The South Face
D Annual Demand
Q Lot or batch size (Number of jackets per replenishment order)
S Order or setup cost
H Annual Holding cost
Q/2
Number of orders per year D/Q
Average inventory Q/2
???
???
Annual Setup Cost (D/Q) S
Annual Holding Cost (Q/2) H
Annual Total Cost Annual Setup Cost Holding Cost
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The South Face Cost
Per Order/Batch Q Batches per Year D/Q Annual Setup Cost Annual Holding Cost Annual Total Cost
50 24.0 48000 1250 49250
100 12.0 24000 2500 26500
150 8.0 16000 3750 19750
200 6.0 12000 5000 17000
250 4.8 9600 6250 15850
260 4.6 9231 6500 15731
270 4.4 8889 6750 15639
280 4.3 8571 7000 15571
290 4.1 8276 7250 15526
300 4.0 8000 7500 15500
310 3.9 7742 7750 15492
320 3.8 7500 8000 15500
330 3.6 7273 8250 15523
340 3.5 7059 8500 15559
350 3.4 6857 8750 15607
400 3.0 6000 10000 16000
500 2.4 4800 12500 17300
600 2.0 4000 15000 19000
700 1.7 3429 17500 20929
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Cost Minimization Goal
Total Cost
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Economic Order Quantity
D Annual Demand Rate
S Order or Setup Cost
H Annual Holding Cost
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Economic Order QuantityThe South Face
D 1200 jackets/year
S 2,000
H 50 per unit-year

• What is the optimal order quantity?
• How many times would you place orders per year,
  i.e., frequency of ordering?
• What is the time duration between successive
  orders (this is also called the cycle time or
  reorder interval)?

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EOQ and Sensitivity Analysis

• What happens to the cost and optimal quantity as
  the parameters change?

As . Cost EOQ Frequency
S ? ? ? ?
H? ? ? ?
D? ? ? ?
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Managerial Implications of EOQ

• Cost curve is almost flat near the optimal
  point
• Use the EOQ formula, but do not worry about
  making minor adjustment to get a number that is
  more realistic for your organization
• The flatness of the cost curve implies that the
  EOQ figure is robust
• Estimating holding cost is usually difficult
• The EOQ formula guarantees that the optimal
  order quantity is not very sensitive to errors in
  estimation

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Managerial ChallengesHow to estimate costs?
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Managerial ChallengesHow to reduce the EOQ
inventory?

• Reduce the set-up cost
• Re-evaluate sources of fixed costs, and find ways
  to reduce, spread-out, or eliminate these costs

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Appendix material
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Contents

• I. INTEGRATED LOGISTICS MANAGEMENT
• Ia. The Growth of Logistics and Its Role in the
  Economy
• A. What is Logistics?
• B. History of Logistics
• C. Role of Logistics in the Economy
• D. Why Logistics is gaining in importance
• Ib. The Integrated Logistics Management Concept
• A. Definition
• B. Logistics is concerned with questions
  about inventories
• D. Strategic profit analysis
• Ic. Logistics As An Element of Corporate
  Strategy
• A. A Few Logistics Facts
• B. Corporate Leverage From Logisitics
• C. Product Strategy Innovation Phase
• D. Product Strategy Cost Leadership Phase
• E. Product Line (Customer Service) Strategies

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Contents

• Id. Distribution Channels
• A. Channels Definition, Types, Functions
• B. Integrated Channel Concept
• C. Some Logistical Implications
• Ie. Customer Service
• A. Defining Customer Service
• B. Measuring Customer Service
• C. Relationship of Customer Service to
  Marketing
• D. Optimizing Customer Service
• E. Stockouts
• F. Stockout Costs
• G. ABC Analysis
• If. International Logistics
• A. Importance of International Logistics
• B. International Strategies
• C. Some Additional Considerations

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Contents

• II. LOGISTICS SYSTEM ELEMENTS
• IIa. Inventory Management - Introduction
• A. Financial Impact
• B. Reasons for Holding Inventory
• C. Types of Inventory
• D. Example of Financial Impact
• IIb. Inventory - Carrying Costs
• A. General
• B. Capital Costs
• C. Other Costs
• D. Annual Inventory Costs
• E. Valuing Inventory (i.e. Value on Balance
  Sheet)
• F. Why Inventory Costs are Often Misstated
• IIc. Inventory - Management Under Certainty
  (EOQ)
• A. Basic Inventory Cycle
• B. Ordering Costs
• C. Effect of Decrease in Cycle Time
• D. Total Costs
• E. Optimum Quantity to Order

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Contents

• IId. Inventory - Uncertainty
• A. Calculating Safety Stocks
• B. Example of Safety Stock Calculations
• C. The Flip Side Reducing Cycle
  Variability for Your Customers
• D. Appendix Derivation of Formula for sc
• IIe. Inventory - Control
• A. Stock Control Methods
• B. Inventory System Design
• C. Fixed Order Point
• D. Fixed Order Interval
• E. Transport Choice Case
• F. Items covered in readings, not in lectures
• G. Postscript Inventory, Production,
  Marketing, Finance
• IIf. International Shipping
• A. Importance
• B. Technology
• C. Demand - Shippers (Two main market segments)
• D. Supply - Shipping Carriers/Owners
• E. Freight Rates

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Contents

• IIg. Transport - Modes and Service
  Characteristics
• A. Mode Characteristics
• B. Costs
• C. Rate-Service Tradeoff
• IIh. Transportation Consolidation
• A. Types of Consolidators
• B. Reasons for Consolidation
• C. Types of Consolidation
• D. Typical LTL Routing
• E. Containers
• IIi. Transportation Traffic Management
• A. Traffic Management Functions
• B. Deregulation
• C. Negotiations
• D. Private Versus Public Carriage

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Contents

• IIj. Warehousing
• A. Functions of Warehousing
• B. Types of Warehouses
• C. Optimal Number of Warehouses
• D. Optimal Size of Warehouse
• E. Stock Location Methods
• F. Order Picking Design
• G. Public versus Private Warehouse Choice
• H. A Note on Warehouse Costs
• IIk. Facility Location
• A. Two Types of Locational Decisions
• B. Transport Cost Models
• C. Other Locational Decisions
• D. Tactical Location Considerations

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Contents

• IIl. Packaging
• A. The Two Functions of Packaging
• B. Unitization
• C. Packaging Materials
• D. Some Packaging Problems/Solutions
• E. Where/When Should Packaging Be Added?
• IIm. Purchasing
• A. Introduction
• B. Forward Buying
• C. Other Aspects of Purchasing
• IIn. Materials Management
• A. Introduction
• B. Materials Requirement Planning (MRP)
• C. Manufacturing Resource Planning (MRP II)

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Contents

• IIo. Total Quality Management
• A. Introduction
• B. TQM versus Traditional Approach
• C. Employee motivation
• D. Examples
• IIp. Just-in-Time Systems
• A. Just-In-Time-System
• B. Manufacturing Resource Productivity (MRP
  III)
• IIq. Production Systems
• IIr. Distribution Requirements Planning
• A. Distribution Requirements Planning (DRP)
• IIs. Order Processing
• A. The Order Cycle
• B. The Order Processing System
• C. Impact on Logistics
• D. Implications of Advanced Order Processing
  Systems

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Inventory Turns 2007 Canada