POM Term Paper[1]

OVERVIEW

Forecasting is the process of estimation in unknown situations. Prediction is

a similar, but more general term. Both can refer to estimation of time series,

cross-sectional or longitudinal data. Usage can differ between areas of

application. Risk and uncertainty are central to forecasting and prediction.

Forecasting is used in the practice of Customer Demand Planning in every

day business forecasting for manufacturing companies. The discipline of

demand planning, also sometimes referred to as supply chain forecasting,

embraces both statistical forecasting and a consensus process.

This project explores the area of Forecasting for Operations : Inventory

Forecasting at McDonald’s and Just in time Method at McDonald’s. It gives

a briefing of the Fast food industry and the profile of the Company whose

case is being analysed , in this case it is McDonald’s.

It gives the needs of Forecasting, its pros and cons and the analysis of the

case “ McDonald’s : Stock Management”.

It further also explores the Just In Time Method followed at McDonald’s

and analysis of the case. I am covering JIT in my term paper because it helps

in inventory management. Thus it can be related to forecasting methods

being covered in the first half of this termpaper.

The project will help in better understanding of both Forecasting and the

Just-in-time method of Product and Operations Management

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FORECASTING

Introduction

Forecasting has long been associated with processes that impacts on stock.

Such process includes production, procurement and sales. Irrespective of the

industry type, whether "make to sell" or "buy to sell", elements of

forecasting springs up. This is because the driving phenomenon of "demand"

is inevitable.

In a "make to sell" industry, the producer can't wait for orders to be received

before the production process is initiated. In like manner, the "buy to sell"

entrepreneur can't wait for customers to request for an item before he

procures the item. However, these behaviors might be practicable for special

order.

From the foregoing, it is evident that some level of inventory must exist at

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any point in time. It can be raw materials for production and/or finished

goods. The crux of the matter then becomes, what should be the relative

inventory level at a particular point in time. In objectively answering this

question, some form of forecasting must be made.

Inventory forecasting in my opinion is a proactive and futuristic strategy

aimed at providing estimated stock level to meet demand at a particular

point in time. Proactiveness can be interpreted as a step taken, prelude to a

known event. Forecasting involves estimating what will be needed based on

certain assumptions. It can also be viewed as projections of some sort.

Steps of forecasting

There are four steps to forecasting:

1

Set objectives for forecast - what decisions will forecast influence, and

how - what aspects of plan are vulnerable to surprise - how accurate must

forecast be to be of any use?

2 Obtain forecast - from existing sources or commissioned study.

3

Evaluate forecast, including assessing the sensitivity of planned actions

on the accuracy of the forecast - what exactly is being forecast - what

assumptions does the forecast itself make - source of forecast and past

reliability - what objectives of forecasters, and how do they compare with

your own?

4Disseminate the forecast, persuade others of its accuracy and

appropriateness.

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Techniques of forecasting

Techniques can be divided into ‘exploratory’, which project forward from the

past/present situation, and ‘normative’, which trace backward from a hypothetical future

situation to assess its likelihood, timing and consequences.

extrapolation

Extend or bend a known line or curve from the past into

the future.  This requires some theory to decide whether

to extend or bend (e.g. straight line, S-curve).  Don't

forget to consider trends, seasonal & cyclical variations.

precursor 

To estimate the success of a new product, consider what

happened last time we introduced this kind of product,

and adust the estimate for any plausible differences. Or

if historical figures are available from other firms or

periods, (especially the rate of technical substitution).

Use with caution.

leading

indicators 

Find internal or external variable(s) that is shown to be

correlated to the variable for which a forecast is desired,

except that the correlated variable either moves sooner,

or can be measured sooner, than the desired variable.

model

building

Develop symbolic representation or simulation for

prediction, to forecast several interrelated variables

together (thus avoiding the dangers mentioned under

extrapolation, above).

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scenarios

Use alternative pictures of the future, not as fixed

predictions but as frameworks for discussing future

possibilities (use brainstorming, synectics, lateral

thinking, ...).

delphiAttempt consensus among experts by iteration of

individual forecasts.

judgement Choose subjectively which forecast(s) to believe.

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Forecasting, Not Predicting

Forecasting is different from predicting, although both strategies involve

statistical projections. In a prediction framework, the results of a statistical

analysis are used to make decisions. Under a forecasting framework,

statistical projections are seen as merely the beginning of a more involved

decision-making process.

In a prediction context, researchers use data about the past to speculate about

the future and they encourage policymakers to act on that statistical vision of

the future. In a forecasting context, researchers combine the outcomes of

prior forecasts with the newest data about actual bed space utilization to

examine how the recent past differed from expectations. By analyzing the

differences between their expectations and subsequent reality, officials learn

about factors that influence future demand for bed space but they don't place

undue faith in anyone's ability to predict the future.

Forecasting is also more inclusive than prediction. Prediction models can

only account for measurable factors, or variables for which data actually

exist. Forecasting models are not limited by data availability. The heart of a

forecasting process, in fact, is often the discussion that takes place after

statistical projections are complete. These discussions can address a much

wider range of factirs, including practice and policy concerns for which

there may never be objective data.

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Forecasting benefits

NOT MANY PEOPLE have trouble calculating costs. It takes a little more

ingenuity to pin down the benefits. There are three main categories of

benefit:

Direct cost savings: savings in expenditure other than labour - print,

paper, telephone, travel costs, etc. - that can be directly attributed to

the introduction of the intranet. These can usually be calculated in

three steps: (1) the number of incidences of expenditure in the time

period, (2) the cost of each incidence and (3) the proportion of these

that could be eliminated using the intranet. For example, if the number

of pages of formal printed material received per person per year was

500, the cost in pence per page, including printing and delivery, was

6p and the percentage of these pages that could be delivered on-line

was 70%, the saving in pounds would be 500 x (6 / 100) x 70% x the

size of the population.

Labour savings: savings in the amount of time required to carry out

tasks as a result of introducing the intranet. These can be expressed in

minutes per person per day. To calculate the saving, divide the

number of minutes saved by the number of minutes in the day (60 x

the number of working hours) and multiply by the size of the

population and the average salary.

Productivity increases: increases in output per person attributable to

the introduction of the intranet, expressed as a percentage. Because

personal productivity has such a wide range of implications from job

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to job and organisation to organisation, it is probably easier to convert

these to simple labour savings. For example, if the total productivity

gains were 3%, calculate the savings as (3 / 103) x the size of the

population x the average salary. The actual effect of higher

productivity, such as increases in sales, could well be much larger

and, if you can estimate these, then you should.

Limitations of Forecasting

A good sales forecast cost money

Sales forecasters seldom have all the time they deem necessary

Sales forecasts are estimates

Changes in fundamental conditions can cause the forecast to vary from actual results

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JUST IN TIME

Just-in-time (JIT) is an inventory strategy implemented to improve the return

on investment of a business by reducing in-process inventory and its

associated carrying costs. In order to achieve JIT the process must have

signals of what is going on elsewhere within the process. This means that the

process is often driven by a series of signals, which can be Kanban ,that tell

production processes when to make the next part. Kanban are usually

'tickets' but can be simple visual signals, such as the presence or absence of a

part on a shelf. When implemented correctly, JIT can lead to dramatic

improvements in a manufacturing organization's return on investment,

quality, and efficiency. Some have suggested that "Just on Time" would be a

more appropriate name since it emphasizes that production should create

items that arrive when needed and neither earlier nor later.

Quick communication of the consumption of old stock which triggers new

stock to be ordered is key to JIT and inventory reduction. This saves

warehouse space and costs. However since stock levels are determined by

historical demand any sudden demand rises above the historical average

demand, the firm will deplete inventory faster than usual and cause customer

service issues. Some[1] have suggested that recycling Kanban faster can also

help flex the system by as much as 10-30%. In recent years manufacturers

have touted a trailing 13 week average as a better predictor for JIT planning

than most forecastors could provide.[2]

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INDUSTRY OVERVIEW

The food service industry continues to grow in volume and revenue every

year and typically divides itself into two categories: full-service restaurants

and fast-food restaurants. Each individual restaurant is in competition with

other food service operations within the same geographical area. The fast

food restaurant industry is highly competitive. McDonald’s competes with

other restaurants through the quality, variety and value perception of food

products offered. McDonald’s Corporation’s main competition comes from

other fast-food restaurants; most notably, YUM! Brands Inc, Wendy’s

International and Burger King.

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COMPANY’S PROFILE

McDonald’s Corporation operates and franchises restaurants in the food

service industry all over the world. They are the leading global food service

retailer by means of over 30,000 restaurants in more than 119 countries,

serving about 50 million people every day. Franchising plays a major role in

McDonald’s system with over 2,400 franchise owners, making up about

25% of their total revenue. Their total revenue in 2004 was $19.06 billion.

McDonald’s success in the fast food industry stems from their main success

factors which are cost efficiency, product development, marketing and

promotions. These success factors are used to promote McDonald’s brand

image, provide customers with quality products and differentiate themselves

from other competitors. These main success factors are important to the

company since the fast food industry is highly competitive and competitors

compete for market share due to the fact it’s easy to enter the industry.

McDonald’s also has operations in other fast food restaurants such as Boston

Market and Chipotle who make about $800 million together in revenues a

year and these additions provide McDonald’s with growth opportunities.

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CASE @ Managing Stock to meet customers

need

Overview of the case

Mc Donalds is one of only a handful of brands that command instant

recognition in virtually every country in the world.

All businesses face challenges everyday. One of the major challenges facing

McDonald’s is managing stock. Stock management involves creating a

balance between customers’ needs whilst at the same time minimizing

waste. Waste is reduced by :

1. Accurate forecasting of demand so that product do not have

to be thrown away as often.

2. Accurate stock control of the raw materials.

This is an increasingly tough balancing act. As customer tastes change,

McDonald’s needs to increase the range of new products it offers, so the

challenge of reducing waste becomes even greater.

In the past, stock ordering was the responsibility of individual restaurant

managers. They order stock using their local knowledge as well as data on

what they store sold the previous day, week and months. For example, if

last weeks sales figures showed they sold 100 units of coffee and net sales

were rising at 10 %, they would expect to sell 110 units this week.

However, this was a simple method and involved no calculations to take

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account of the factors such as National promotions or School holidays. It

looks up a lot of the restaurant manager’s time, leaving them with less time

to concentrate on delivering quality food, service and cleanliness in the

restaurants.

The New System

Restaurant Supply Planning Department.

Launched in 2004

This department communicates with restaurants managers on a

regular basis to find out local events.

The department then builds these factors into the new planning and

forecasting system called Manugistics to forecast likely demand of

finished menu items (e.g. Big Macs)

This case study being analyzed looks at how McDonald’s manages its

Stock through management systems and what benefits this brings.

*The case studies are in European context not Indian.

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CASE ANALYSIS

At McDonald’s, all raw materials, wok-in-progress and finished products are

handled on a First in, First out (FIFO) basis. (Types of Stocks at

McDonald’s are given in the Appendix section of this project) This means

raw materials are used in the order they are received. Therefore stock is

always fresh because products are sold in the order they are made.

Stock management

This is the process of making sure there is enough stock at all times to

meet the customer demands. Having too little stock means

dissatisfied customers. Having too much means waste.

McDonald’s use Lean stock control – carrying as little as possible- to

save on waste. The central team has 14 regional planners who each

work with around 80 outlets and communicate regularly with them.

Managers inform the planners of any local factors that could affect

sales, so they can be accounted for in store forecasts within the

planning system – Manugistics

Forecasting using Manugistics

Manugistics uses 2yrs worth of product mix history to produce

accurate forecast for each restaurant. This data has to be accurate.

Managers record closing stocks of major items daily and of all items

weekly on the store computer system.

Managers use a web tool called “Weblog” to view and amend orders

- Weblog creates a daily proposed order for the manager to view

and change if necessary.

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Once confirmed, the order is sent to the distribution centre to be

picked. Weblog then creates a delivery note to be checked

against the items delivered and also gives the exact quantities

and descriptions of the delivery.

All managers need to do is simply click ‘confirm’ on WebLog.

This saves valuable time and makes the process more cost

effective.

Both managers and customers benefit from the system. Outlets run out of

stock less often, time is saved on ordering and there is less waste. This also

reduces costs – a benefit that can be passed on to the customer. Factors such

as promotions are taken into account and deliveries can be less frequent

because amounts are more accurate.

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McDonald’s, a guide to the benefits of

JIT

Just-in-Time (JIT) inventory is the big thing right now in operations.  This,

along with lean operations and six-sigma are the buzz words being talked

most about.  But what exactly is the deal with JIT operations?

First of all, JIT is a form of providing supplies for customers, as the name

suggests, just in time.  JIT model involves not even being in possession of

the raw materials needed to fulfill an order until that order is placed and yet

being capable of filling orders in a short period of time.

McDonald's doesn't begin to cook (well, I should probably say reheat and

assemble what may or may not be actual food) its orders until a customer

has placed a specific order.

What used to be the case was McDonald's would pre-cook a batch of

hamburgers and let them sit under heat lamps.  They would keep them for as

long as possible and eventually discard what couldn't be sold.  The only way

to get a fresh hamburger under the old system was to make a special order. 

Now, due to more sophisticated burger-making technology (including a

record-breaking bun toaster), McDonald's is able to make food fast enough

to wait until it's been ordered.

What McDonald's do is, provide a customer with their order as fast as

possible while having the finished product sitting in inventory for as short as

possible.

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What are the benefits for

McDonald's? The major benefits for McDonald's are better food at a lower cost.

Let's stop here for a second to drive home a very important point: Whenever

you can implement something that allows you to raise quality AND lower

costs, you should definitely look into implementing that practice.  Unless

illegal, immoral, socially irresponsible, or likely to drive down demand

(which is unlikely considering quality is being improved), you are probably

going to want to implement this practice.  Back to McDonald's.

McDonald's has found something that allows them to improve quality and

lower costs.  Let's take a look at how it does both.

Improved Quality

I think benefits of a better tasting burger should be fairly apparent.  Unless

of course you prefer aged burgers, the fresher burger is going to be higher

quality if made fresh just for you.

The less obvious benefit is the higher quality customer service that arises

from the JIT burger assembly.  When McDonald's waits for you to order the

burger, they do a few things to improve customer service.  First of all, when

you place a special order, it doesn't send McDonald's into a panic that causes

huge delays.

Now that McDonald's is in the practice of waiting until you order a burger

until they make it, they don't freak out when they have to make a special

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order fresh just for you.  This higher quality customer service is subject to

McDonald's ability to actually produce faster.  Without this ability,

McDonald's ordering costs would be sky-high because the costs associated

with ordering would be the loss of customers tired of ordering fast food that

really isn't fast.

Second, JIT allows McDonald's to adapt to demand a little bit better. 

Seemingly, lower inventory levels would cause McDonald's bigger problems

in a higher demand because they wouldn't have their safety stock.  However,

because they can produce burgers in a record time, they don't have to worry

about their pre-made burger inventories running out in the middle of an

exceptionally busy shift.

Lower Costs

The holding costs for burger parts are fairly high because of their spoilage

costs.  Frozen ground chicken that's good today might not be so good in a

few months.  Once cooked, the same ground chicken’s spoilage rate shoots

through the roof.  Instead of having a shelf life of months or weeks, the

burger needs to be sold within 15 minutes or so.  The holding costs go from

roughly 20% per week to 100% per hour.

In other words, under McDonald's old system, they produced at a level that

gave them high inventories so that food would be available fast, which is the

main benefit of fast food.  Unfortunately, food that was unsold after a short

period of time was scrapped.  Food that was sold was forced to be sold at a

higher price in order to absorb the scrap costs of unsold food.  Ultimately

this meant higher costs for McDonald's.

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For McDonald's, the benefits of JIT are fairly clear. 

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Why

Economic Order quantity Savings

A large benefit of JIT is that it reduces the total cost of ordering and holding

inventory.  Let's quickly recap three firms that have achieved this and how

they did so.

McDonald's High holding costs is the nature of the fast food industry.  JIT

system allowed it to exploit the savings that were realized by holding less

inventory.

High holding costs and low ordering costs are the factors that drive JIT. 

Generally, it's the ability to lower ordering costs that make it a feasible

solution.  McDonald's is slave to the high holding costs.  It was just the

nature of their industry.  The solution for them was that while they couldn't

lower holding costs, they could lower ordering costs.  McDonald's has very

high holding costs in comparison to their ordering costs.  Ultimately, this,

coupled with the ability to lower safety stock, is when JIT is effective.  EOQ

determines how much you should order and there are two factors that drive

economic order quantities down: low ordering costs and high holding costs. 

Depending on the product and the industry, one or both of these qualities

may exist in your operations.  If they do, JIT may be right for you.  Without

the ability to make ordering costs low as a percentage of holding costs then

there is no need for JIT.  In fact, the increased frequency in ordering will

result in cost increases.

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Safety stock Reductions

The other aspect of JIT is the drastic reduction in safety stock. The two

reasons safety stock exists:  variability in demand and variability in lead

times from suppliers (in McDonald's case, the supplier is the internal

production process).

It is because of this variability that safety stock exists in the first place. 

What JIT does is tries to reduce the lead times and variation in lead times in

order to help reduce safety stock.  McDonald's accomplished this by creating

a system that allowed a faster burger production (remember, McDonald's

lead times are internal) by standardizing production.

In order to accomplish the tasks of shortening lead times and reducing their

variances, a considerable amount of work needs to be done with

suppliers/internal operations.  For some firms this is worth the trouble, for

others, it is not.

Conclusively, there are two major parts to JIT inventory operations:

lowering the ratio between ordering costs and holding costs and shortening

lead times.  What results is a firm with such high holding costs that ordering

very small batches very frequently is the most profitable solution.  This

eliminates average inventory above the safety stock level.  Then, if lead

times and lead time variability can be decreased, safety stock can be

decreased.  The result is inventory coming in as it needs to come in.  In other

words, it comes in just in time.

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CONCLUSION

Efficient stock management is essential to any business. It enables the

business to operate in a responsible way. Because McDonald's has taken

much of the hard work out of stock management, Restaurant Managers are

able to spend more time focusing on delivering McDonald's high standards

of Quality, Service and Cleanliness. Customers are happy because they can

be sure the item they want is on the menu that day.

The system also minimizes waste. Efficient use of materials means that

society’s resources are being used well with very few waste products. For

example, fewer materials end up as waste in landfill sites. This leads to a

reduction in costs. Due to lower costs, McDonald's can pass the benefits on

to customers, providing better service and lower prices. The reduction of

waste provides a win-win situation for McDonald's, its customers and wider

society.

McDonald's avoid running out of stock. As a result, customers can

always receive what they order.

The system eliminates inexperience in the ordering. The system

enables a new Restaurant Manager to ensure the order is right first

time.

Time saved in ordering as the system calculates how much is required.

Orders are based on the current stocks. The Restaurant Manager

simply inputs the current stock levels.

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Less waste means food costs are reduced. This cost saving is then

passed on in better value for money for customers.

The amount of stock ordered for promotions is more accurate, being

based on past performance.

There is a reduction in the need for emergency deliveries, saving

money.

Stock levels are always at optimum level, helping to ensure sales and

the freshest product.

Stock can be reduced automatically at the end of a promotion,

avoiding too much stock.

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APPENDIX

Types of Stock

Stock is the physical product a company buys, creates or sells. Every

business has three main types of stocks:

i. Raw materials

The raw materials are the ingredients that will go into

producing the finished product. For McDonald's, these will

include the buns, patties, paper cups, salad ingredients and

packaging. These are delivered to the restaurants between 3

and 5 times a week. The raw materials arrive together on one

lorry with three sections so that each product can be stored at a

suitable temperature. The three sections are:

frozen

chilled

ambient – which means foods that can be stored at room

temperature. This applies to items such as coffee or

sugar sachets.

ii. Work-in-progress

Work-in-progress refers to stocks that are in the process of

being made into finished product. A Big Mac consists of bun, to

beef patties, lettuce, cheese, pickles, onions, sauce and a small

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amount of seasoning. The restaurant will only combine these

items just before the customer orders them so the Big Macs are

hot and fresh when served.

iii. Finished products

Finished products are goods that are ready for immediate sale to

a customer. At any one time, a restaurant will have a range of

products ready for sale. Many of these will include finished

products like filet-o-Fish, Big Macs and side salads.

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BIBLIOGRAPHY

1. Google.com

2. Yahoo.com

3. Wikipedia

4. Production and operations management by Adam & Ebert

5. Operations Management by B.Mahadevan

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