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Merton Trucks Case Note

Abstract We discuss Merton Trucks [Dhe90a] as a case to introduce linear programming in the MBA program. This case adapted from Sherman Motor Company case, was used to introduce Linear Programming formulations as well as duality. Refer to the teaching note [Dhe90b]. Our approach differs from the approach suggested by Dhebar [Dhe90b]. First, our audience consists pre-dominantly of engineers with not too much work experience. As a result, handling math and algebra is relatively easy. Explaining the algebraic formulation, graphical approach and using the Excel solver do not consume that much time. Second, because this case is used during the rst week of the MBA program, students are still unfamiliar with the case methodology and we spend signicant time in understanding case facts. The circular logic used in allocating xed costs based on the product mix that in turn is used in deciding the product mix takes some time to understand. Third, because of the participant background, they have difculty in translating the model to the specic business situation and interpreting the trade-offs involved in various what-if analyses that are prompted by the case questions. We return to the case when we teach duality. After explaining duality, we analyze the case to show how some of the questions and what-if analyses can be simplied using duality. This note is based on our experiences with teaching three large batches of students in our MBA programs.

1 Without Duality: (2 70) minutes


We use the case to illustrate the following issues: Analyze case facts: What is the factual basis for some of the opinions expressed? Where did the overhead cost numbers shown in Table B come from? Is it appropriate to allocate xed costs as done in Table C? Decision making alternatives: Evaluate one product suggestions and current product-mix. Evaluate trade-offs and how to improve a solution manually with its limitations. Algebraic formulation of the linear program. Graphical solution method and its limitations. Solution using Excel solver.

1.1 Objective: 5 minutes


We ask the students to articulate in plain English answers to the following questions without going into the low level details: What is Merton deciding? On what should this decision be based? What constrains Merton?

1.2 Roles and Rationales: 5 minutes


We would like the students to understand the data that supports the opinions expressed in the case. This is a prelude to analyzing validity of the data.

Why do the company president and sales manager feel that 101s are making a loss and hence 101s production should be stopped? From Table B, it costs $40,205 to produce a 101-truck while it sells for $39,000. Why do the president and the production manager feel outsourcing engine assembly will help? No slack in engine assembly currently. Show Resource Usage worksheet of merton facts.xls. Why does the controller feel that cutting back on 102s is an answer? Overheads are the answer and they are dealt next.

1.3 Understanding the Exhibits: 15 minutes


The numbers in Table A are straight forward resource utilization numbers. The numbers in Table B show total costs including xed overheads allocated based on Table C. Allocation of xed costs are done based on the ratio of resource usage. The fallacy in allocating xed costs based on product mix to decide the product mix can be illustrated by using the Exhibits worksheet of merton facts.xls. The grayed out areas represent data that does not change with product mix. Try the following combinations as a basis for the controllers comments: (1000, 1500) for negative contributions of 101s and to explain current exhibit values in Table B, (2500, 500) for both positive contributions, (2500, 125) for negative contributions of 102s and (500, 125) for both negative contributions.

1.4 Relevance of Overheads: 5 minutes


Allocated xed costs should not be included in deciding the contributions. The actual costs for (101s, 102s) are: direct materials - ($24,000, $20,000) from Table B, direct labor - ($4,000, $4,500) from Table B and, 3

variable overhead - ($8,000, $8,500) from Table C. What are the contributions of 101s and 102s? ($3000, $5000).

1.5 Evaluate current plan: 15 minutes


We use the Evaluate worksheet of merton facts.xls to set up the model close to the algebraic formulation discussed next. Analyzing the president and sales managers decision to stop 101s is easy. The constraints imply that the number of 102s produced should be given by min[4000/2, 6000/2, 4500/3]. This gives $7.5 million, worse than the current plan contributions of $10.5 million. Current plan for productions is (101s, 102s) = (1000, 1500). Is this the best? Reduce one model 102 and see how many extra 101s can be produced. Reducing one 102 frees (2, 2, -, 3) resources in (engine assembly, metals stamping, 101-assembly, 102-assembly) that can be used to produce two 101s. Show that this increases contribution by $1000 (2 $3000 $5000). How long can you do this? Net resource effect of the substitution of each 102 is (-, +2, +4, -3) on remaining resources (-, 1000, 3000, -). This implies that we can change up to a minimum of (-, 1000/2, 3000/4, -) and non-negativity requirement on number of 102s produced. Explain that it is tedious to do this kind of analysis, and more than two product-lines implies many trade-offs.

1.6 Algebraic Model: 5 minutes


How do we describe the model algebraically? Decisions are coded using variables called decision variables. How do we express the objective and constraints using these variables? Decisions variables: t101 = number of model 101 trucks produced, t102 = number of model 102 trucks produced.

The algebraic formulation is: max 3000t101 + 5000t102 1t101 + 2t102 + 2t102 2t101 2t101 3t102 t101 t102 4000 6000 5000 4500 0 0 Objective: contributions, Engine Assembly, Metal Stamping, 101 Assembly, 102 Assembly, Non-negativity, Non-negativity.

1.7 Develop graphical model: 10 minutes


Show merton trucks.ppt, slides 2 through 13. We show how the trade off that we talked about in section 1.5 moves along the engine assembly capacity constraint line. In our rst 70 minute session in 4 sections of roughly 75 students each, we reached this point.

1.8 Develop spreadsheet model: 10 minutes


Excel formulation. Set it up on-line using the Evaluate worksheet of merton facts.xls.

1.9 Solutions to Problems: 60 minutes


We ask the students to ignore problem 3(b) since it requires reduced costs. Problem 1: (10 minutes) a. Optimal monthly mix is (2000, 1000) with a contribution of $11 million. This part is already handled while setting up the spreadsheet optimization model in section 1.8. b. What is it worth to add an extra hour of engine assembly capacity? Unutilized resources (engine assembly, metal stamping, 101 assembly, 102 assembly) = (0, 0, 1000, 1500). To use the extra engine assembly hour, we can give up a 101 truck and make a 102 truck and the net increase in contribution for the swap (-1, +1) is $2,000. Net effect on resources is (+1, 0, -2, +3) for the swap. The effect on a graph can be seen in slides 12 and 13 of merton trucks.ppt. 5

c. Resolve to verify that change of engine assembly capacity from 4000 to 4100 hours increases contribution by 2, 000 100 = 0.2million. d. The number of swaps that we can do is 500. min , , 2000, 1500 , = 500. 3

Note 101 assembly does not impose a constraint on the number of swaps directly because each swap increases the unused resources by two units. But, the number of swaps is constrained by the number of 101s being produced currently, i.e., 2000. We can not give up more resources than what we are using. Problem 2: (10 minutes) This problem should not take much time but students get confused with the unfortunate wording used in the case. Production manager is talking about reimbursing the outside supplier for materials, labor and overhead. Hence the students question why are we not considering the xed overheads in column two of Table C when computing the results? Fixed overheads are based on Mertons infrastructure and do not hold for the outside supplier. Only the variable overheads are relevant here. The second doubt that arises in some students, due to a mis-reading of the case text, is about what is being outsourced. They assume that a specic models capacity is increased by the outsourcing. The text is clear that we do not outsource any specic models engine capacity. Either 101s or 102s are expected to be made by the outside supplier. Since we are not using duality, the answer is same as in problem 1 (b) and 1 (d). Sourcing out engine assembly is acceptable from 1 (b), and the largest rent Merton can pay is $2000 and no more than 500 hours of engine assembly can be purchased. Problem 3: (10 minutes) Model 103: a. Resources required for 103 = (.8, 1.5, 1, -) and net contribution of $2000. Re-solve the problem and it is not worth producing. The optimal mix does not include model 103s and hence no change in contributions.

Decisions variables: t101 = number of model 101 trucks produced, t102 = number of model 102 trucks produced, t103 = number of model 103 trucks produced. The algebraic formulation is: max 3000t101 + 5000t102 1t101 + 2t102 + 2t102 2t101 2t101 3t102 t102, t101, b. Ignore. Problem 4: (20 minutes) Overtime production - re-solve. Students take time understanding that even though the trucks are identical after production, the trucks produced during over time and regular time have to be disambiguated in the model by using extra variables due to differing engine assembly costs and the capacity constraints of engine assembly. Decisions variables: t101 t102 o101 o102 = = = = number of model 101 trucks produced in regular time, number of model 102 trucks produced regular time, number of model 101 trucks produced in over time, number of model 102 trucks produced over time. + + + + 2000t103, 0.8t103 4000, 1.5t103 6000, 1t103 5000, 4500, t103 0.

The contribution of the trucks produced during overtime reduces to (2400, 3800) from the regular time contributions of (3000, 5000) because of 50% extra costs for the engine assembly labor given in Table B. Some students multiply total direct labor by 1.5 instead of multiplying only the engine assembly labor component. The labor costs increase to (1800, 3600). In addition to the variables, a new constraint for overtime engine assembly capacity has to be added and the metal stamping, 101-assembly, 102assembly constraints have to incorporate the overtime variables. The full 7

algebraic formulation is: max 3000t101 + 5000t102 + 2400o101 1t101 + 2t102 1o101 2t101 + 2t102 + 2o101 + 2o101 2t101 3t102 t101, t102, o101, + 3800o102, + 2o102 + 2o102 + 3o102 o102 0. 4000, 2000, 6000, 5000, 4500,

The optimal solution yields a contribution of $11.7 million with 1500 model 101 trucks and 1250 model 102s produced in regular time and 250 model 102s produced in over time. Hence paying a monthly xed overhead of $.75 million is not worth the increase of $.7 million. Problem 5: (10 minutes) Marketing constraint - re-solve. To the base model add the constraint t101 3t102 0. This leads a contribution of $10.5 million with a plan of (2250, 750). Instead of requiring the number of 101s produced to be at least three times the number of 102s, if this constraint was altered to say that it should be at least two times the number of 102s, then the optimal solution does not change since the original optimal solution still remains feasible for the new constraint. Based on this, we generalize about the effect of extra constraints on the feasible region.

2 With Duality: 30 minutes References


[Dhe90a] Anirudh Dhebar. Merton truck company. Case 9-189-163, Harvard Business School, HBS Publishing, Boston, MA 02163, apr 1990. [Dhe90b] Anirudh Dhebar. Merton truck company. Teaching Note 5189-171, Harvard Business School, HBS Publishing, Boston, MA 02163, may 1990.

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