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Managing Uncertainty in theSupply Chain: Safety

Inventory

Supply Chain Management

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Outline

The role of safety inventory in a supply chain

Determining the appropriate level of safetyinventory

Impact of supply uncertainty on safetyinventory

Impact of replenishment policies on safetyinventory

Estimating and managing safety inventory inpractice

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The Role of Safety Inventoryin a Supply Chain

Forecasts are rarely completely accurate

If average demand is 1000 units per week, then halfthe time actual demand will be greater than 1000, andhalf the time actual demand will be less than 1000what happens when actual demand is greater than1000!

If you kept only enough inventory in stock to satisfyaverage demand, half the time you would run out

"afety inventory# Inventory carried for the purpose ofsatisfying demand that e$ceeds the amountforecasted in a given period

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Role of Safety Inventory

%verage inventory is therefore cycleinventory plus safety inventory

There is a fundamental tradeo'aising the level of safety inventory

provides higher levels of product availabilityand customer service

'aising the level of safety inventory alsoraises the level of average inventory andtherefore increases holding costs

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Safety Stock(hen both lead time and demand are

constant, you know e$actly when yourreorder point is )))

Q

L

R

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Safety Stock

*nder these assumptions#

'eorder point + total demand during the lead timebetween placement of the order and its receipt)

'- + d . /, where

d + demand per unit time, and

/ + lead time in the same time units

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Safety Stock(Uncertainties

ut what happens when either demand or leadtime varies!

Q

L!

R

L"

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Safety Stock

%dditional inventory beyond amountneeded to meet average2 demand duringlead time

-rotects against uncertaintiesin demandor lead time

alancesthe costs of stocking out againstthe cost of holding e$tra inventory

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T#o Questions to $ns#er in%lanning Safety Inventory

(hat is the appropriate level of safetyinventory to carry!

(hat actions can be taken to improve

product availability while reducing safetyinventory!

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&eter'ining the $ppropriateLevel of Safety Inventory

3easuring demand uncertainty

3easuring product availability

'eplenishment policies

Evaluating cycle service level and 4ll rate

Evaluating safety level given desired cycleservice level or 4ll rate

Impact of re5uired product availability anduncertainty on safety inventory

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&eter'ining the $ppropriateLevel of &e'an Uncertainty

%ppropriate level of safety inventorydetermined by#supply or demand uncertainty

desired level of product availability6igher levels of uncertainty re5uire higher

levels of safety inventory

6igher levels of desired product availability

re5uire higher levels of safety inventorygiven a particular level of uncertainty

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Measuring &e'anUncertainty

Demand has a systematic component and a random componentThe estimate of the random component is the measure of

demand uncertainty

'andom component is usually estimated by the standarddeviation of demand

7otation#

D + %verage demand per period

D + standard deviation of demand per period

/ + lead time + time between when an order is placed and

when it is received*ncertainty of demand during lead time is important

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Measuring &e'anUncertainty

Demand during / periods + /D

/+ std dev of demand during /

periods + D"5rt8/9:oe;cient of variation + cv + /+

stddev

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Measuring %rouct$vaila)ility

-roduct availability# a 4rm>s ability to 4ll acustomer>s order out of available inventory

"tockout# a customer order arrives when productis not available

-roduct 4ll rate 8fr9# fraction of demand that is

satis4ed from product in inventory

rder 4ll rate# fraction of orders that are 4lled

from available inventory:ycle service level# fraction of replenishment

cycles that end with all customer demand met

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Replenish'ent %olicies

'eplenishment policy# decisions regarding whento reorder and how much to reorder

:ontinuous review# inventory is continuously

monitored and an order of si=e ? is placed whenthe inventory level reaches the reorder point'-

-eriodic review# inventory is checked at regular

8periodic9 intervals and an order is placed toraise the inventory to a speci4ed threshold 8theorder@up@to2 level9

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Continuous Revie# Syste'(Orers #hen inventory rops to R

L*T

Q

R

Inventorylevel

Time

lea ti'e toget a ne#orer in

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%erioic Revie# Syste'(Orers at regular intervals

Inventorylevel

Time2 4 6

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Recalculating the Reorer%oint to inclue Safety Stock

timeleadduringdemandaverage

theabovedeviationsdardtansofnumberztimeleadofvariance

periodtimeduringdemandofvariance

timeleadaverageLperiodtimeperdemandaveraged

where

dLzLdSSLdROP

L

d

Ld

=

=

=

=

=

++=+=

2

2

222

:

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&eter'ining +z

z + number of standard deviationsabove the average demand duringlead time

The higherzis#

The lower the risk of stocking out

The higher the average inventorylevel

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Determining z

Typical choices forz#

z+ 1)AB

B0Cservice levelz+ 1)BC service levelz+

A) BBC servicelevelAverage Inventory = Q

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Safety Inventory an CycleService Level

L#/ead time for replenishment

D: %verage demand perunit time

D:"tandard deviation of

demand per period

DL#3ean demand during lead

time

L# "tandard deviation of

demand during lead time

CSL# :ycle service levelss# "afety inventory

ROP# 'eorder point ),,(

)(1

LL

L

LS

DL

L

D

D

F

D

ROPFCSL

ssROP

CSLss

L

DL

=

+=

=

=

=

Average Inventory = Q/2

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,-a'ple,sti'ating Safety Inventory

D ="./001#eek2 D 3 /00

L3 " #eeks2 Q3 !0.0002 ROP3 4.000

DL= DL 3 ("/00(" 3 /000

ss3 ROP - DL=4000 * /000 3 !000

Cycle inventory 3 Q1" 3 !00001" 3 /000

$verage Inventory 3 cycle inventory 5 ss3 /000 5 !000 3 4000

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,sti'ating Cycle ServiceLevel

D =A,00

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,valuatingSafety Inventory 6iven CSL

D =A,00

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I'pact of Re7uire %rouct$vaila)ility an Uncertainty on

Safety InventoryDesired product availability 8cycle service level or 4llrate9 increases, re5uired safety inventory increases

Demand uncertainty 8/9 increases, re5uired safety

inventory increases

3anagerial levers to reduce safety inventorywithout reducing product availabilityreduce supplier lead time, / 8better relationships with

suppliers9

reduce uncertainty in demand, / 8better forecasts,better information collection and use9

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I'pact of SupplyUncertaintyD:%verage demand per period

D#"tandard deviation of demand per

period

L# %verage lead times/# "tandard deviation of lead time

sD

D

LDL

L

L

DL

222

+=

=

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I'pact of SupplyUncertainty

D =A,00

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I'pact of SupplyUncertainty

"afety inventory when sL + 0 is 1,B

"afety inventory when sL+ 1 is ,A

"afety inventory when sL+ A is ,AN

"afety inventory when sL+ is B,H0

"afety inventory when sL+ M is 1A,BAH

"afety inventory when sL+ is 1,10B

"afety inventory when sL+ is 1B,ABN

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11@AB

,sti'ating an ManagingSafety Inventory in %ractice

%ccount for the fact that supply chain demandis lumpy

%dOust inventory policies if demand is seasonal

*se simulation to test inventory policies"tart with a pilot

3onitor service levels

Focus on reducing safety inventories

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T6%7P Q*