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Dynamic planned safety stocks in

supply networks
a a a
J.J. Kanet , M.F. Gorman & M. Stößlein
a
Department of MIS, Operations Management, and Decision
Sciences , University of Dayton , Dayton, OH, USA
Published online: 11 Dec 2009.

To cite this article: J.J. Kanet , M.F. Gorman & M. Stößlein (2010) Dynamic planned safety stocks in
supply networks, International Journal of Production Research, 48:22, 6859-6880

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 International Journal of Production Research
Vol. 48, No. 22, 15 November 2010, 6859–6880

Dynamic planned safety stocks in supply networks

J.J. Kanet*, M.F. Gorman and M. Stößlein

Department of MIS, Operations Management, and Decision Sciences, University of Dayton,

Dayton, OH, USA
(Received 2 March 2009; final version received 10 September 2009)

Safety stocks are commonly used in inventory management for tactically planning
against uncertainty in demand and/or supply. The usual approach is to plan a
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single safety stock value for the entire planning horizon. More advanced methods
allow for dynamically updating this value. We introduce a new line of research in
inventory management: the notion of planning time-phased safety stocks. We
assert that planning a time-phased set of safety stocks over a planning horizon
makes sense because larger safety stocks are appropriate in times of greater
uncertainty while lower safety stocks are more appropriate when demand and/or
supply are more predictable. Projecting a vector of safety stock values is necessary
to assure upstream members in the supply network have advanced warning of
changes. We perform an empirical study of U.S. industry, which demonstrates
that significant savings can be achieved by employing dynamic planned safety
stocks, confirming recent case study reports. We provide a simple optimisation
model for the problem of minimising inventory given a vector of safety stock
targets. We propose a computationally efficient solution procedure and demon-
strate its implementation in an MRP/ERP system. We then illustrate an MRP/
ERP planning system feature, which employs a dynamic planned safety stock
module that supports a production planner by showing the inventory implications
of safety stock plans.
Keywords: planned safety stocks; service level; fill rate; heteroscedasticity

1. Introduction
Traditionally, in the practice of inventory planning, the desired safety stock is determined
by first estimating risk and then setting the safety stock to a single appropriate level to be
applied for future time periods. Safety stock levels are typically calculated under the
following assumptions: (a) stationary (and usually normally distributed) demand forecast
error and (b) stationary (and usually certain) replenishment lead time. More advanced
methods are sometimes employed which dynamically update the safety stock value as
conditions change. A straightforward example of this is the practice of maintaining a
safety stock level based on a constant number of days of supply. The basis here is the
intuition (first asserted by Brown (1959)) that the coefficient of variation in demand
remains steady, with consequently higher (lower) safety stocks needed when demand is
relatively high (low).

*Corresponding author. Email: kanet@udayton.edu

ISSN 0020–7543 print/ISSN 1366–588X online

ß 2010 Taylor & Francis
DOI: 10.1080/00207540903341887
http://www.informaworld.com
 6860 J.J. Kanet et al.

This paper introduces another level of sophistication beyond simply dynamically

updating to a new safety stock value as conditions change. The new notion is to plan for
this dynamic updating, i.e. to provide for time-varying planned safety stock targets. The
idea is to plan for cases when lead time demand is predictably not stationary for whatever
reason, e.g. when lead time and/or when product demand is not stationary. We introduce
here a planning system feature which supports dynamic planned safety stock (DPSS)
planning with the motivation that such a feature might reduce total safety inventory,
improve service, or both. The basic argument for such added planning complexity is
founded in the need to assure upstream supply chain members have adequate warning of
the changing requirements when a change to safety stocks is planned.
The idea of dynamic planned safety stocks is already gaining headway in modern
software systems for production planning. For example, the software firm SAP provides
this feature (in German ‘Planlager’: dynamic safety stock per period) in its latest release of
SAP APO (Advanced Planning and Optimisation) with their ‘Enhanced Safety Stock
Planning’ feature (Hoppe 2006, pp. 311–323). Similarly, in an article by Troyer et al. (2005)
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the authors describe an implementation of a new planning system by SmartOps Corp. at

John Deere & Co. that has this capability. The system has a number of other advanced
features so it is impossible to isolate the benefits of DPSS. Nor is an objective analysis of
the specific benefits of DPSS found in the aforementioned description of SAP’s Enhanced
Safety Stock Planning. There the writers simply state, ‘‘The enhanced methods of safety
stock planning provide a significant opportunity to optimize inventory if they are used
correctly. Therefore we absolutely recommend their use.’’ (Hoppe 2006, p. 322). Given this
background, our purposes in this work are several:
(a) to provide an organised review of the circumstances in which implementing DPSS
might provide value;
(b) to provide empirical evidence of the marginal benefits of implementing DPSS into
an existing ERP/MRP system;
(c) to provide a simple ‘patch’ that can be used to implement DPSS in an existing
ERP/MRP system; and
(d) to illustrate a planning interface that lets a planner see the inventory implications
of DPSS.
What we contribute here is an organised treatment of how demand non-stationarity is
manifested by time-varying variance and that when the variance can be seen to
systematically vary, substantial savings can be achieved by planning time-phased safety
stocks. Moreover, we show how to do this so that it is computationally simple to
implement.
The next section scrutinises the reasons for considering time phasing safety stocks.
Section 3 reviews the relevant literature. Section 4 presents a data analysis that provides
evidence that demand forecast error for manufactured products is highly heteroscedastic
(non-stationary). We use aggregate data from the U.S. Census Bureau to estimate impacts
on the SKU level. Section 5 demonstrates the inventory savings that can accrue when
safety stock levels are deliberately planned to vary in accordance with this hetero-
scedasticity. Section 6 shows how planner-specified time-varying safety stocks can be
integrated into the production planning process. Specifically, we demonstrate how
production requirements can be altered to form safety stock adjusted requirements to
accommodate time-varying planned safety stocks in such a way as to minimise their effect
on inventory. Section 6.2 provides a visualisation showing how the ideas here might be
 International Journal of Production Research 6861

implemented in an ERP system and how the inventory effects of setting safety stock levels
might be isolated, thereby providing an additional important decision-support feature for
production planning. Section 7 summarises the paper.

2. Rationale for dynamic planned safety stocks

We envision three factors at work that can make dynamic planned safety stocks
advantageous: (a) when the distribution of product demand is not stationary; and/or (b)
when the distribution of lead time is not stationary; and/or (c) when service level
requirements vary with time. Table 1 summarises the possible assumptions surrounding
uncertainty in lead time and demand during lead time (cases (a) and (b)), highlighting
situations where dynamic planned safety stocks may be sensible.
Cell e of the table identifies the case when safety stocks are unnecessary (both demand
and lead times are known with certainty). Cells B, D, and E represent the cases when
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constant safety stocks suffice. Shaded cells C, F, G, H, and I are the cases when it would
be sensible to plan time-varying safety stocks, i.e. when demand and/or lead time is
non-stationary. We describe likely sources of non-stationary lead times and demand in
more detail below.
Non-stationary supply (lead times) (cells G, H, and I of Table 1) are common.
Traditional thinking in production and inventory planning is that safety stocks are a
function of constant or stationary lead time. Lead times, in fact, typically do vary over
time when capacity is limited and/or time varying. First, in light of limited capacity and
systematic variation in demand (e.g., seasonality), lead times will exhibit systematic
variation. Second, in real-world factories, vacation and holiday schedules cause systematic
changes to periodic capacity that cause increased variance in lead times. Third, when one
product is competing with others for the services of a scarce resource, there is the
additional variability in available capacity caused by prior commitments of the resource to
other products. Finally, delivery reliability may vary seasonally, e.g. winter months are less
predictable due to weather conditions.
Non-stationary demand (cells C, F, and I of Table 1) is common. First, a firm may
experience seasonal variability: the variance of demand may well be heteroscedastic. We
test this possibility in Section 4. Second, when the planning unit is a component that is
multi-usage or sold to different identifiable customers, then it is quite possible that
different requirements in the horizon (coming from different sources of demand) have

Table 1. Possible states of nature for lead time and demand (shaded cells indicate applicability for
dynamic planned safety stocks).

Nature of demand

Stochastic

Certain Stationary Non-stationary

Nature of supply Certain e B C

(lead time) Stochastic Stationary D E F
Non-stationary G H I
 6862 J.J. Kanet et al.

different variances leading to a pattern of total variance that is time varying. Third, as
described by Graves and Willems (2008), the demand process for a product evolves over its
life cycle and is never stationary, exhibiting predictably different distributions over the
major life cycle phases (product launch, demand ramp, peak demand, and end-of-life).
Moreover, the life cycles of many products are becoming ever shorter (e.g., electronic
products); thus, understanding and planning for such heterogeneity is ever more
important.

2.1 Systematic variation in demand variance

Dynamic planned safety stocks make sense whenever the variance of periodic demand i2 is
known to be time-varying – a special case of which is when it is correlated to mean period
demand i. An example of this is the commonly seen assumption of constant coefficient of
variation for period demand, such that  i ¼ ci (e.g., Brown (1959, p. 94), Bollapragada
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and Morton (1999) or Nahmias (2001, p. 381)). Silver et al. (1998, p. 126) describe a more
general characterisation,  i ¼ abi , where a and b are constants found via regression.
Another example would be when we know periodic demand to be exponentially (or
Poisson) distributed with systematic (perhaps seasonally changing) mean. Then we have
/ ¼ 1 for the case when demand is exponentially distributed (or  2/ ¼ 1, for Poisson).
The key issue here is not whether demand processes are stationary or not; there is
ample evidence that non-stationarity is the appropriate assumption. The relevant issue is
whether we can recognise the nature of the non-stationarity to be able to put this
knowledge to good use in production and inventory planning. Many of the
above-mentioned sources of non-stationarity of lead times and demand are intuitive and
plausible, but difficult to demonstrate empirically on a wide scale basis. We are able to
demonstrate conclusively the pervasive existence of seasonal heteroscedasticity of demand
forecasts in Section 3, a sufficient condition for non-stationarity and one motivation for
production planners to have the capability to specify desired safety stock levels that are
time varying – i.e. a vector of desired safety stocks.
All of the aforementioned cases for justifying dynamic planned safety stocks arise from
situations when the nature of any non-stationarity is predictable. However, aside from
situations of non-stationarity of demand or supply, dynamic planning of safety stocks can
make sense for another entirely different reason – even when demand and supply are
stationary (adding a third dimension to Table 1). Dynamic planned safety stocks will be
sensible whenever service level requirements vary with time. (For example, see the multiple
demand class problem studied by Arslan et al. (2007).)

2.2 Why safety stock levels must be planned

The key issue here is not whether demand processes are stationary; there is bountiful
evidence that non-stationarity is the more appropriate assumption. The relevant question
is, ‘‘Whenever we can recognise the nature of the non-stationarity, how can we put this
knowledge to good use in production and inventory planning?’’ Because of the compounding
of lead times in a supply network, lower levels of materials in the planning hierarchy
(upstream suppliers in the supply chain) need time to react. By not updating safety
requirements in advance, shortages of both materials and capacity might result. Intentions
regarding future safety stock levels need to be continuously communicated to upstream
 International Journal of Production Research 6863

supply chain members in order for supporting materials to be available in the correct
quantities when they are needed.

3. State-of-the-art in dynamic planned safety stocks

Early studies of non-stationary demand date back to at least 1980 whereby Hillestad and
Carillo studied the case of time-varying Poisson demand processes in spare parts planning
for the U.S. Air Force (Hillestad and Carillo 1980). See Graves (1999) for a survey of the
prior literature on inventory policies when the demand process is non-stationary. The
stream of existing research most relevant to the topic of dynamic planned safety stocks is
the work of Graves and Willems (2008) and Neale and Willems (2009). Lagodimos and
Anderson (1993), Weng (1999), Graves and Willems (2000), and Sitompul et al. (2008) all
study the related problem of how to strategically place safety stocks along the nodes of a
supply network.
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The issue of time-varying safety stocks was first addressed in the research literature by
Graves and Willems (2008) where the analysis is extended to the case of non-stationary
demand and a procedure for specifying the amount of safety stock to be held by each node
in a supply network for each time period is provided. The model assumes each node in a
supply chain operates a periodic review base stock replenishment regimen. The model
minimises total inventory cost over the network with the constraint that end customer
demand for each period (a random variable) be filled within the quoted delivery time.
Critical assumptions of the model are that demand remains certain from the time a
customer places an order until its delivery and that maximum demand for each period is
known. The former assumption is the key that allows safety stock to be distributed up the
supply chain. The latter assumption assures that the planning system is able to meet all
demands. A third assumption is that a period’s required reduction in safety stock never
exceeds the period’s total demand.
A more recent paper by Vargas (2009) approaches the problem of planning dynamic
discrete order quantities, extending the well-known Wagner–Whitin (1958) algorithm to
the case when periodic demand density is given and time varying. Safety stock
requirements are implicitly included in planned order quantities whereby the objective is
to minimise the sum of expected setup, backorder, and inventory holding costs. A
particularly elegant solution procedure is developed for the case when periodic demands
are normally distributed.
Aside from the scientific literature, we found it useful to review the relevant trade
literature on inventory management software to see the extent to which dynamic planned
safety stocks are supported. We reviewed the top 10 companies by revenue share in the
supply chain management segment (e.g., SAP, i2 Technologies, etc.; Hillman 2007) and
other promising software companies (e.g., IBM, SmartOps, and Optiant). Our evaluation
is primarily based on publicly available information such as brochures, white papers, case
studies, and corporate websites. We also reviewed corporate online help forums and
integrated selected experts’ opinions in our analysis (Stadtler and Kilger 2000, Hauptmann
and Zeier 2000, Hoppe 2006, 2007, Jacobs 2007). In addition, Informs articles (Troyer
et al. 2005, Neale and Willems 2009) provided reports on applications of the software of
the firms SmartOps and Optiant.
From our assessment of the commercial literature, SAP seems to provide comprehen-
sive support in dealing with safety stock with their product Advanced Planner and
 6864 J.J. Kanet et al.

Optimiser (APO). In APO, the safety stock planning consists of three steps: assigning the
safety stock planning method (target service levels or replenishment method), running the
safety stock planning module, and adjusting safety stocks interactively. Manually entered
parameters create high maintenance costs. An advanced version automatically adapts
safety stocks based on target service levels using the requirement forecasts and actual and
planned replenishment lead times. APO provides what they call ‘dynamic safety stock’
requirements. If planned safety stocks in one period exceed those in a previous period, a
‘virtual requirement’ is generated representing the quantity difference. If lower,
requirements are partially covered with excess safety stock from the previous period.
Interestingly, APO specifies that in applying such ‘enhanced planning’, requirements
should be regular, all significantly larger than zero, and not highly fluctuating – seemingly
obviating the motivation for the dynamic safety stock goal they seek to achieve (see Hoppe
(2006, p. 311)).
Like Graves and Willems (2000), Troyer et al. (2005) assume a periodic review
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base-stock replenishment policy with non-stationary end customer demands. Starting at

the end customer node(s), demand and orders are propagated back up the supply chain so
that service level requirements at each node in the network are satisfied with each node
receiving a time-phased recommendation for safety stock. Unlike Graves and Willems, end
customer demand is not realised until the due date; so the optimal (in terms of total
inventory cost) allocation of safety stocks in the network cannot be modelled. The model is
implemented in the multi-stage inventory planning (MIPO) of the software firm
SmartOps. Troyer et al. (2005) report on the successful implementation of MIPO at
Deere & Company, whereby extraordinary improvements in inventory and customer
service were achieved.
The software firm Optiant has produced remarkable operating improvements in the
management of Microsoft’s Entertainment and Devices (E&D) Division (Xbox, Zune, and
PC hardware). Its core module is based on the model of Graves and Willems (2000). In
essence, it provides time-phased safety stock plans that are fed into SAP APO – see Neale
and Willems (2009) for a detailed description. Similar success with an Optiant
implementation was achieved for Case New Holland, a major manufacturer of agricultural
and construction equipment.
In summary, we conclude that despite the progress of firms like SAP, SmartOps, and
Optiant, advanced planning methods are still not widely used. In particular, small and
midsized companies simply cannot afford to purchase high-maintenance software
packages such as SAP. Consequently, many organisations still plan inventory with
simple methods as the Aberdeen Group (2006) found out. Nevertheless, we perceive a
demand for dynamically adjusted safety stocks in software packages, which we derive from
the remarkable results outlined by Troyer et al. (2005) and Neale and Willems (2009) and
from online discussion forums and conferences for practitioners (e.g., Management Circle
2008). Generally, software vendors do not consider non-stationary demand or
customer-specific service levels. Including situational and individual factors to support
decisions about safety stocks seems to be in its infancy. Nevertheless, improving service
level remains one of the highest priorities for inventory management professionals.1
Although the advanced software packages of SAP, Optiant, and SmartOps appear to
accommodate the feature of dynamic planned safety stocks, there is no report that isolates
the need for and benefits of this specific feature. Providing such evidence is one of the
contributions of the work reported here.
 International Journal of Production Research 6865

4. Exploring the pervasiveness of non-stationarity of demand forecast errors: an

empirical study
One motivation for employing dynamic planned safety stocks would be, as mentioned
previously, whenever non-stationarity in demand forecast errors is due to heteroscedastic
demand variance. We were interested in testing the extent to which such a phenomenon
might be present in U.S. industries. To explore this, we examined data from the U.S.
Census Bureau to evaluate the extent of demand heteroscedasticity and the resulting
heteroscedastic forecast errors among U.S. industries. In this analysis, we seek to
demonstrate the prevalence of heteroscedasticity in U.S. industry; accordingly, aggregate
industry data is appropriate. Although firm-specific data at the stock keeping unit (SKU)
level is desirable for establishing forecasting analysis and safety stock policies, sufficient
SKU-level data to perform a thorough analysis was not readily available. To the extent
that the data we use is hierarchically aggregated, starting with SKUs consolidated to
product dollars, then to firm dollars, and finally to industry group dollars, this tends to
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dampen variance. Thus, to the extent we can demonstrate heteroscedasticity at this most
aggregated level we will have a clear indicator that it will exist in an SKU’s time series to
an even greater degree.

4.1 The industry data

We used the well-known two-digit Standard Industrial Classification (SIC) industry data for
manufacturing (known as the M3 series; see U.S. Department of Commerce, Bureau of
Census (2007)). We evaluated monthly time series data for all 61 two-digit SIC industries
between January 1958 and March 2001, as listed in Table 2. The sample ends in 2001 because,
at that time, the Census Bureau discontinued use of SIC industrial classifications and began
using a new North American Industry Classification System (NAICS) to replace it.2
We forecast the shipments series. We chose shipments because the shipments series is
buffered from new orders with backorders, which are out of scope for this research. In this
way, we focus strictly on the buffering impact and appropriate levels of inventory as
production levels relate to shipments, keeping backorders exogenous to the analysis. We
adjust shipments for price inflation by the Implicit Price Deflator (IPD; U.S. Department
of Commerce, Bureau of Economic Analysis 2007). As indicated appropriate by Gorman
and Brannon (2000), we considered data that is unadjusted for seasonality in our analysis,
as seasonal adjustments would dampen the uncertainty and variability of demand and
reduce implied incentive for safety stocks. Unadjusted data are more appropriate because
seasonal variability exists in the raw data and this variability drives firms’ safety stocks.

4.2 Forecasting methodology

We wanted to make sure we had well-specified forecast equations, and thus evaluated a
number of different univariate time series forecasting methodologies that are widely used
and available in practice: additive and multiplicative Holt–Winters, exponential smoothing
with trend, stepwise autoregression and autoregressive integrated moving average
(ARIMA). We evaluated the accuracy of each forecast methodology within-sample on a
one-period-ahead forecast, consistent with our assumption on lead time in our subsequent
safety stock analysis.
The autoregressive integrated moving average (ARIMA model), also known as the
Box–Jenkins (1970) model, specification with monthly dummy variables and a time trend
 Downloaded by [Aston University] at 23:59 30 January 2014

6866

Table 2. Regression statistics, forecast fit statistics, and heteroscedasticity tests for two-digit SIC codes.

Time Series Forecast Statistics Regression Statistics Heteroscedasticity Statistics DPSS Results

Mean Mean
Monthly Mean Absolute Bruesch- Stdev Avg SS Avg Pct.
Shipments Absolute Percent Adjusted Durbin- White Pagan F-Test (Monthly (est. based SS reduction
Category ($Millions) Error Error RMSE R-Square Watson (p-value) (p-value) (p-value) Stdev) on model) (pct)

Defense Products 6,065 339 6% 0.18 0.99 1.99 0.5593 0.3022 0.0001 376.57 5.69 28.65%
Instruments and Related Products 8,857 194 2% 0.03 1.00 1.74 0.0001 0.0001 0.0001 68.59 0.32 22.73%
Health Care Products 5,963 164 3% 0.03 1.00 1.90 0.0001 0.0001 0.0001 92.03 0.85 20.03%
Fabricated Metal Products 15,519 338 2% 0.03 0.98 1.99 0.0001 0.0001 0.0006 91.46 0.42 17.97%
Electronic and Other Electrical 17,698 456 2% 0.03 0.99 1.67 0.0001 0.0001 0.0017 243.68 2.40 16.81%
Equipment
Home Goods and Apparel 18,203 406 2% 0.03 0.96 2.04 0.0001 0.0001 0.0001 99.99 0.47 16.17%
Transportation Equipment 31,596 1,646 6% 0.08 0.93 2.00 0.0001 0.0001 0.0001 971.38 16.86 14.93%
Motor Vehicles and Parts 20,105 1,489 8% 0.12 0.89 2.00 0.0001 0.0001 0.0001 920.73 19.68 14.17%
Automotive Equipment 10,193 746 8% 0.12 0.89 2.00 0.0001 0.0001 0.0001 450.65 9.57 14.01%
J.J. Kanet et al.

Communication Equipment 3,522 178 5% 0.06 0.98 1.68 0.0001 0.0001 0.0001 125.05 2.43 13.93%
Chemicals and Allied Products 22,479 504 2% 0.03 0.99 1.86 0.0001 0.0001 0.0015 142.17 0.89 13.75%
Nondefense Capital Goods 36,042 1,022 3% 0.04 0.98 1.50 0.0001 0.0001 0.0001 369.83 3.78 12.51%
Metal working Machinery 2,668 111 4% 0.06 0.95 1.92 0.0001 0.0001 0.0001 55.40 0.91 12.34%
Search and Navigation Equipment 2,325 102 4% 0.06 0.99 1.73 0.0001 0.0001 0.0001 54.41 1.00 11.52%
Drugs, Soaps, and Toiletries 7,255 246 3% 0.04 0.99 1.98 0.0001 0.0001 0.0001 111.84 1.65 11.25%
Nondefense Capital Goods 30,971 827 3% 0.03 0.98 1.33 0.0001 0.0001 0.0004 276.17 2.78 11.24%
Excluding Aircraft
Engines and Turbines 1,633 113 7% 0.10 0.94 1.98 0.0001 0.0001 0.0001 60.22 1.43 10.70%
Machinery and Equipment 45,640 1,208 3% 0.04 0.98 1.82 0.0003 0.0001 0.0001 393.61 4.06 10.63%
Textile Mill Products 6,863 167 2% 0.03 0.94 1.95 0.0001 0.0001 0.0001 43.01 0.35 10.48%
Electronic Components and 5,073 184 3% 0.04 1.00 1.92 0.0001 0.0001 0.2079 114.92 2.26 10.27%
Accessories
Medical Instruments and Supplies 1,999 61 3% 0.04 1.00 1.75 0.0001 0.0001 0.0049 28.89 0.45 10.12%
All Other Food and Kindred 15,123 370 2% 0.03 0.97 1.92 0.0001 0.0001 0.0005 103.36 0.93 10.08%
Products
 Downloaded by [Aston University] at 23:59 30 January 2014

Computer and Office Equipment 4,833 281 6% 0.08 0.99 1.50 0.0001 0.1516 0.0019 148.21 3.52 9.56%
Blast Furnaces, Steel Mills 7,549 396 5% 0.10 0.86 1.99 0.0001 0.0584 0.1641 231.77 5.66 9.21%
Information Technology Industries 15,195 426 3% 0.04 0.99 1.44 0.0009 0.0158 0.1693 152.17 1.99 9.17%
Broad woven Fabrics and Other 4,429 128 3% 0.04 0.90 1.87 0.0001 0.0001 0.0001 38.91 0.48 8.89%
Textiles
House hold Durable Goods 7,925 200 3% 0.03 0.97 1.97 0.0001 0.0001 0.0007 51.97 0.51 8.72%
Electric Lighting and Wiring 1,703 57 3% 0.04 0.98 1.85 0.0001 0.0001 0.0001 19.90 0.30 8.66%
Equipment
Electrical Transmission and 2,694 87 3% 0.04 0.97 1.95 0.0001 0.0001 0.0003 30.46 0.48 8.05%
Distribution Equipment and
Industrial Apparatus
Paper board Containers and Boxes 2,617 57 2% 0.03 0.99 1.99 0.0911 0.4413 0.5108 11.99 0.09 8.05%
Industrial Chemicals 12,131 296 3% 0.03 0.99 1.94 0.0001 0.0001 0.0004 74.03 0.75 7.96%
Industrial Machinery and 23,134 648 3% 0.04 0.99 1.40 0.0001 0.0001 0.0002 186.96 2.40 7.82%
Equipment
Pulp, Paper, and Paper board Mill 4,292 103 2% 0.03 0.99 1.99 0.0049 0.0001 0.0162 24.77 0.25 7.70%
Products
Defense Capital Goods 7,749 316 4% 0.05 0.96 1.95 0.0001 0.0086 0.0015 120.88 2.45 7.56%
Primary Metals Industries 15,880 518 3% 0.05 0.93 2.00 0.0001 0.272 0.534 199.65 3.95 6.67%
Dairy Products 4,932 112 2% 0.03 0.94 1.94 0.0001 0.3265 0.4971 23.16 0.23 6.32%
Measuring and Controlling 2,444 72 3% 0.04 0.99 1.84 0.0001 0.0007 0.124 23.08 0.40 6.24%
Devices
Miscellaneous Converted Paper 3,319 91 3% 0.04 0.99 2.02 0.0164 0.0667 0.012 24.02 0.35 6.12%
Products
Ships, Tanks, and Tank 1,143 88 8% 0.12 0.83 1.99 0.0007 0.1774 0.0036 34.62 1.16 5.79%
Components
Stone, Clay, and Glass Products 6,119 150 3% 0.03 0.98 1.98 0.0001 0.0011 0.042 30.39 0.35 5.70%
International Journal of Production Research

Rubber and Miscellaneous Plastics 8,037 183 2% 0.03 0.99 1.98 0.0001 0.0158 0.1724 32.97 0.33 5.55%
Products
Ironand Steel Foundries 1,475 57 4% 0.06 0.94 1.96 0.0001 0.0001 0.0001 17.33 0.38 5.47%
Photographic Goods 1,705 66 4% 0.05 0.99 2.05 0.0001 0.0001 0.0003 20.44 0.47 5.29%
Petroleum and Coal Products 13,986 396 3% 0.04 0.99 2.00 0.2088 0.3352 0.6364 113.99 2.35 4.52%
Aircraft, Missiles, 8,825 468 5% 0.07 0.94 2.02 0.0002 0.0001 0.0001 146.56 4.53 4.51%
SpaceVehiclesand Parts
Construction, Mining, Material 3,286 127 4% 0.05 0.97 2.01 0.0034 0.0001 0.0066 35.62 0.90 4.35%
Handling Equipment

(continued )
6867
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6868

Table 2. Continued.

Time Series Forecast Statistics Regression Statistics Heteroscedasticity Statistics DPSS Results

Mean Mean
Monthly Mean Absolute Bruesch- Stdev Avg SS Avg Pct.
Shipments Absolute Percent Adjusted Durbin- White Pagan F-Test (Monthly (est. based SS reduction
Category ($Millions) Error Error RMSE R-Square Watson (p-value) (p-value) (p-value) Stdev) on model) (pct)

Shipbuilding, Tanks, Tank 1,809 105 6% 0.09 0.91 1.99 0.0396 0.0066 0.0083 32.16 1.06 4.32%
Components, and Ordance
Beverages 4,519 130 3% 0.04 0.99 2.01 0.0001 0.0001 0.0246 24.29 0.47 3.45%
Meat Products 8,481 204 2% 0.03 0.96 1.96 0.0001 0.4933 0.6177 30.79 0.43 3.44%
House hold Audio and Video 1,150 83 7% 0.10 0.87 2.01 0.0001 0.0004 0.0007 21.64 0.93 3.05%
Equipment
Nonferrous Metals 6,856 197 3% 0.04 0.97 2.00 0.0001 0.225 0.3855 36.76 0.82 2.92%
Household Appliances 1,874 4 4% 0.05 0.88 1.99 0.0001 0.0287 0.1118 15.68 0.49 2.73%
J.J. Kanet et al.

Tobacco Products 2,256 177 8% 0.10 0.89 1.95 0.0001 0.0002 0.5212 51.33 2.69 2.55%
Farmand Garden Machinery 1,633 113 7% 0.09 0.93 2.00 0.0469 0.0018 0.0141 26.01 1.25 2.36%
Food and Kindred Products 35,118 553 2% 0.02 0.99 1.89 0.0001 0.0001 0.0073 133.69 – 0.00%
Other Materials, Supplies and 94,453 1,488 2% 0.02 0.99 2.03 0.0001 0.0055 0.012 426.60 – 0.00%
Intermediate products
Paper and Allied Products 10,228 185 2% 0.02 0.99 1.99 0.0001 0.0001 0.0001 53.23 – 0.00%
Business Supplies 18,544 297 2% 0.02 1.00 2.00 0.0001 0.0001 0.0003 97.21 – 0.00%
Consumer Staples 55,007 830 1% 1.00 1.00 1.80 0.0001 0.0001 0.0001 234.08 – 0.00%

*For all series, n ¼ 519, except Defense Capital Goods and Machinery and Equipment, n ¼ 399.
**All p-values reported 0.0001 are 50.0001; all heteroscedasticity tests found to be significant at the 10% confidence level are in bold italics.
 International Journal of Production Research 6869

demonstrated the best statistical qualities, including low standard error of prediction (and
low mean absolute error), high r2 values, low serial correlation and general significance of
the explanatory variables. We opted not to remove insignificant regressors in a stepwise
fashion to maintain consistency in the regression equation among our forecast groups and
to avoid any omitted variable bias. We specified a log transformation of the time series and
included a time trend regressor, obviating the need to difference the series to remove the
unit root. It was found necessary to correct for serially correlated errors of prediction
using a third-order error lag. In summary, we found an ARIMA(3,0,0) (autoregressive
error correction of lag 3, zero differences of the series, zero lags of the dependent variable)
specification performed well.
Advanced forecasting techniques such as generalised autoregressive conditional
heteroscedasticity (GARCH) (Engle 1982) could be used to improve the efficiency of
coefficient estimates, but this would not change our results. These techniques would not
reduce the heteroscedasticity of the error terms; they would only improve the efficiency of
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the estimators in the face of heteroscedasticity, allowing the forecaster to make valid
claims on the significance of the regression coefficients. In any case, advanced techniques
such as GARCH are seldom used, if at all, in practice when developing product forecasts
(Granger 1996). Practitioners are not likely to have the skills, or be willing to invest the
time to undergo this effort.
Table 2 presents summary forecast statistics for all forecasted series.3 As can be seen
from the summary results, within the sample, predictive accuracy was quite good. R2
values are all over 0.95, and Durbin Watson statistics are all very near two. Thus, we
conclude that we have well-specified statistical models, and heteroscedasticity is in fact
inherent in the time series themselves and not necessarily the result of a mis-specified
model. Makridakis and Hibon (2000) come to the similar conclusion that real-life time
series are not stationary. Therefore, heteroscedasticity is likely to be present in many
forecasting implementations and must be dealt with accordingly with effective inventory
management policies.

4.3 Statistical tests for heteroscedasticity

We conducted three tests for heteroscedasticity: White’s test (White 1980), the Breusch–
Pagan test (Breusch and Pagan 1979), and an F-test from a regression on observed
variance. Both White’s test and the Breusch–Pagan test are chi-squared tests based on the
squared residuals of the fitted model. White’s test makes no assumptions about the form of
the heteroscedasticity. Because of its generality, White’s test may identify heteroscedas-
ticity of any form (Thursby 1982). Thus, White’s test may be significant when the errors
are heteroscedastic but not necessarily with respect to monthly demand patterns. The null
hypothesis for White’s test is that all variances are equal; H0: i2 ¼  2 for all i. The
alternative hypothesis is that there is some inequality, whatever the cause. The Breusch–
Pagan test is more restrictive; it tests whether there is heteroscedasticity that is correlated
with the regressors, Xi. For the estimated equation: i2 ¼  2( þ iXi), we specify the null
hypothesis, H0: i ¼ 0, 8i. The alternative hypothesis is that some i 6¼ 0.
The third test, which is a similar but simpler test, regresses the squared errors of each
regression against a constant and our monthly dummy variables and uses an F-test to see
if, as a whole, the monthly dummy variables explain error variance. If the variance is white
noise, then there will be no significant explanatory value of the monthly dummy variables
on the error variance.
 6870 J.J. Kanet et al.

Table 2 shows the results for the three tests of heteroscedasticity. The White test
rejects homoscedasticity in 97% of the industries examined. The Bruesch–Pagan test
rejects homoscedasticity in 85% of the industries examined. The F-test is least able to reject
homoscedasticity, but still does so in 78% of the industries examined.

4.4 The case for heteroscedasticity

The analysis above clearly shows that there is a case to be made that heteroscedastic errors
can exist around an accurate and well-specified forecast model. One could hypothesise that
the observed heteroscedasticity in this test is a function of a mis-specified model (Thursby
1982). Although we did not run detailed diagnostics on all the industries considered (such
as Chow or Goldfeld Quandt tests for structural change in the industries examined), we
observed no indication that our predictive equation is mis-specified, nor do we think that it
is likely that over 80% of our forecasts are mis-specified. We observe that
heteroscedasticity is based on the errors of forecast. Thus, if the forecast has an omitted
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variable, it could reduce these errors and potentially eliminate heteroscedasticity. We do

not find this at all likely. All reasonable time series explanatory variables have been
included, including lagged values of the dependent variable and adjustment for
autocorrelated forecast errors. As such, our forecasts pass the test of reasonability.
Moreover, the Thursby (1982) observation applies only to White’s test which identifies
heteroscedasticity whatever the source. The Breusch–Pagan and regression tests are
designed specifically to find heteroscedasticity with respect to the regressors, and we find
support an overwhelming majority of the time. Because predictive power is very high, it is
not likely that an additional variable or model re-specification will help predictive ability
appreciably or reduce heteroscedasticity; there is simply not much room for improvement
in these forecast equations. Rather, we conclude the observed heteroscedasticity is inherent
in the data, and reasonably developed forecasting methods cannot account for it.

5. Estimating the savings from dynamic planned safety stocks

Given heteroscedastic monthly demand, we were interested in estimating the value of
employing dynamic planned safety stocks.

5.1 The model

We assumed monthly shipments with a one month lead time and no backorders. Orders
are placed each month based on the upcoming month’s forecasted requirements (expected
value ¼ Rt). We assumed a constraint requiring a minimum average annual fill rate (FR).
We chose FR ¼ 99.0%.4 Thus, we could compute the expected monthly shortages (ESt)
resulting from the set of safety stock values (SSt | t ¼ 1 , . . . , 12) by solving the following
safety stock optimisation (SSO) model:
Minimise : t¼1,...,12 ðSSt Þ=12, ð1Þ
subject to
FR ¼ 1  t¼1,...,12 ðESt =Rt Þ  0:99, ð2Þ
where
ESt ¼ SSt ð1  Fs ðSSt =t ÞÞ þ t fs ðSSt =t Þ,
 International Journal of Production Research 6871

and  t is the standard deviation of the forecast error for month t. Here Fs is the standard
normal distribution function and fs is the standard normal density function.5 We then
solved SSO for each of the 61 industry designations. The minimum average inventory
achieved for SSO was then compared with the minimum average inventory achieved using
the same model but with the additional ‘all-equal’ constraint that
SSt ¼ SSu j t 6¼ u, t, u ¼ 1, . . . , 12 ð3Þ
represents the constraint of a single safety stock level. For the purposes of the constant
safety stock model, we used the average standard deviation of forecast errors across all
months, i.e.
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
t2
AVE ¼ ðt¼1,...,12 =12Þ: ð4Þ

This is the standard deviation that one would use for setting a single safety stock level
under the assumption of homoscedastic forecast errors. The last column of Table 2 shows
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the estimated percent improvement in total annual safety stocks from using dynamic
planned safety stocks for each of the 61 industries studied. On average, we find a 9.76%
reduction in safety stock potential for these industries from DPSS. Roughly, the safety
stock represents 21% of the total inventory in these industries (total inventory reported by
the Bureau of the Census). Thus, the inventory savings from DPSS is approximately 2% of
total inventories.
Our savings estimate is conservative for a number of reasons. First, our assumption of
one month lead time identifies a low estimate of safety stock since the required safety stock
would systematically increase with lead time. Second, our estimate of savings for an
individual member of any of these industries would have to be higher than what we see
here because of the effect of aggregation across firms on the forecast error. Clearly, any
company’s forecast error would likely be considerably higher than the aggregate error for
the entire industry. Likewise, product family forecast error is likely higher than total
company sales forecast error. Finally, variance of demand at the SKU level at which safety
stocks are often held is likely to be higher than the variance of the firm’s total sales
numbers (some three levels of aggregation below a firm’s monthly total sales numbers).
Thus, there is good reason to believe the savings for a given company’s line item (SKU
level) inventories would be higher still.6

5.2 Estimated savings for the automotive equipment case

We illustrate the aforementioned analysis with the automotive equipment industry.
Figure 1 plots its average forecasted demand by month along with its 95% confidence
interval using the standard deviation of demand forecast for each month in the regression
sample. As demonstrated by the varying 95% confidence interval, the forecast error is
highly seasonal, signaling the potential benefit of time-varying safety stocks. This example
illustrates that variance is not necessarily positively correlated with average demand levels;
month eight shows low demand, but high variance.
Table 3 provides the detailed results of the optimisation analysis from the SSO model
for the automotive equipment industry. Input to the analysis is the mean monthly forecast
and standard deviation of the forecast error. Outputs are the monthly safety stock values
for dynamic planned and constant safety stocks with the constraint on minimum fill rate.
 6872 J.J. Kanet et al.

Forecast Variability by Period

14,000 (95% Confidence Intervals)

12,000
Sales ($ millions)
10,000 Forecast
8,000 LCL

6,000 UCL

4,000

2,000
1 2 3 4 5 6 7 8 9 10 11 12
Month of Year

Figure 1. Automotive equipment industry forecasted demand by month with 95% confidence
interval.
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Also reported are the expected monthly shortages under the two safety stock policies. As
described earlier, the safety stocks for the case ‘Dynamic Planned SS’ are the minimum
stocks needed to achieve a 99% fill rate for the year. The safety stock recommendations for
the case ‘Constant SS’ are those found by assuming the single valued standard deviation of
error of 1044 (the average standard deviation as computed by Equation (4)). As can be
seen, both policies achieve the targeted annual fill rate with the associated expected
average monthly shortage of $102 billion. It should be noted that the constant SS model
performs much more erratically; dramatically worse months are offset by high
performance months. There is an implicit cost to this erratic performance that is not
included in our benefits estimate. The constant safety stock policy achieved the fill rate
requirement with an average safety stock of $957 million, whereas the dynamic planned
policy was able to do so with $823 million safety stock (14% less, as shown in Table 3).

6. Implementing dynamic planned safety stocks

As noted previously, most existing ERP software does not accommodate dynamic planned
safety stocks. Moreover, not every company has an ERP system. So implementation of
dynamic planned safety stocks may be a challenge. In this section, we describe a simple
approach for effectively implementing DPSS in a practical setting.

6.1 Foundation
Consider the production planning of a single SKU over a planning horizon of n periods, as
illustrated in Figure 2. Given that we have a forecast of customer requirements e along
with a vector of desired safety stock levels f, how do we adjust requirements in order to
accomplish desired safety levels with minimum additional inventory? The desired safety
stock levels f might be automatically generated (possibly via the SSO model or equivalent)
with each new forecast so that levels are adjusted to the latest estimates of error variance.
Alternatively, such a vector might well be a simple specification based on the experience of
the production planner through trial and error.
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Table 3. Illustration of the SSO model for the automotive equipment industry (millions of dollars).

Minimum dynamic planned SS Minimum constant SS

Input data (time-varying std. dev.) (single-valued std. dev.)

Mean forecasted Forecast error Safety Expected Fill rate Expected Fill rate
Month demand std. dev. stock shortage (%) Safety stock shortage (%)

1 9557 883 763 95 99 957 63 99

2 10,775 690 596 74 99 957 26 100
3 11,169 728 630 78 99 957 32 100
4 10,855 592 512 64 99 957 13 100
5 10,960 514 444 55 99 957 6 100
6 11,135 655 566 70 99 957 21 100
7 7697 1119 967 120 98 957 122 98
8 8718 2228 1929 238 97 957 491 94
9 10,404 942 814 101 99 957 76 99
10 11,217 895 774 96 99 957 65 99
11 10,541 1030 891 110 99 957 98 99
12 9270 1143 988 123 99 957 129 99
International Journal of Production Research

Average 10,191 1044 823 102 99 957 95 99

6873
 6874 J.J. Kanet et al.

Planning procedure Supply chain

1
Requirements Customer
level

Generate
gross requirements Bill of materials

2
Forecast error
Generate desired safety stock levels
variance

Is
period-to-period
desired safety stocks
DPSS

no >0 ? yes
4 3
Decrease Increase
requirements requirements
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(as soon as possible) (as late as possible)

Generate dynamic planned safety stock

adjusted net requirements

Lot sizing
Generate production plan
rules

Generate
material requirement plan

Supplier
Material requirements level
Legend:
Start / end Process Decision Subroutine Data

Figure 2. Block diagram of the MRP system using Dynamic Planned Safety Stocks (DPSS).

We conceive two types of requirement adjustments needed to implement dynamic

planned safety stocks: we must boost requirements to accomplish increases in
period-to-period desired safety stocks g. To assure minimum additional inventory, we
insert such requirement adjustments as late as possible. Similarly, we must decrease
production requirements h to accomplish reductions in period-to-period desired safety
stocks. To minimise inventory, we want to assure such reductions are accomplished as
soon as possible, but we cannot prescribe decreases that would result in a negative net
requirement.

6.1.1 A linear programming formulation

We can express the above problem as a linear program. For a planning horizon comprised
of n periods, define the following parameters:
R(i)  0 as net requirements (demand) for period i (i ¼ 1 , . . . , n);
SS(i)  0 as desired safety stock inventory as of end of period i (i ¼ 1 , . . . , n);
 International Journal of Production Research 6875

and the following variables:

PRA(i) as the positive requirement adjustments for period i (i ¼ 1 , . . . , n);
NRA(i) as the negative requirement adjustments for period i (i ¼ 1 , . . . , n);
SSAR(i) as safety stock adjusted requirements for period i (i ¼ 1 , . . . , n);
SSII(i) as the safety stock induced inventory at end of period i (i ¼ 1 , . . . , n).
Note that the variables PRA and NRA are akin to the ‘virtual’ requirements used by
SAP in APO. Then we have the following linear program formulation:
Minimise : i¼1,...,n SSIIðiÞ,
subject to
ð1Þ PRAðiÞ  NRAðiÞ  SSðiÞ ði ¼ 1, . . . , nÞ,
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ð2Þ NRAðiÞ  RðiÞ þ PRAðiÞ ði ¼ 1, . . . , nÞ,

ð3Þ SSARðiÞ ¼ RðiÞ þ PRAðiÞ  NRAðiÞ ði ¼ 1, . . . , nÞ,

ð4Þ SSIIðiÞ ¼ SSIIði  1Þ þ NRAðiÞ  PRAðiÞ ði ¼ 2, . . . , nÞ,

ð5Þ SSIIð1Þ ¼ NRAð1Þ  PRAð1Þ,

ð6Þ PRAðiÞ, NRAðiÞ, SSARðiÞ, SSIIðiÞ  0 ði ¼ 1, . . . , nÞ:

As indicated, the objective is to minimise total inventory through the planning horizon
where constraints (1) assure that requirements are adjusted so that safety stock levels are
met. Constraints (2) assure that negative requirement adjustments do not exceed positive
requirements (i.e. net requirements may not be negative). Constraints (3) set the new net
requirements necessary to ensure safety stock levels are incorporated in the requirements
plan. Constraints (4) and (5) assure inventory is balanced. Constraints (6) require
non-negativity of all variables.
The formulation provides a clear conveyance of the problem. We can envision
extensions/variations to the formulation above such as the addition of periodic capacity
constraints and/or alternative objectives (e.g., NPV). The above formulation serves a basis
for more sophisticated models.

6.1.2 A simple solution procedure

One need not solve the Safety Stock Adjusted Requirements (SSAR) via a linear program.
This section describes a simple calculus which can be easily implemented within ERP
systems without the use of commercial linear program solver packages. A simple O(n)
solution procedure for integrating time-varying safety stocks into a material requirements
plan (i.e. generating ‘safety stock adjusted requirements’) is outlined below where the
additional variable CUNRA represents the accumulation of negative requirement
adjustments. The procedure ‘covers’ each desired safety stock level with a positive
requirement adjustment which is then removed in subsequent periods via negative
requirement adjustments. The negative adjustments are accomplished as early as possible
 6876 J.J. Kanet et al.

(so as to minimise inventory), but not so large that a negative adjustment would drive any
period’s safety stock adjusted requirements (original requirements þ positive adjustments–
negative adjustments) below zero.
Procedure SSAR generator
1 PRA(0) 0
2 CUNRA(0) 0
3 SSII(0) 0
4 For i ¼ 1, . . . , n do
5 PRA(i) SS(i)
6 CUNRA(i) max{0, CUNRA(i  1) þ PRA(i  1)  R(i)  PRA(i)}
7 NRA(i) min{PRA(i  1) þ CUNRA(i  1), R(i) þ PRA(i)}
8 SSAR(i) R(i) þ PRA(i)  NRA(i)
9 SSII(i) SSII(i  1) þ PRA(i)  NRA(i)
10
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End do
End SSAR generator
Since PRA are fixed in statement 5, it follows that statement 9 assigns SSII values such
that total SSII will be minimum when NRA are maximum. Statement 7 assures that NRA
are maximum without exceeding total positive requirements (R þ PRA). Thus Procedure
SSAR assures an optimum solution.

6.2 Implementing in a planning system: illustration

In the following, we illustrate the proposed procedure as a Microsoft ExcelTM spreadsheet.
The layout provides immediate visibility into the inventory implications of decisions in
managing safety stock levels, i.e. the safety stock induced inventory (SSII) which we refer
to above (see Figure 3). The first two rows of the sheet e show an item’s requirements and
the desired safety stock levels (to be achieved at the end of the respective periods). Note
that the rows between Desired Safety Stocks, SS(i), and Safety Stock Adjusted
Requirements, SSAR(i) (gray shading), would normally be hidden from the planner for
simplicity. We show them here only to illustrate the embedded calculations. The third row
f shows the resulting ‘positive requirement adjustments’ (line 6 of the aforementioned
procedure). The next row shows the initial assignments to NRA (procedure line 7) g,
which are simply the positive adjustments shifted one period later. When a negative
adjustment (NRA) exceeds the corresponding period’s total positive requirements
(R þ PRA) h, the excess must be shifted to the next future period. This process continues
until all excesses are ‘absorbed’ or the planning horizon is reached. For example, the

Period past 1 2 3 4 5 6 7 8 9 10 11 12 Total

Requirements R(i) 100 100 100 100 100 20 100 100 100 100 100 1020
Desired Safety Stocks SS(i) 11 60 25 50 22 20 50 122 360
Positive Requirement Adjustments PRA(i) 11 60 25 50 22 20 50 122 360
Positively Adjusted Requirements R(i) + PRA(i) 111 100 160 125 150 42 120 150 100 222 100 1380
(Initial) Negative Requirement Adjustments NRA(i) 11 60 25 50 22 20 50 122 360
Cumulative Unfilled Negative Adjustments CUNRA(i) 8 30 22
(Final) Negative Requirement Adjustments NRA(i) 11 60 25 42 30 20 50 100 338
Safety Stock Adjusted Requirements SSAR(i) 111 89 160 65 125 90 130 50 222 1042
Safety Stock Induced Inventory SSII(i) 11 60 25 50 30 30 20 50 122 22 420

Figure 3. Prototype planning interface to illustrate the procedure SSAR generator.

 International Journal of Production Research 6877

calculation for CUNRA(6) is max{0, CUNRA(5) þ NRA(6)  R(6)  PRA(6)} ¼ max{0,

0 þ 50  20  22} ¼ 8 i. This makes the (final) NRA as shown in the spreadsheet for period
6 to be 42 j, which follows line 9 of the procedure: NRA(6) min{NRA(6) þ CUNRA(5),
R(6) þ RPA(6)} ¼ min{50 þ 0, 20 þ 22}. As can be seen in the penultimate row of the
spreadsheet, the (net) Safety Stock Adjusted Requirements (SSAR) are simply the
algebraic sum R(i) þ PRA(i)  NRA(i) (as per line 10 of the procedure) k; which produces
the resulting Safety Stock Induced Inventory (SSII). From the figure, we can observe the
average inventory (35 units) needed to provide the proposed plan of safety stocks. Observe
that the ending SSII is 22 l; since the final period’s requirements of 100 are not sufficient
to completely absorb the 122 units of safety stock no longer desired after period 11. Note
that the procedure guarantees the minimum inventory investment needed to support the
safety stock program.
One sees that the model here takes the point of view of providing a set of adjusted
requirements that assure desired ending inventory values. This differs from the point of
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view of the Graves and Willems (2000) model that focuses on providing a set of order
quantities. The approach here specifies that order quantities be determined after
requirements are adjusted. This feature avoids the need for nonsensical negative order
quantities and allows the planner to determine order quantities based on economic and/or
capacity reasons. We see possible environments where users may want safety stocks larger
than expected demand or even when expected demand for a given period is zero as might
be the case when demand is very lumpy. In the latter case, the planner may have no
expected requirements but still wants a safety stock.

6.3 Making planned inventory transparent

An important point to highlight is that this interface model allows the planner to factor
out exactly how much additional inventory due to safety stock is actually being held (and
when). This is an important planning feature that is not available in most planning
systems. Note this safety stock induced inventory will be different from desired targets
because there may not be sufficient ‘hard’ requirements to absorb safety stock reductions.
It is important to see that with this feature we enable the planner to classify planned
inventory according to why it occurs (and make the total cost of a given service policy easy
to calculate). As described by Neale et al. (2003, p. 37), classifying inventories in this way
enables managers to better address inventory planning questions of location, level, and
timing.

7. Summary and discussion

We have shown that dynamic planned safety stock (DPSS) planning is sensible whenever
demand or lead time is non-stationary and have argued that non-stationarity is prevalent.
We have shown that one realisation of non-stationarity – heteroscedastic demand and
resulting heteroscedastic demand forecast errors – is indeed pervasive in U.S. industry. We
subsequently showed that inventory savings in going from a policy of constant safety
stocks to time-varying safety stocks can be significant. This hypothesis is further endorsed
by the case study reports of using DPSS as reported by Troyer et al. (2005) and Neale and
Willems (2009).
 6878 J.J. Kanet et al.

Our estimate of the improvement in inventory is quite conservative since safety stocks
are implemented by firms at the SKU level, which is far removed from the aggregated (less
variable) industry demand that we analysed.
Given that we have a forecast of customer requirements along with a vector of desired
safety stock levels, we have shown how this program of safety stocks can be implemented
with minimum inventory. We provided both a Linear Programming formulation as well as
a straightforward O(n) algorithm for so doing. We proposed a planning interface
illustrating how the feature of DPSS could be implemented as a component in an ERP
system.
The implementation of dynamic planned safety stocks can reduce unnecessary safety
stocks, improve service, or both relative to a single value safety stock regimen. We can say
this because time phasing of the safety stocks facilitates their planned elimination or
reduction. The implementation of DPSS as presented has the added feature that it
provides the planner with the inventory implications (SSII) of his decisions regarding the
tactical placement of safety stocks. This is a feature that is currently not available even in
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leading ERP systems.

Notes
1. For example, in a recent survey of 190 manufacturers, distributors, and retailers, half the
respondents identified ‘improve service level’ as their most important inventory management
objective (Brandel 2007).
2. The NAICS series begins in 1992; we opted to use the data set with a longer history and thus
more observations for our forecasting analysis.
3. Detailed regression results and coefficient values can be obtained from the authors.
4. This is consistent with the assumption of Graves and Willems (2008) that firms do not
deliberately plan to have stockouts.
5. See, for example, Chopra and Meindl (2004) for verification of this form for ES.
6. Interestingly, some firms are just discovering the value in setting safety stock levels in concert
with the demand variance at the SKU level (see the account of Intel by Arnow et al. (2008)).

References

Aberdeen Group, 2006. IBM puts a pragmatic face on advanced inventory optimization [online].
Available from http://www.aberdeen.com/c/report/research_briefs/RB_IBM_DIOS_BE_
2915.pdf
Arnow, D., Singh, A., and Mastrantonio, P., 2008. Less than perfect. APICS, 18 (1), 24–27.
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