Managing Uncertainty: Safety Inventory

Role of Inventory in the Supply Chain

Improved Supply/Demand Match

Improved Forecasting
Cost Availability
Reduce Material Flow Time

Efficiency Reduce Waiting Time Responsiveness

Reduce Buffer Inventory

Supply/Demand Economies of Seasonal

Variability Scale Variability

Safety Inventory Cycle Inventory Seasonal Inventory

Managing Uncertainty: Safety Inventory

Role of Safety Inventory in the Supply Chain

Safety inventory: Inventory carried for the purpose of satisfying demand that exceeds the
amount forecasted in a given period

Average Inventory = Cycle Inventory + Safety Inventory

Need to determine the safety inventory level to trade-off product availability and holding cost

Two key questions to be considered

 What is the appropriate level of safety inventory to carry?
 What actions can be taken to improve product availability while reducing safety inventory
Managing Uncertainty: Safety Inventory

Role of Safety Inventory in the Supply Chain

Quantity

Re-order Cycle
ROP
Point Inventory

Time
LT
Lead Time
Managing Uncertainty: Safety Inventory

Role of Safety Inventory in the Supply Chain

Quantity

Cycle Inventory

Safety Inventory

Time

Average Inventory = Cycle Inventory + Safety Inventory

Average Flow Time = Average Inventory / Demand
Managing Uncertainty: Safety Inventory

Determining Appropriate Level of Safety Inventory

 Uncertainty of both Demand and Supply
 The desired level of product availability

 Higher levels of uncertainty require higher levels of safety inventory given a

particular desired level of product availability
 Higher levels of desired product availability require higher levels of safety
inventory given a particular level of uncertainty

Measuring Demand Uncertainty

 Demand has a systematic component and a random component
 The estimate of the random component is the measure of demand uncertainty
 Random component is usually estimated by the standard deviation of demand
Managing Uncertainty: Safety Inventory

Determining Appropriate Level of Safety Inventory

Measuring Demand Uncertainty
 Demand has a systematic component and a random component
 Random component is usually estimated by the standard deviation of demand

𝐷= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑

=𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝐷 𝐿 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑳 𝑝𝑒𝑟𝑖𝑜𝑑=𝐷𝐿
 𝐿 =𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑳 𝑝𝑒𝑟𝑖𝑜𝑑= √ 𝐿 
Managing Uncertainty: Safety Inventory

Determining Appropriate Level of Safety Inventory

Measuring Product Availability
 Product availability: a firm’s ability to fill a customer’s order out of available inventory
 Stockout: a customer order arrives when product is not available

Important Measures
 Product fill rate: fraction of demand that is satisfied from product in inventory
 Order fill rate: fraction of orders that are filled from available inventory –
multiproduct scenario
 Cycle service level: fraction of replenishment cycles that end with all
customer demand being met
Managing Uncertainty: Safety Inventory

Determining Appropriate Level of Safety Inventory

Replenishment Policies
decisions regarding when to reorder and how much to reorder
 Continuous review: inventory is continuously monitored and an order of size Q
is placed when the inventory level reaches the reorder point ROP
 Periodic review: inventory is checked at regular (periodic) intervals and an order
is placed to raise the inventory to a specified threshold (the “order-up-to” level)
Quantity

Re-order
Point ROP

Time
LT
Lead Time
Managing Uncertainty: Safety Inventory
Evaluating Safety Inventory Given a Replenishment Policy
𝐷= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝐿= 𝐿𝑒𝑎𝑑 𝑇𝑖𝑚𝑒
𝐷 𝐿 =𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒=𝐷𝐿
𝑅𝑂𝑃= 𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑝𝑜𝑖𝑛𝑡
𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 𝒔𝒔= 𝑅𝑂𝑃 − 𝐷𝐿
𝑄
𝐶𝑦𝑐𝑙𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
2

Example problem
𝐷=2500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘 𝑅𝑂𝑃=6000 𝑢𝑛𝑖𝑡
𝐿=2 𝑤𝑒𝑒𝑘𝑠 𝑄=10000 𝑢𝑛𝑖𝑡 /𝑙𝑜𝑡

𝑪𝒂𝒍𝒄𝒖𝒍𝒂𝒕𝒆: Averageinventory∧average flow time(throughput )

Managing Uncertainty: Safety Inventory
Evaluating Cycle Service Level Given a Replenishment Policy
𝑧=𝑇h𝑒 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑠 𝑛𝑒𝑒𝑑𝑒𝑑 𝑓𝑜𝑟 𝑎 𝑔𝑖𝑣𝑒𝑛 𝑐𝑦𝑐𝑙𝑒− 𝑠𝑒𝑟𝑣𝑖𝑐𝑒 𝑙𝑒𝑣𝑒𝑙
𝐷 𝐿 =𝐷𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑳 𝑝𝑒𝑟𝑖𝑜𝑑=𝐷𝐿
 𝐿 =𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑳 𝑝𝑒𝑟𝑖𝑜𝑑= √ 𝐿 

𝑅𝑂𝑃 − 𝐷 𝐿 𝑅𝑂𝑃 − 𝐷𝐿
𝑧= ¿
𝐿 √𝐿 

Example problem
𝐷=2500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘
𝑅𝑂𝑃=6000 𝑢𝑛𝑖𝑡
𝐿=2 𝑤𝑒𝑒𝑘𝑠
𝑄=10000 𝑢𝑛𝑖𝑡 /𝑙𝑜𝑡
=500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘

𝑪𝒂𝒍𝒄𝒖𝒍𝒂𝒕𝒆:Cycle Service Level

Managing Uncertainty: Safety Inventory
Evaluating Cycle Service Level Given a Replenishment Policy
Managing Uncertainty: Safety Inventory
Evaluating Safety Inventory Given a Cycle Service Level

Example problem

𝐷=2500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘

𝐶𝑆𝐿=0.9
𝐿=2 𝑤𝑒𝑒𝑘𝑠
𝑄=10000 𝑢𝑛𝑖𝑡 /𝑙𝑜𝑡
=500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘

𝑅𝑂𝑃 − 𝐷 𝐿 𝑅𝑂𝑃 − 𝐷𝐿 𝑠𝑠 ss
𝑧= = ¿
𝐿 √𝐿 √𝐿 

𝑪𝒂𝒍𝒄𝒖𝒍𝒂𝒕𝒆 : Safety inventory

Managing Uncertainty: Safety Inventory
Impact of Supply Uncertainty on Safety Inventory
𝐷= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
=𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 𝑝𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑
𝐿= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐿𝑒𝑎𝑑 𝑡𝑖𝑚𝑒
𝑠=𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓 𝑙𝑒𝑎𝑑𝑡𝑖𝑚𝑒
𝐷 𝐿 =𝐷𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒=𝐷𝐿
 𝐿 =𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛𝑜𝑓𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒= √ 𝐿  2+ 𝐷2 𝑠 2

Example problem
𝐷=2500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘
=500 𝑢𝑛𝑖𝑡 /𝑤𝑒𝑒𝑘
𝐿=7 𝑑𝑎𝑦𝑠 =
𝑠=7 𝑑𝑎𝑦𝑠
𝐶𝑆𝐿=0.9

𝑪𝒂𝒍𝒄𝒖𝒍𝒂𝒕𝒆: Safety inventory