Probabilistic Models and

Safety Stock
All the inventory models we have discussed so far make the assumption that
demand for a product is constant and certain. We now relax this assumption.
The following inventory models apply when product demand is not known but
can be specified by means of a probability distribution. These types of models
are called probabilistic models. Probabilistic models are a real-world
adjustment because demand and lead time won’t always be known and
constant.
by zawminn oo
Service Level and Safety Stock
1 Service Level 2 Safety Stock
An important concern of
management is
maintaining an
adequate service level
in the face of uncertain
demand. The service
level is the complement
of the probability of a
stock out. For instance,
if the probability of a
stock out is 0.05, then
the service level is .95.
3 Reorder Point
Uncertain demand
raises the possibility of
a stock out. One
method of reducing
stock outs is to hold
extra units in inventory.
As we noted earlier such
inventory is referred to
as safety stock.
The inclusion of safety
stock (ss) changes the
expression for reorder
point, which is crucial
for maintaining an
adequate service level
in the face of uncertain
demand.
Calculating Safety Stock
Approach
The objective is to find the
amount of safety stock that
minimizes the sum of the
additional inventory holding
costs and stock out costs.
Solution
We begin by looking at zero
safety stock and then
compare the total costs for
each of the three alternatives
to determine the most
economical decision.
Insight
The optical company now
knows that a safety stock of
20 frames will be the most
economical decision.
Learning Exercise: Inventory Policy
1 Policy Adjustment
When it is difficult or impossible to determine the cost of being out of stock, a manager
may decide to follow a policy of keeping enough safety stock on hand to meet a
prescribed customer service level.

2 Cost Consideration
The cost of the inventory policy increases dramatically with an increase in service levels,
highlighting the importance of finding the right balance between holding costs and stock
out costs.
Probabilistic Demand: Hospital Example

a) What is the appropriate b) How much safety stock c) What reorder point should
value of Z? should the hospital be used?
maintain?
A: Z = 1.645 B: Safety stock = 16.5 kits C: ROP = 366.5, or 367 kits