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    2.0 Managing Uncertainty in Demand With Safety Stock

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    saswat1953419
    Safety inventory is inventory carried for the purpose of satisfying demand that exceeds the amount forecast in a given period. There is a fundamental tradeoff: - Raising the level of safety inventory provides higher levels of product availability and customer service - Raising the level of average inventory also increases holding costs. What actions can be taken to improve product availability while reducing safety inventory?

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    2.0 Managing Uncertainty in Demand With Safety Stock

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    saswat1953419
    120 views19 pages
    Safety inventory is inventory carried for the purpose of satisfying demand that exceeds the amount forecast in a given period. There is a fundamental tradeoff: - Raising the level of safety inventory provides higher levels of product availability and customer service - Raising the level of average inventory also increases holding costs. What actions can be taken to improve product availability while reducing safety inventory?

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    Safety inventory is inventory carried for the purpose of satisfying demand that exceeds the amount forecast in a given period. There is a fundamental tradeoff: - Raising the level of safety inventory provides higher levels of product availability and customer service - Raising the level of average inventory also increases holding costs. What actions can be taken to improve product availability while reducing safety inventory?

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    120 views19 pages

    2.0 Managing Uncertainty in Demand With Safety Stock

    Uploaded by

    saswat1953419
    Safety inventory is inventory carried for the purpose of satisfying demand that exceeds the amount forecast in a given period. There is a fundamental tradeoff: - Raising the level of safety inventory provides higher levels of product availability and customer service - Raising the level of average inventory also increases holding costs. What actions can be taken to improve product availability while reducing safety inventory?

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    You are on page 1of 19

    Managing Uncertainty in the g g y Supply Chain: Safety Inventory

    2007 Pearson Education

    11-1

    Role of Inventory in the Supply Chain


    Improve Matching of Supply and Demand Improved Forecasting Reduce Material Flow Time Reduce Waiting Time Reduce Buffer Inventory

    Economies of Scale Cycle Inventory


    2007 Pearson Education

    Supply / Demand Variability Safety Inventory

    Seasonal Variability Seasonal Inventory


    11-2

    Outline
    The role of safety inventory in a supply chain Determining the appropriate level of safety inventory Impact of supply uncertainty on safety inventory Impact of aggregation on safety inventory Impact of replenishment policies on safety inventory Managing safety inventory in a multi echelon supply multi-echelon chain Estimating and managing safety inventory in practice

    2007 Pearson Education

    11-3

    The Role of Safety Inventory in a Supply Chain


    Forecasts are rarely completely accurate If average demand is 1000 units per week, then half the time actual demand will be greater than 1000, and half the time actual demand will be less than 1000; what happens when actual demand is greater than 1000? If you kept only enough inventory in stock to satisfy k l hi i k if average demand, half the time you would run out Safety inventory: Inventory carried for the purpose of satisfying demand that exceeds the amount forecasted in a given period 2007 Pearson Education

    11-4

    Role of Safety Inventory


    Average inventory is therefore cycle inventory plus safety inventory f t i t There is a fundamental tradeoff:
    Raising the level of safety inventory provides higher levels of product availability and customer service Raising the level of safety inventory also raises the level of average inventory and therefore increases holding costs
    Very important in high-tech or other industries where obsolescence is a significant risk (where the value of inventory, such as PCs, can drop in value) Compaq and Dell in PCs
    2007 Pearson Education 11-5

    Two Questions to Answer in Planning Safety Inventory


    What is the appropriate level of safety inventory to t carry? ? What actions can be taken to improve product availability while reducing safety inventory?

    2007 Pearson Education

    11-6

    Determining the Appropriate Level of Safety Inventory


    Measuring demand uncertainty Measuring product availability Replenishment policies Evaluating cycle service level and fill rate Evaluating safety level given desired cycle service level or fill rate Impact of required product availability and uncertainty on safety inventory

    2007 Pearson Education

    11-7

    Determining the Appropriate Level of Demand Uncertainty


    Appropriate level of safety inventory determined by:
    supply or demand uncertainty 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
    2007 Pearson Education

    11-8

    Measuring Demand Uncertainty


    Demand has a systematic component and a random component The estimate of the random component is the measure of p demand uncertainty Random component is usually estimated by the standard deviation of demand Notation: D = Average demand per period D = standard deviation of demand per period L = lead time = time between when an order is placed and when it is received Uncertainty of demand during lead time is what is important
    2007 Pearson Education 11-9

    Measuring Demand Uncertainty


    P = demand during k periods = kD = std dev of demand during k periods = D Sqrt(k) Coefficient of variation = cv = / = mean/(std dev) = size of uncertainty relative to demand

    2007 Pearson Education

    11-10

    Measuring Product Availability


    Product availability: a firms ability to fill a customer s customers order out of available inventory Stockout: a customer order arrives when product is not available Product fill rate (fr): fraction of demand that is satisfied from product in inventory Order O d fill rate: f i of orders that are filled from fraction f d h fill d f available inventory Cycle service level: fraction of replenishment cycles that end with all customer demand met
    2007 Pearson Education 11-11

    Replenishment Policies
    Replenishment policy: decisions regarding when to reorder and how much to reorder d dh ht d 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) i ( i di ) intervals and an order is placed to raise the l d d i l d i h inventory to a specified threshold (the order-up-to level)

    2007 Pearson Education

    11-12

    Continuous Review Policy: Safety Inventory and Cycle Service Level


    L: Lead time for replenishment D: Average demand per unit time D:Standard deviation of demand per period DL: Mean demand during lead time L: Standard deviation of demand during lead time CSL: Cycle service level ss: Safety inventory ROP: Reorder point
    2007 Pearson Education

    = DL = L D
    1

    ss = F S (CSL) L ROP = D L + ss

    CSL = F ( ROP, D L , L )
    Average Inventory = Q/2 + ss
    11-13

    Example 11.1: Estimating Safety Inventory (Continuous Review Policy)


    D = 2,500/week; D = 500 L = 2 weeks; Q = 10,000; ROP = 6,000
    DL = DL = (2500)(2) = 5000 ss = ROP - DL = 6000 - 5000 = 1000 Cycle inventory = Q/2 = 10000/2 = 5000 Average Inventory = cycle inventory + ss = 5000 + 1000 = 6000 Average Flow Time = Avg inventory / throughput = 6000/2500 = 2.4 weeks

    2007 Pearson Education

    11-14

    Example 11.2: Estimating Cycle Service Level (Continuous Review Policy)


    D = 2,500/week; D = 500 L = 2 weeks; Q = 10,000; ROP = 6,000

    =D
    L

    L = (500) 2 = 707

    Cycle service level, CSL = F(DL + ss, DL, L) = y , ( , = NORMDIST (DL + ss, DL, L) = NORMDIST(6000,5000,707,1)

    = 0.92 (This value can also be determined from a Normal probability distribution table)
    2007 Pearson Education 11-15

    Fill Rate
    Proportion of customer demand satisfied from stock Stockout occurs when the demand during lead time exceeds the reorder point ESC is the expected shortage per cycle (average demand in excess of reorder point in each replenishment cycle) ss is the safety inventory Q is the order quantity

    f fr = 1

    ESC Q

    ss ESC = ss{1 F S } L ss + L f S L

    ESC = -ss{1-NORMDIST(ss/L, 0, 1, 1)} + L NORMDIST(ss/ L, 0, 1, 0)


    2007 Pearson Education 11-16

    Example 11.3: Evaluating Fill Rate


    ss = 1,000, Q = 10,000, L = 707, Fill Rate (fr) = ? ESC = -ss{1-NORMDIST(ss/L, 0 1, 1)} + {1 NORMDIST( / 0, 1 L NORMDIST(ss/L, 0, 1, 0) = -1,000{1-NORMDIST(1,000/707, 0, 1, 1)} + 707 NORMDIST(1,000/707, 0, 1, 0) = 25.13 fr = (Q - ESC)/Q = (10,000 - 25.13)/10,000 = 0.9975
    2007 Pearson Education 11-17

    Factors Affecting Fill Rate


    Safety inventory: Fill rate increases if safety inventory is increased. This also increases the i t i i d Thi l i th cycle service level. Lot size: Fill rate increases on increasing the lot size even though cycle service level does not change.

    2007 Pearson Education

    11-18

    Example 11.4: Evaluating Safety Inventory Given CSL


    D = 2,500/week; D = 500 L = 2 weeks; Q = 10,000; CSL = 0.90 DL = 5000, L = 707 (from earlier example) ss = FS-1(CSL)L = [NORMSINV(0.90)](707) = 906 (this value can also be determined from a Normal probability distribution table) ROP = DL + ss = 5000 + 906 = 5906
    2007 Pearson Education 11-19

    Evaluating Safety Inventory Given Desired Fill Rate


    D = 2500, D = 500, Q = 10000 If desired fill rate is fr = 0.975, how much safety 0 975 inventory should be held? ESC = (1 - fr)Q = 250 Solve ss ss + L f S ESC = 250 = ss 1 F S L L
    ss ss 250 = ss 1 NORMSDIST + L NORMDIST ,1,1,0 L L
    2007 Pearson Education 11-20

    10

    10

    Evaluating Safety Inventory Given Fill Rate (try different values of ss)
    F ill R ate 97.5% 98.0% 98.5% 99.0% 99.5%
    2007 Pearson Education

    Safety In ven tory 67 183 321 499 767


    11-21

    Impact of Required Product Availability and Uncertainty on Safety Inventory


    Desired product availability (cycle service level or fill rate) increases, required safety inventory increases t )i i d f t i t i Demand uncertainty (L) increases, required safety inventory increases Managerial levers to reduce safety inventory without reducing product availability
    reduce supplier lead time, L (better relationships with suppliers) reduce uncertainty in demand, L (better forecasts, better information collection and use)
    2007 Pearson Education 11-22

    11

    11

    Impact of Supply Uncertainty


    D: Average demand per period D: Standard deviation of demand per period L: Average lead time sL: Standard deviation of lead time

    D
    2007 Pearson Education

    = DL
    2 2

    L = L D + D

    2 L
    11-23

    Impact of Supply Uncertainty


    D = 2,500/day; D = 500 L = 7 days; Q = 10 000; CSL = 0 90; sL = 7 days 10,000; 0.90; DL = DL = (2500)(7) = 17500
    2 = L 2 + D 2 sL D L

    = (7) 5002 + (2500)2 (7)2 = 17500


    ss = F-1s(CSL)L = NORMSINV(0.90) x 17550 = 22,491
    2007 Pearson Education 11-24

    12

    12

    Impact of Supply Uncertainty


    Safety inventory when sL = 0 is 1,695 Safety inventory when sL = 1 is 3,625 Safety inventory when sL = 2 is 6,628 Safety inventory when sL = 3 is 9,760 Safety inventory when sL = 4 is 12,927 Safety inventory when sL = 5 is 16,109 16 109 Safety inventory when sL = 6 is 19,298

    2007 Pearson Education

    11-25

    Impact of Aggregation on Safety Inventory


    Models of aggregation Information centralization Specialization Product substitution Component commonality Postponement

    2007 Pearson Education

    11-26

    13

    13

    Impact of Aggregation
    If number of independent stocking locations decreases by n, the expected level of safety inventory n will be reduced by square root of n (square root law) Many e-commerce retailers attempt to take advantage of aggregation (Amazon) compared to bricks and mortar retailers (Borders) Aggregation has two major disadvantages:
    Increase in response time to customer order Increase in transportation cost to customer Some e-commerce firms (such as Amazon) have reduced aggregation to mitigate these disadvantages
    2007 Pearson Education 11-27

    Information Centralization
    Virtual aggregation Information system that allows access to current y inventory records in all warehouses from each warehouse Most orders are filled from closest warehouse In case of a stockout, another warehouse can fill the order Better responsiveness, lower transportation cost, higher product availability, but reduced safety inventory Examples: McMaster-Carr, Gap, Wal-Mart
    2007 Pearson Education 11-28

    14

    14

    Specialization
    Stock all items in each location or stock different items at different locations?
    Different products may have different demands in different locations (e.g., snow shovels) There can be benefits from aggregation

    Benefits of aggregation can be affected by:


    coefficient of variation of demand (higher cv yields greater reduction in safety inventory from centralization) value of item (high value items provide more benefits from centralization) Table 11.4
    2007 Pearson Education 11-29

    Value of Aggregation at Grainger (Table 11.4)


    Motors Mean demand 20 SD of demand 40 Disaggregate cv 2 Value/Unit $500 Disaggregate ss $105,600,000 Aggregate cv 0.05 Aggregate ss $2,632,000 Holding Cost $25,742,000 Saving Saving / Unit $7.74
    2007 Pearson Education

    Cleaner 1,000 , 100 0.1 $30 $15,792,000 0.0025 $394,770 $3,849,308 $0.046
    11-30

    15

    15

    Product Substitution
    Substitution: use of one product to satisfy the demand for f another product th d t Manufacturer-driven one-way substitution Customer-driven two-way substitution

    2007 Pearson Education

    11-31

    Component Commonality
    Using common components in a variety of different products diff t d t Can be an effective approach to exploit aggregation and reduce component inventories

    2007 Pearson Education

    11-32

    16

    16

    Example 11.9: Value of Component Commonality


    450000 400000 350000 300000 250000 200000 150000 100000 50000 0 1 2 3 4 5 6 7 8 9

    SS

    2007 Pearson Education

    11-33

    Postponement
    The ability of a supply chain to delay product differentiation or customization until closer to the diff ti ti t i ti til l t th time the product is sold Goal is to have common components in the supply chain for most of the push phase and move product differentiation as close to the pull phase as possible Examples: Dell, Benetton

    2007 Pearson Education

    11-34

    17

    17

    Impact of Replenishment Policies on Safety Inventory


    Continuous review policies Periodic review policies

    2007 Pearson Education

    11-35

    Estimating and Managing Safety Inventory in Practice


    Account for the fact that supply chain demand is lumpy Adjust inventory policies if demand is seasonal Use simulation to test inventory policies Start with a pilot Monitor service levels Focus on reducing safety inventories

    2007 Pearson Education

    11-36

    18

    18

    Summary of Learning Objectives


    What is the role of safety inventory in a supply chain? What are the factors that influence the required level of safety inventory? What are the different measures of product availability? What managerial levers are available to lower safety inventory and improve product availability?

    2007 Pearson Education

    11-37

    19

    19

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