Session 6

Safety inventory is carried to satisfy
demand that exceeds the amount

forecasted
Raising the level of safety inventory

increases product availability and thus
the margin captured from customer
purchases
Raising the level of safety inventory
increases inventory holding costs
A LWAY S L E A R N I N G
PEARSON
Supply Chain Management, 6e
Copyright 2016 Pearson Education, Inc.
Sunil Chopra, Peter Meindl, Dharam Vir Kalra

12 1
"Copyright 2016 Pearson India Education Services Pvt. Ltd".
The Role of Safety Inventory
FIGURE 12-1
PEARSON

12 2
Three key questions

1. What is the appropriate level of product
availability?
2. How much safety inventory is needed
for the desired level of product
availability?
3. What actions can be taken to reduce
safety inventory without hurting
product availability?
PEARSON

12 3
Determined by two factors
The uncertainty of both demand and

supply
The desired level of product availability
Measuring Demand Uncertainty
D = Average demand per period

D = Standard deviation of demand
(forecast error) per period
Lead time (L) is the gap between when an
order is placed and when it is received
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The Level of Safety Inventory
DL Di
i1
i 2 ij i j
i1
DL DL
Evaluating Demand
Distribution
Over L Periods
i j
L L D
The coefficient of variation
cv /
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1. Product fill rate (fr)

Fraction of product demand satisfied
from
product in inventory
2. Order fill rate

Fraction of orders filled from available
inventory
3. Cycle service level (CSL)

Fraction of replenishment cycles that end
with Supply Chain Management, 6e
P E A R Sall
O N customer demand being met
12 6
Measuring Product
Availability
1. Product fill rate (fr)
Measuring Product
Availability
Fraction of product demand satisfied from

product in inventory
replenishment
cycle the
2. Order fill
rate
interval
between
two
successive
Fraction of orders filled from available inventory
replenishment deliveries
3. Cycle service level (CSL)
Fraction of replenishment cycles that end with

all customer demand being met
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1. Continuous review
Inventory is continuously tracked
Order for a lot size Q is placed when the
inventory declines to the reorder point
(ROP)
2. Periodic review
Inventory status is checked at regular
periodic intervals
Order is placed to raise the inventory
level toSupply
a specified
threshold
Chain Management, 6e
PEARSON
12 8
Replenishment Policies
Determining the
Appropriate Level of Safety
Inventory
Evaluating Safety Inventory
Given a Replenishment Policy
Expected demand during lead time = D x L

Safety inventory, ss = ROP D x L
PEARSON

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Average demand per week, D = 2,500

Standard deviation of weekly demand, D = 500
Average lead time for replenishment, L = 2 weeks
Reorder point, ROP = 6,000
Average lot size, Q = 10,000
Safety inventory, ss = ROP DL = 6,000 5,000 = 1,000

Cycle inventory = Q/2 = 10,0002 = 5,000
PEARSON

12 10
Determining the
Inventory
Average inventory
= cycle inventory + safety inventory
= 5,000 + 1,000 = 6,000

Average flow time
= average inventory/throughput
= 6,000/2,500 = 2.4 weeks
PEARSON

12 11
Determining the
Inventory
Evaluating Cycle Service Level

Given a Replenishment Policy
CSL = Prob(ddlt of L weeks ROP)
CSL = F(ROP, DL, L) = NORMDIST(ROP, DL, L, 1)
(ddlt = demand during lead time)

PEARSON

12 12
Determining the
Inventory
Q = 10,000, ROP = 6,000, L = 2 weeks

D = 2,500/week, D = 500
DL D L 2 2,500 5,000
L L D 2 500 707
CSL = F(ROP, DL, L) = NORMDIST(ROP, DL, L, 1)
= NORMDIST(6,000, 5,000, 707, 1) = 0.92
PEARSON

12 13
Determining the
Inventory
Given a Desired Cycle Service Level
Desired cycle service level = CSL

Mean demand during lead time = DL
Standard deviation of demand during lead time = L
Probability(demand during lead time DL + ss) =
CSL
Identify safety inventory ss so that

F(DL + ss, DL, sL) = CSL
PEARSON

12 14
Determining the
Inventory
Evaluating Required Safety Inventory
DL ss F 1(CSL, DL , L ) NORMINV(CSL, DL , L )
or
ss F 1(CSL,DL , L ) DL NORMINV(CSL, DL , L ) DL
ss FS1(CSL) L FS1(CSL) L D
NORMSINV(CSL) L D
PEARSON

12 15
Determining the
Inventory
Determining the
Inventory
D = 2,500/week, D = 500, CSL = 0.9, L = 2
weeks
DL DL 2 2,500 5,000
L L D 2 500 707
ss Fs1(CSL) L NORMSINV(CSL) L
NORMSINV(0.90) 707 906
PEARSON

12 16
Evaluating Fill Rate Given a

Replenishment Policy
Expected shortage per
replenishment cycle (ESC) is the

average units of demand that are
not satisfied from inventory in
stock per replenishment cycle
Product fill rate
fr = 1 ESC/Q = (Q ESC)/Q
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12 17
ESC
xROP

(x ROP) f (x) dx
ss
ss
ESC ss 1 Fs
L fs
L
L
ESC ss[1 NORMDIST(ss/ L ,0,1,1)]

L NORMDIST(ss/ L ,0,1,0)
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12 18
Lot size, Q = 10,000

Average demand during lead time, DL = 5,000
Standard deviation of demand during lead time, L = 707

Safety inventory, ss = ROP DL = 6,000 5,000 = 1,000
ESC 1,000[1 NORMDIST(1,000 / 707,0,1,1)]

707NORMDIST(1,000 / 707,0,1,0) 25
fr = (Q ESC)/Q = 110,000 252/10,000 = 0.9975
PEARSON

12 19

FIGURE 12-2
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Key Point
Both fill rate and cycle service
level increase as the safety
inventory is increased. For the
same safety inventory, an
increase in lot size increases the
fill rate but not the cycle service
level.
PEARSON

12 21
Evaluating Safety Inventory Given

Desired Fill Rate
Expected shortage per replenishment

cycle is
ESC = (1 fr)Q
No equation for ss
Try values or use GOALSEEK in Excel
PEARSON

12 22

Desired Fill Rate
Desired fill rate, fr = 0.975
Lot size, Q = 10,000 boxes
2 500 707
L
Standard deviation of
ddlt,
ESC = (1 fr)Q = (1 0.975)10,000 = 250
PEARSON

12 23

Desired Fill Rate
ss
ss
L fs
L
L
ESC 250 ss 1 Fs
ss 1 Fs
ss
ss
707 fs
707
707
250 ss[1 NORMDIST(ss/ 707,0,1,1)]

707NORMDIST(ss/ 707,0,1,0)
Use GOALSEEK to find safety inventory ss = 67 boxes
PEARSON

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Desired Fill Rate
FIGURE 12-3
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As desired product availability goes

up the required safety inventory
increases
Fill Rate
97.5%
98.0%
98.5%
99.0%
99.5%
PEARSON
Safety
Inventory
67
183
321
499
767
TABLE 12-1

12 26
Impact of Desired Product

Availability and Uncertainty
Key Point
The required safety inventory
grows rapidly with an increase in
the desired product availability.
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Key Point
The required safety inventory
increases with an increase in the
lead time and the uncertainty of
periodic demand.
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Goal is to reduce the level of
safety inventory required in a way

that does not adversely affect
product availability
1. Reduce the supplier lead time L
2. Reduce the underlying uncertainty
of demand (represented by D)
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12 29
Impact of Desired Product

Availability and Uncertainty
Benefits of Reducing Lead

Time
D = 2,500/week, D = 800, CSL = 0.95
ss NORMSINV(CSL) L D
NORMSINV(.95) 9 800 3,948
If lead time is reduced to one week

ss NORMSINV(.95) 1 800 1,316
If standard deviation is reduced to 400

ss NORMSINV(.95) 9 400 1,974
PEARSON

12 30

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Safety inventory is carried to satisfy

demand that exceeds the amount

Raising the level of safety inventory

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

The Role of Safety Inventory

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

The Role of Safety Inventory

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

Three key questions

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

The Role of Safety Inventory

Determined by two factors

The uncertainty of both demand and

Measuring Demand Uncertainty

D = Average demand per period

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

The Level of Safety Inventory

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

The coefficient of variation

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

1. Product fill rate (fr)

2. Order fill rate

3. Cycle service level (CSL)

Copyright 2016 Pearson Education, Inc.

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

1. Product fill rate (fr)

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

Fraction of product demand satisfied from

3. Cycle service level (CSL)

Fraction of replenishment cycles that end with

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

Copyright 2016 Pearson Education, Inc.

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

Evaluating Safety Inventory

Given a Replenishment Policy

Expected demand during lead time = D x L

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

Average demand per week, D = 2,500

Safety inventory, ss = ROP DL = 6,000 5,000 = 1,000

Supply Chain Management, 6e

Copyright 2016 Pearson Education, Inc.

Sunil Chopra, Peter Meindl, Dharam Vir Kalra

"Copyright 2016 Pearson India Education Services Pvt. Ltd".

= cycle inventory + safety inventory

= 5,000 + 1,000 = 6,000

= 6,000/2,500 = 2.4 weeks