Logistics and Supply
Chain Management
TOPIC 11: SAFETY INVENTORY –
MANAGING UNCERTAINTIES MS. BING HAN
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Week 9 – timetable
Wed 19:20 -20:55
Fri 16:35 – 17:20
Topic 11 (Recorded)
Fri 17:25 – 18:10
Tutorial 5
EBU6609 L&SCM
EBU6609 LOGISTICS AND SUPPLY CHAIN MANAGEMENT
Learning Objectives
1. Whatistheroleofsafetyinventoryinasupplychain?
2. Whatarethefactorsthatinfluencetherequiredlevelof
safety inventory?
3. Whatarethedifferentmeasuresofproductavailability?
4. Whatmanagerialleversareavailabletolowersafety inventory and improve product availability?
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Role of Inventory in the Supply Chain
Seasonal Inventory
Improve Matching of Supply and Demand
Improved Forecasting
Reduce Material Flow Time
Reduce Waiting Time
Reduce Buffer Inventory
Supply / Demand V ariability
Seasonal V ariability
Economies of Scale
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Cycle Inventory
Safety Inventory
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Role of Safety Inventory
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 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
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Role of Safety Inventory
Safety inventory is carried because product demand and lead time are uncertain and a product shortage may result if actual demand during lead time exceeds the forecast amount.
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Safety Inventory
Average inventory is therefore cycle inventory plus safety inventory
◦ it tends to have a negative impact on supply chain cost but a positive impact on supply chain responsiveness/availability
There is a fundamental trade-off:
◦ 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
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Safety Inventory – obsolescence
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 very quickly)
◦Compaq and Dell in PCs
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Two Questions to Answer in Planning Safety Inventory:
What is the appropriate level of safety inventory to carry?
What actions can be taken to improve product availability while reducing safety inventory?
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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
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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
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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
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Measuring Demand Uncertainty (cont’d)
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
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Measuring Demand Uncertainty Demand during L periods = LD
L = std dev of demand during L periods = LSqrt(L)
Coefficient of variation = cv = = stddev/mean = size of uncertainty relative to demand
is commonly notated as L We will use the designation of L
EBU6609 LOGISTICS AND SUPPLY CHAIN MANAGEMENT
Measuring Product Availability
Product availability: a firm’s ability to fill a customer’s order out of available inventory
Stockout/backlog: a customer order arrives when product is notavailable
◦ Product fill rate (fr): fraction of demand that is satisfied from product in inventory
◦ Order fill rate: fraction of orders that are filled from available inventory
◦ Cycle service level: fraction of replenishment cycles that end with all customer demand met
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Replenishment Policies
Replenishment policy: 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)
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Continuous Review Policy: Safety Inventory and Cycle Service Level
DL DL L LD
ss F1(CSL) SL
ROP DL ss
CSLF(ROP,D , )
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
Average Inventory = Q/2 + ss
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Example 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
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Factors Affecting Fill Rate
Safety inventory: Fill rate increases if safety inventory is increased. This also increases the cycle service level.
Lot size: Fill rate increases on increasing the lot size even though cycle service level does not change.
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Impact of Product Availability
Impact of Required Product Availability and Uncertainty on Safety Inventory:
◦Desired product availability (cycle service level or fill rate) increases, required safety inventory increases
◦Demand uncertainty (L) increases, required safety inventory increases
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Impact of Product Availability (cont’d)
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)
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Information Centralisation
Virtual aggregation
Information system that allows access to current 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
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Information Centralisation (cont’d)
Better responsiveness, lower transportation cost, higher product availability, but reduced safety inventory
Examples: McMaster-Carr, Gap, Wal- Mart
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Specialisation
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
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Specialisation
Benefits of aggregation can be affected by:
◦coefficient of variation of demand (higher cv yields greater reduction in safety inventory from centralisation)
◦value of item (high value items provide more benefits from centralisation)
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Product Substitution
Substitution: use of one product to satisfy the demand for another product
Manufacturer-driven one-way substitution Customer-driven two-way substitution
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Component Commonality
Using common components in a variety of different products
Can be an effective approach to exploit aggregation and reduce component inventories
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Postponement
The ability of a supply chain to delay product differentiation or customisation until closer to the 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
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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
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Dynamics of Promotional Activity
BASE CASE:
◦ Weekly demand = 100 units
◦ 3 weeks’ target cover = 300 units
PROMOTIONAL UPLIFT:
◦ 10% anticipated sales gain = 110 units
EFFECT ON INVENTORY:
◦ New target cover 110 x 3 = 330 units
◦ Therefore order 140 units (to meet new sales level of 110 plus extra 30 required to meet new starting level)
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Projected sales uplift of 10% has resulted in a one-off demand increase of 40% on supplier
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EBU6609 LOGISTICS AND SUPPLY CHAIN MANAGEMENT
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