Chapter 12
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Managing Uncertainty in a Supply
Chain: Safety Inventory
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
The Role of Safety Inventory
• Safety inventory is carried to satisfy demand that exceeds the
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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
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
The Role of Safety Inventory
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Figure 12-1
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Determining the Appropriate Level
• Determined by two factors
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The uncertainty of both demand and supply
The desired level of product availability
• Measuring Demand Uncertainty
D= Average demand per period
sD = 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
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Evaluating Demand Distribution Over L
Periods
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L L
2
DL =å Di sL = ås i
+ 2å rijs is j
i=1 i=1 i> j
DL =DL s L = Ls D
The coefficient of variation
cv =s / m
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Measuring Product Availability
• Product fill rate (fr)
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Fraction of product demand satisfied from product in inventory
• Order fill rate
Fraction of orders filled from available inventory
• Cycle service level (CSL)
Fraction of replenishment cycles that end with all customer
demand being met
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Replenishment Policies
• Continuous review
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Inventory is continuously tracked
Order for a lot size Q is placed when the inventory declines to the
reorder point (ROP)
• Periodic review
Inventory status is checked at regular periodic intervals
Order is placed to raise the inventory level to a specified
threshold
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Evaluating Safety Inventory Given
Desired Cycle Service Level
Desired cycle service level = CSL
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Mean demand during lead time = DL
Standard deviation of demand during lead time = σL
Probability(demand during lead time ≤ DL + ss) = CSL
• Identify safety inventory so that
F(DL + ss, DL, sL) = CSL
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Evaluating Safety Inventory Given
Desired Cycle Service Level
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DL + ss =F –1(CSL, DL ,s L ) =NORMINV(CSL, DL ,s L )
or
ss =F –1(CSL, DL ,s L ) – DL =NORMINV(CSL, DL ,s L ) – DL
ss =FS–1(CSL) ´s L =FS–1(CSL) ´ Ls D
=NORMSINV(CSL) ´ Ls D
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
• P= 0.7778;
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• Look up critical ratio in the Standard Normal Distribution Function
Table: z 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
–Ifthe critical ratio falls between two values in the table, choose the greater z-
statistic
–Choose z = 0.77
Q =m + z ´s
=3192 + 0.77 ´1181 =4101
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Evaluating Safety Inventory Given
Desired Cycle Service Level
Q = 10,000, CSL = 0.9, L = 2 weeks
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D = 2,500/week, sD = 500
DL =DL =2 ´2,500 =5,000
s L = LSD = 2 ´500 =707
ss =Fs–1(CSL) ´s L =NORMSINV(CSL) ´s L
=NORMSINV(0.90) ´707 =906
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Desired Product Availability
and Uncertainty
• As desired product availability goes up the required safety
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inventory increases
Fill Rate Safety Inventory
97.5% 67
98.0% 183
98.5% 321
99.0% 499
99.5% 767
Table 12-1
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Desired Product Availability
and Uncertainty
• Goal is to reduce the level of safety inventory required in a way
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that does not adversely affect product availability
Reduce the supplier lead time L
Reduce the underlying uncertainty of demand (represented by
s D)
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Benefits of Reducing Lead Time
D = 2,500/week, sD = 800, CSL = 0.95
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SS =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
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Supply Uncertainty
on Safety Inventory
• We incorporate supply uncertainty by assuming that lead time is
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uncertain
D: Average demand per period
sD: Standard deviation of demand per period
L: Average lead time for replenishment
sL: Standard deviation of lead time
DL =DL s L = Ls D2 + D2 sL2
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Lead Time Uncertainty
on Safety Inventory
Average demand per period, D = 2,500
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Standard deviation of demand per period, sD = 500
Average lead time for replenishment, L = 7 days
Standard deviation of lead time, sL = 7 days
Mean ddlt, DL = DL = 2,500 x 7 = 17,500
Standard deviation of ddlt s L = Ls D2 + D2 sL2
= 7 ´5002 + 2,5002 ´72
=17,500
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Lead Time Uncertainty
on Safety Inventory
• Required safety inventory
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ss =FS–1(CSL) ´s L =NORMSINV(CSL) ´s L
=NORMSINV(0.90) ´17,500
=22,491 hard drives
sL sL ss (units) ss (days)
6 15,058 19,298 7.72
5 12,570 16,109 6.44
4 10,087 12,927 5.17
3 7,616 9,760 3.90
2 5,172 6,628 2.65
1 2,828 3,625 1.45
0 1,323 1,695 0.68 Table 12-2
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Aggregation on
Safety Inventory
• How does aggregation affect forecast accuracy and safety
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inventories
Di: Mean weekly demand in region i, i = 1,…, k
si: Standard deviation of weekly demand in region i, i = 1,…, k
rij: Correlation of weekly demand for regions i, j,
1≤i≠j≤k
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Aggregation on
Safety Inventory
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Total safety inventory in =å FS–1(CSL) ´ L ´s i
decentralized option i=1
k
k
DC =å Di ;
i=1 ( )
var DC =å s i2 + 2å rijs is j ;
i=1 i> j
s DC = var DC ( )
DC =kD s DC = ks D
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Aggregation on
Safety Inventory
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k
Require safety inventory on
aggregation =å FS–1(CSL) ´ L ´s DC
i=1
Holding-cost savings on aggregation per unit sold
FS–1(CSL) ´ L ´H æ k
C
ö
= ´çç å s i – s D ÷÷
DC è i=1 ø
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Aggregation on
Safety Inventory
• The safety inventory savings on aggregation increase with the
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desired cycle service level CSL
• The safety inventory savings on aggregation increase with the
replenishment lead time L
• The safety inventory savings on aggregation increase with the
holding cost H
• The safety inventory savings on aggregation increase with the
coefficient of variation of demand
• The safety inventory savings on aggregation decrease as the
correlation coefficients increase
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Aggregation on
Safety Inventory
• The Square-Root Law
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Figure 12-4
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Correlation on
Value of Aggregation
Standard deviation of weekly demand, sD = 5;
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Replenishment, L = 2 weeks; Decentralized CSL = 0.9
Total required safety inventory,
ss =k ´Fs–1(CSL) ´ L ´s D
=4 ´Fs–1(0.9) ´ 2 ´5
=4 ´NORMSINV(0.9) ´ 2 ´5 =36.24 cars
Aggregate r = 0
Standard deviation of weekly
demand at central outlet, s DC = 4 ´5 =10
ss =Fs–1(0.9) ´ L ´s DC =NORMSINV(0.9) ´ 2 ´10 =18.12
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Correlation on
Value of Aggregation
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Disaggregate Aggregate
r Safety Inventory Safety Inventory
0 36.24 18.12
0.2 36.24 22.92
0.4 36.24 26.88
0.6 36.24 30.32
0.8 36.24 33.41
1.0 36.24 36.24
Table 12-3
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Impact of Correlation on
Value of Aggregation
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• Two possible disadvantages to aggregation
Increase in response time to customer order
Increase in transportation cost to customer
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Trade-offs of Physical Centralization
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• Use four regional or one national distribution center
D = 1,000/week, sD = 300, L = 4 weeks, CSL = 0.95
• Four regional centers
Total required
safety inventory, ss=4 ´Fs–1(CSL) ´ L ´s D
=4 ´NORMSINV(0.95) ´ 4 ´300 =3,948
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Trade-offs of Physical Centralization
• One national distribution center, r = 0
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Standard deviation of weekly
demand, s DC = 4 ´300 =600
ss =Fs–1(0.95) ´ L ´s DC
=NORMSINV(0.95) ´ 4 ´600 =1,974
Decrease in holding costs = (3,948 – 1,974) $1,000 x 0.2
= $394,765
Decrease in facility costs = $150,000
Increase in transportation = 52 x 1,000 x (13 – 10) = $624,000
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Information Centralization
• Online systems that allow customers or stores to locate stock
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• Improves product availability without adding to inventories
• Reduces the amount of safety inventory
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Component Commonality
• Without common components
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Uncertainty of demand for a component is the same as for the
finished product
Results in high levels of safety inventor
• With common components
Demand for a component is an aggregation of the demand for
the finished products
Component demand is more predictable
Component inventories are reduced
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Value of Component Commonality
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27 PCs, 3 components, 3 x 27 = 81 distinct components
Monthly demand = 5,000
Standard deviation = 3,000
Replenishment lead time = 1 month
CSL = 0.95
Total safety inventory =81´NORMSINV(0.95) ´ 1´3,000
required
=399,699 units
Safety inventory per
common component =NORMSINV(0.95) ´ 1´ 9 ´3,000
=14,804 units
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Value of Component Commonality
• With component commonality
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• Nine distinct components
Total safety inventory required = 9 x 14,804 = 133,236
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Value of Component Commonality
Number of Finished Safety Marginal Total Reduction
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Products per Inventory Reduction in in Safety
Component Safety Inventory
Inventory
1 399,699
2 282,630 117,069 117,069
3 230,766 51,864 168,933
4 199,849 30,917 199,850
5 178,751 21,098 220,948
6 163,176 15,575 236,523
7 151,072 12,104 248,627
8 141,315 9,757 258,384
9 133,233 8,082 266,466
Table 12-5
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Postponement
• Delay product differentiation or customization until closer to the
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time the product is sold
Have common components in the supply chain for most of the
push phase
Move product differentiation as close to the pull phase of the
supply chain as possible
Inventories in the supply chain are mostly aggregate
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Postponement
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Figure 12-5
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
Evaluation Safety Inventory for a Periodic
Review Policy
D = 2,500, sD = 500, L = 2 weeks, T = 4 weeks
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Mean demand during T + L periods, DT+L =(T + L)D
=(2 + 4)2,500 =15,000
Std dev demand during T + L periods, s T+L = T + Ls D
= ( )
4 + 2 500 =1,225
ss =FS–1(CSL) ´s D+L =NORMSINV(CSL) ´s T+L
=NORMSINV(0.90) ´1,225 =1,570 boxes
OUL =DT+L + ss =15,000 +1,570 =16,570
Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra
