1. 11-1 Managing Uncertainty in the Supply Chain: Safety Inventory Supply Chain Management

2. 11-2 The Role of Safety Inventory in a Supply Chain uForecasts are rarely completely accurate uIf 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? uIf you kept only enough inventory in stock to satisfy average demand, half the time you would run out uSafety inventory: Inventory carried for the purpose of satisfying demand that exceeds the amount forecasted in a given period

3. 11-3 Role of Safety Inventory uAverage inventory is therefore cycle inventory plus safety inventory uThere 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)

4. 11-4 Two Questions to Answer in Planning Safety Inventory uWhat is the appropriate level of safety inventory to carry? uWhat actions can be taken to improve product availability while reducing safety inventory?

5. 11-5 Determining the Appropriate Level of Safety Inventory uMeasuring demand uncertainty uMeasuring product availability uReplenishment policies uEvaluating cycle service level and uEvaluating safety level given desired cycle service level uImpact of required product availability and uncertainty on safety inventory

6. 11-6 Determining the Appropriate Level of Demand Uncertainty uAppropriate level of safety inventory determined by: –supply or demand uncertainty –desired level of product availability uHigher levels of uncertainty require higher levels of safety inventory given a particular desired level of product availability uHigher levels of desired product availability require higher levels of safety inventory given a particular level of uncertainty

7. 11-7 Measuring Demand Uncertainty uDemand has a systematic component and a random component uThe estimate of the random component is the measure of demand uncertainty uRandom component is usually estimated by the standard deviation of demand uNotation: 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 uUncertainty of demand during lead time is what is important

8. 11-8 Measuring Demand Uncertainty uP = 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

9. 11-9 Measuring Product Availability uProduct availability: a firm’s ability to fill a customer’s order out of available inventory uOrder Fill rate: Fraction of orders filled from available inventory uCycle service level: fraction of replenishment cycles that end with all customer demand met

10. 11-10 Replenishment Policies uReplenishment policy: decisions regarding when to reorder and how much to reorder uContinuous review: inventory is continuously monitored and an order of size Q is placed when the inventory level reaches the reorder point ROP uPeriodic 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)

11. 11-11 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 D L : 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

12. 11-12 1. Weekly demand for Motorola cell phones at a Best Buy store is normally distributed with a mean of 300 and a standard deviation of 200. Motorola takes two weeks to supply a Best Buy order. Best Buy is targeting a cycle service level of 95 percent and monitors its inventory continuously. How much safety inventory of cell phones should Best Buy carry? What should their reorder point be?

13. 11-13 2. Reconsider the Best Buy store in problem 1. The store manager has decided to follow a periodic review policy to manage inventory of cell phones. They plan to order every three weeks. Given a desired cycle service level of 95 percent, how much safety inventory should the store carry? What should their order up to level be?….

14. 11-14 4. Weekly demand for Hewlett Packard printers at a Sam's Club store is normally distributed with a mean of 250 and a standard deviation of 150. The store manager continuously monitors inventory and currently orders a thousand printers each time the inventory drops to 600 printers. Hewlett Packard currently takes two weeks to fill an order. How much safety inventory does the store carry? What cycle service level does Sam's Club achieve as a result of this policy?

15. 11-15 5. Return to the Sam's Club store in problem 4. Assume that the supply lead time from HP is normally distributed with a mean of 2 weeks and a standard deviation of 1.5 weeks. How much safety inventory should Sam's Club carry if they want to provide a cycle service level of 95 percent? How does the required safety inventory change as the standard deviation of lead time is reduced from 1.5 weeks to zero in intervals of 0.5 weeks?

16. 11-16 Impact of Required Product Availability and Uncertainty on Safety Inventory uDesired product availability (cycle service level or fill rate) increases, required safety inventory increases  Demand uncertainty (  L ) increases, required safety inventory increases uManagerial 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)

17. 11-17 Impact of Supply Uncertainty uD: Average demand per period u  D: Standard deviation of demand per period uL: Average lead time u  s L : Standard deviation of lead time

18. 11-18 Impact of Supply Uncertainty Safety inventory when s L = 0 is 1,695 Safety inventory when s L = 1 is 3,625 Safety inventory when s L = 2 is 6,628 Safety inventory when s L = 3 is 9,760 Safety inventory when s L = 4 is 12,927 Safety inventory when s L = 5 is 16,109 Safety inventory when s L = 6 is 19,298

19. 11-19 Impact of Aggregation The Gap has started selling through its online channel along with its retail stores. Management has to decide which products to carry at the retail stores and which products to carry at a central warehouse to be sold only via the online channel. The Gap currently has 900 retail stores in the United States. Weekly demand for large Khaki pants at each store is normally distributed with a mean of 800 and a standard deviation of 100. Each pant costs $30. Weekly demand for purple Cashmere sweaters at each store is normally distributed with a mean of 50 and a standard deviation of 50. Each sweater costs $100. The Gap has a holding cost of 25 percent. The Gap manages all inventories using a continuous review policy and the supply lead-time for both products is 4 weeks. The targeted cycle service level is 95 percent. How much Safety Inventory reduction in holding cost per unit sold can The Gap expect on moving each of the two products from the stores to the online channel? Which of the two products should The Gap carry at the stores and which at the central warehouse for the online channel? Why? Assume demand from one week to the next to be independent.

20. 11-20 Impact of Aggregation InputsKhaki PantsCashmere Sweaters Expected demand 800 50 Lead time4 4 SD of demand per unit time100 50 Target cycle service level0.95 Costs per unit30 100 Holding costs0.25 Number of retail stores 900

21. 11-21 Value of Aggregation at Grainger

22. 11-22 Impact of Aggregation uIf number of independent stocking locations decreases by n, the expected level of safety inventory will be reduced by square root of n (square root law) uMany e-commerce retailers attempt to take advantage of aggregation (Amazon) compared to bricks and mortar retailers (Borders) uAggregation 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

23. 11-23 Information Centralization uVirtual aggregation uInformation system that allows access to current inventory records in all warehouses from each warehouse uMost orders are filled from closest warehouse uIn case of a stockout, another warehouse can fill the order uBetter responsiveness, lower transportation cost, higher product availability, but reduced safety inventory uExamples: Gap, Wal-Mart

24. 11-24 Specialization uStock 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 uBenefits 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)

25. 11-25 Product Substitution uSubstitution: use of one product to satisfy the demand for another product uManufacturer-driven one-way substitution uCustomer-driven two-way substitution

26. 11-26 Component Commonality uUsing common components in a variety of different products uCan be an effective approach to exploit aggregation and reduce component inventories

27. 11-27 Value of Component Commonality

28. 11-28 Postponement uThe ability of a supply chain to delay product differentiation or customization until closer to the time the product is sold uGoal 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 uExamples: Dell, Benetton

29. 11-29 Impact of Replenishment Policies on Safety Inventory uContinuous review policies uPeriodic review policies