Determining the optimal level of seryice (product availability)

The levei of product availability is measured using CSL (cycle Service Level) or the fillrate.

company can use a high level of product availability to improve its responsiveness and thus attracting the customers, which in turn, increases the revenue. However, a high level of product

availability requires large inventories and hence increased costs. Therefore the company must
strike
a

balance between the level of availability and the cost of inventory.

In this note, we focus on the products that are ordered repeatedly and safety stock (SS) is used

to

increase the level

of availability

and decrease the probability

of

stocking out between

successive del iveries.

Most safety stock decisions are based on a more or less arbitrary level of protection (95% CSL in the textbook examples is a case in point). How do we set this level? If the inventory control
manager increases the level

of safety inventory, more orders are satisfied from the stock,

of

resuiting in lower backlogs (or unmet demand). This decreases the backlogging cost (or lost
sales cost). However, the cost of holding inventory increases. The manager must pick a level

safely inventory that minimizes the backlogging (or lost sales) cost and the holding cost.

The fbllowing analysis (approximation) shows how to minimize cost by considering the cost
and saving of a one-unit change in the safety stock level.

Suppose that we considered reducing safety stock (SS) by one

unit. Wat will it save? If SS is

lowered the entire inventory curve moves down, indicating a lower average inventory. The
saving is therefore Cs (holding cost per unit per unit).

Wat will it

cost? The answer depends on

the expected number of times per year we are out of stock. Each time we were out of stock last year,

if

SS had been lower we

would have had greater shorlages. Thus, lowering

SS

by one unit

wtll cost us one more unit of shortage for each out-of-stock condition; hence the average cost
pcr year is

(1 sholtagc)

* (Expected number of stockout occasions per year) x(cost per urut shortage,

C6)

Il'rlr, .',,-r ir lt.s. thrrr .rrirrs.

(1 shortaue) 'I'l'rus, thc

rve should reduce SS. Ilcosr exceeds the savinus. SS should be htgher. Therefore, at

the optimal SS, the cost of marginal change should equal saving, i.e.,

* (F:xpected number of stockout occasions per year) *(cost per urut shortage, Cd =
fi, stock ierrel (55; should be set in such a way that:
,

Cu

safe

li.r1r.'1'1.. .1 rrLrrrrb.-r

rf srockout occrstons per yexr

C' f C, C' f C,

->
=>

(l :xpcctccl nlrnrber

of stockout occasions per cycie)+(No. of cycles per year)

C'
f C,

(Ir.xpectccl number

of stockout occasions per cycle)* E(D)/Q

per cycle Irxpccted nr-rmber of stockout occasions L =* ) E(D)

+ Cs

Sir-rcc stocl<orit

cither arises or doesn't arise in any cyc1e, therefore,

r-rf

lixpcctcc'l number

stockout occasions per cycle doesn't arise in a cycle)

= 1 { P(stockiti-rt,.rLises in a cvcle) + 0 * P(stockout = I),str,t'ii,ut rris.'s in I

cicJe) =

#
= 1*P(stockoutarisesinacycle)

T'hcrctirre, (-SI- = P(stockoutdoesn'tariseinacycle)

=,

,b-#

Note: 'l'his is arr approxirnation since we said "lowering SS by 1 urut rvill cost us 1 more urut of shortage for each stocliot-lt occasiorl." IIere, we chd not account for the extra stockout occasions that wrl,1 arise on lowering SS by 1
urut. Thesc extra stockout occasions rvI-1 happen when the inventory position just before repierushment was exactly
0.