Session 13 Chapter 12 Chopra 5thed

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
Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.
Chapter 12
Understand the role of safety inventory in a supply chain
Identify factors that influence the required level of safety inventory
Describe different measures of product availability
Examine Inventory Replenishment Policies and Vendor Managed

Inventory
Utilize managerial levers available to lower safety inventory and

improve product availability
Learning Objectives
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
The Role of Safety Inventory
Three key questions

What is the appropriate level of product availability?
How much safety inventory is needed for the desired level of
product availability?
What actions can be taken to improve product availability while
reducing safety inventory?
Figure 12-1
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
Determining the Appropriate Level
DL Di
i1
2
i
i1
2 ij i j
i j
L L D
DL DL
The coefficient of variation
cv /
Evaluating Demand Distribution Over L

Periods
Product fill rate (fr)

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
Measuring Product Availability
Periodic review
Inventory status is checked at regular periodic intervals
Order is placed to raise the inventory level to a specified
threshold
Continuous review
Inventory is continuously tracked
Order for a lot size Q is placed when the inventory declines to the
reorder point (ROP)
Replenishment Policies
Impact of Replenishment Policies on

Safety Inventory
Figure 12-6
A single point of replenishment
CRP wholesaler or manufacturer replenishes based on POS

data
VMI manufacturer or supplier is responsible for all decisions

regarding inventory
Substitutes
Continuous Replenishment and VendorManaged Inventories
Sellers and buyers in a supply chain may collaborate along any or

all of the following
Strategy and planning
Demand and supply management
Execution
Analysis
Retail event collaboration
DC replenishment collaboration
Collaborative Planning, Forecasting, and

Replenishment (CPFR)
CPFR Scenario
Where Applied in
Supply Chain
Industries Where
Applied
Retail event
collaboration
Highly promoted
channels or categories
All industries other than

those that practice EDLP
DC replenishment
collaboration
Retail DC or distributor
DC
Drugstores, hardware,
grocery
Store replenishment
collaboration
Direct store delivery or

retail DC-to-store
delivery
Mass merchants, club

stores
Collaborative
assortment planning
Apparel and seasonal

goods
Department stores,
specialty retail
Table 10-2
Common CPFR Scenarios
Store replenishment collaboration
Collaborative assortment planning
Organizational and technology requirements for successful CPFR
Risks and hurdles for a CPFR implementation


Figure 10-4
Indian Industries suffer due to slow speed of and distortions in the

information that flows due through the distribution channels, due
to the presence of large number of intermediaries .
Quite often, the only information that is available to the
manufacturer is the demand from the next level down the
distribution channel.
Advent of organised retailing and company owned and operated
distribution channels adopt CPFR practices to streamline the
replenishment processes and derive the economies inherent in lean
supply chains.
Godrej Groups Godrej Consumer Products Limited (GCPL) adapted
CPFR philosophy to Indian Conditions (next slide)
Raheja Groups HyperCITY resulted in various benefits (next slide)

Replenishment (CPFR)-Indian Experience
Godrej Groups Godrej Consumer Products Limited (GCPL) adapted

CPFR philosophy to Indian Conditions
obtains distributor level inventory details on daily basis and

arranged regular replenishment,
enabling improved forecasting, and
production planning at the manufacturing levels.

Replenishment (CPFR)-Godrej Groups GCPL
Increase of 25-30% in food sales

Decrease of 2% in stock levels
Increased revenue
Lower inventory holding cost, positively impacting company
profitability
Higher availability of product on the shelf with nominal out-ofstocks
Improved brand loyalty
Assured customer retention with improved shopping experience
Elimination of expired stocks
Reduction in write-offs
Longer shelf life for consumption
Raheja Groups HyperCity- benefits due to

the adoption of CPFR
The safety inventory savings on aggregation increase with

desired cycle service level CSL
replenishment lead time L
holding cost H
coefficient of variation of demand
The safety inventory savings on aggregation decrease as
correlation coefficients increase
the
the
the
the
the
Impact of Aggregation on
Safety Inventory
Two possible disadvantages to aggregation

Increase in response time to customer order
Increase in transportation cost to customer
Impact of Correlation on
Value of Aggregation
Online systems that allow customers or stores to locate stock
Improves product availability without adding to inventories
Reduces the amount of safety inventory
Information Centralization
Inventory is carried at multiple locations
Should all products should be stocked at every location?

Required level of safety inventory
Affected by coefficient of variation of demand
Low demand,
slow-moving items, typically have a high
coefficient of variation
High
demand,
fast-moving
items,
typically
have
coefficient of variation
low
Specialization
The use of one product to satisfy demand for a different product
Manufacturer-driven substitution
Allows aggregation of demand
Reduce safety inventories
Influenced by the cost differential, correlation of demand

Customer-driven substitution
Allows aggregation of safety inventory
Product Substitution
Without common components

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
Component Commonality
Delay product differentiation or customization until closer to the

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
Postponement
In multiechelon supply chains stages often do not know demand

and supply distributions
Inventory between a stage and the final customer is called the

echelon inventory
Reorder points and order-up-to levels at any stage should be

based on echelon inventory
Decisions must be made about the level of safety inventory

carried at different stages
Managing Safety Inventory in a

Multiechelon Supply Chain
IT systems can help

Improve inventory visibility
Coordination in the supply chain
Track inventory (RFID)
Value tightly linked to the accuracy of the inventory information
The Role of IT in Inventory Management
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
Estimating and Managing Safety Inventory

in Practice
1.
.
.
Understand the role of safety inventory in a supply chain.

Safety inventory helps a supply chain provide customers with a high
level of product availability in spite of supply and demand uncertainty.
It is carried just in case demand exceeds the amount forecasted or
supply arrives later than expected.
Summary of Learning Objectives
2. Identify factors that influence the required level of safety inventory.

Safety inventory is influenced by demand uncertainty, replenishment
lead times, lead time variability, and desired product availability.
As any one of them increases, the required safety inventory also
increases.
The required safety inventory is also influenced by the inventory policy
implemented.
Continuous review policies require less safety inventory than periodic
review policies.
3. Describe different measures of product availability.

The three basic measures of product availability are product fill rate,
order fill rate, and cycle service level.
Product fill rate is the fraction of demand for a product that is
successfully filled.
Order fill rate is the fraction of orders that are completely filled.
Cycle service level is the fraction of replenishment cycles in which no
stockouts occur.
4. Examine Inventory Replenishment Policies and Vendor

Managed Inventory- adoption of CPFR Philosophies
Partners may set CPFR relationships to collaborate on store events,

DC replenishment, store replenishment, or assortment planning.
Indian Experiences on using CPFR- Godrej Groups Godrej
Consumer Products Limited and Raheja Groups HyperCITY projects
have accrued immense benefits.
4. Utilize managerial levers available to lower safety inventory and

improve product availability.
The required level of safety inventory may be reduced and product
availability may be improved if a supply chain can reduce demand
uncertainty, replenishment lead times, and the variability of lead times.
A switch from periodic monitoring to continuous monitoring can also
help reduce inventories.
Another key managerial lever to reduce the required safety inventories
is to exploit aggregation.
This may be achieved by physically aggregating inventories, virtually
aggregating inventories using information centralization, specializing
inventories based on demand volume, exploiting substitution, using
component commonality, and postponing product differentiation.
Group work for review next class

Identify various SCM decisions made during Product Availability Design
and determine effectiveness evaluation criteria for each decision

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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

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Understand the role of safety inventory in a supply chain

Identify factors that influence the required level of safety inventory

Describe different measures of product availability

Examine Inventory Replenishment Policies and Vendor Managed

Utilize managerial levers available to lower safety inventory and

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Safety inventory is carried to satisfy demand that exceeds the

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

The Role of Safety Inventory

Three key questions

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

The Role of Safety Inventory

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

The Role of Safety Inventory

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Determined by two factors

Measuring Demand Uncertainty

Average demand per period

Standard deviation of demand (forecast error) per

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Determining the Appropriate Level

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Evaluating Demand Distribution Over L

Product fill rate (fr)

Order fill rate

Cycle service level (CSL)

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Measuring Product Availability

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Impact of Replenishment Policies on

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

A single point of replenishment

CRP wholesaler or manufacturer replenishes based on POS

VMI manufacturer or supplier is responsible for all decisions

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.

Continuous Replenishment and VendorManaged Inventories

Sellers and buyers in a supply chain may collaborate along any or

Retail event collaboration

Supply Chain Management: Strategy, Planning, and Operation, 5/e

Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.