Inventory Management

Uncertain Demand Models

How to counter uncertainty in demand
Environment is uncertain
Safety Stock
Maintain excess inventory which is held in case demand exceeds expectation

Service Level

Re - order point  daily demand  Lead Time  Safety Stock

Standard deviation
 Safety Stock 4

Maintain excess inventory which is held in case demand exceeds expectation

Service Level Standard

deviation

 ( x i  x)
2

sd 
N 1

High standard deviation

= more spread

Service Level = 1 - Probability of stockout

• 95 % service level means possibility of stock out is 5% low standard deviation

• 70 % service level means possibility of stock out is 30% = less spread

Probabilistic Models and Safety Stock
 Used when demand is not constant or certain
 Use safety stock to achieve a desired service level and
avoid stockout.
ROP  d  L Known demand
ROP  d  L  SS Uncertain demand
 SLA Example 1
Wk Volume Wk Volume Wk Volume Wk Volume Average = 600 tons
1 300 14 800 27 500 40 550 Deviation = 150 tons
500 15 605 28 420 41 630 Max = 900 tons
2
Min = 250 tons
3 600 16 600 29 380 42 650
4 800 17 850 30 490 43 450 Range Frequency
5 450 18 700 31 580 44 590 201-300 3
6 580 19 570 32 680 45 660 301-400 2
7 660 20 690 33 790 46 775 401-500 10
8 780 21 780 34 810 47 470
501-600 13
9 890 22 750 35 250 48 590
601-700 13
10 900 23 390 36 300 49 620
701-800 7
11 480 24 480 37 490 50 540
801-900 4
12 580 25 550 38 550 51 525
13 660 26 680 39 680 52 605
z=(x-μ)/α
Solve

Service level Quantity needed

Layman Method Probability distribution
50%
75%
80%
90%
95%
100%
Safety Stock Example 2
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year

Number of Units Probability

30 .2
40 .2
ROP 
.3
50
60 .2
70 .1
1.0
9
 Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year

Safety Additional Total

Stock Holding Cost Stockout Cost Cost

(20)($5) = $100 $0
20 $100

(10)($5) = $ 50 (10)(.1)($40)(6) = $240

10 $290
(10)(.2)($40)(6) + (20)(.1)($40)(6) =
$ 0
0 $960 $960
Holding costs = Excess inventory x Annual stockout costs =∑ units short x the
carrying cost probability x the stockout cost/unit x the number
of orders per year
A safety stock of 20 frames gives the lowest total cost
ROP = 50 + 20 = 70 frames
Service Levels

1) Type 1 service: Choose R so that the probability of

not stocking out in the lead time is equal to a
specified value.
• Appropriate when a shortage occurrence has the same consequence
independent of its time and amount.

2) Type 2 service: Choose both Q and R so that the

proportion of demands satisfied from stock equals a
specified value.
• Percentage of demand that is satisfied from inventory
• In general,  is interpreted as the fill rate.
 Comparison of Type 1 and Type 2 Services
Order Cycle Demand Stock-Outs
1 180 0
For a type 1 service objective
2 75 0 there are two cycles out of ten
in which a stock-out occurs,
3 235 45 so the type 1 service level is
80%.
4 140 0
5 180 0
For type 2 service, there
6 200 10 are a total of 1,450 units
demand and 55 stock outs
7 150 0 (which means that 1,395
8 90 0 demand are satisfied).
This translates to a 96% fill
9 160 0 rate.

10 40 0
∑1450 ∑ 55
 Service Level is complement of probability of stockout
 Probability of stockout + service level = 1
or
service level = 1 - Probability of stockout
Safety Stock scenario I
the demand fluctuates but the lead time remain constant

R  d  L  z  sd  L
Where
sd = standard deviation of demand during lead time
L = Lead Time
• Daily avg sales = 10
• Lead time = 16 days
• Reorder point = 160
• SLA needed 96%
R  10  16  1.75  11 .09  16  160  77.60
• sd = 11.09 shirts
R  237.60  238 shirts

Demand during lead time or order cycles

1 2 3 4 5 6 7 8 9 10
170 155 160 158 168 183 144 156 165 174
Safety Stock scenario II
Variation in both demand and lead time

ROP  dL  zsdL
ROP  dL  zs d L

sd  standard deviation in daily demand

sL  standard deviation in lead time
and
sdL  L  sd  d  sL