Managing Flow Variability
Chapter 7: managing flow variability: safety inventory
7.1 Objective
In the previous chapter on inventory, we focused on economies of scale as the major driver for inventory. The purpose of this chapter is to introduce the notion of safety inventory as a buffer against stochastic variability in supply / demand and discuss various levers for reducing it.
The chapter is covered over two classes each of duration 100 minutes. In the first class, we first motivate the need for forecasting as a way of estimating demand. We emphasize the four key characteristics of forecast without getting into any details of forecasting methodologies. This is key since the strategies for managing inventories critically exploit these characteristics. The first two characteristics of a forecast emphasize the need to estimate the variability of demand in addition to its mean. Building up on the examples of economic order quantity model in chapter 6, we discuss the notion of stock-outs (when demands become uncertain), introduce the cycle service level measure, and derive the safety stock as a buffer against uncertain demand to provide a certain service level. The key determinants of safety stock – demand variability and the mean and the variability of replenishment lead time - are emphasized. These are positioned as primary levers. Subsequently, the third characteristic of forecast (the aggregation principle) is used to discuss the concept of physical centralization of stocks as a way to reduce safety stock without affecting the cycle service level. Other manifestations of this principle in terms of virtual centralization, substitution, specialization, and component commonality are discussed qualitatively. Discussion of periodic review models can also be introduced here. Either this can be done soon after the basic model for continuous review is done (so there is a direct contrast) or after completing the discussion of centralization concepts.
In the second class, we emphasize the last
7.1 Objective
In the previous chapter on inventory, we focused on economies of scale as the major driver for inventory. The purpose of this chapter is to introduce the notion of safety inventory as a buffer against stochastic variability in supply / demand and discuss various levers for reducing it.
The chapter is covered over two classes each of duration 100 minutes. In the first class, we first motivate the need for forecasting as a way of estimating demand. We emphasize the four key characteristics of forecast without getting into any details of forecasting methodologies. This is key since the strategies for managing inventories critically exploit these characteristics. The first two characteristics of a forecast emphasize the need to estimate the variability of demand in addition to its mean. Building up on the examples of economic order quantity model in chapter 6, we discuss the notion of stock-outs (when demands become uncertain), introduce the cycle service level measure, and derive the safety stock as a buffer against uncertain demand to provide a certain service level. The key determinants of safety stock – demand variability and the mean and the variability of replenishment lead time - are emphasized. These are positioned as primary levers. Subsequently, the third characteristic of forecast (the aggregation principle) is used to discuss the concept of physical centralization of stocks as a way to reduce safety stock without affecting the cycle service level. Other manifestations of this principle in terms of virtual centralization, substitution, specialization, and component commonality are discussed qualitatively. Discussion of periodic review models can also be introduced here. Either this can be done soon after the basic model for continuous review is done (so there is a direct contrast) or after completing the discussion of centralization concepts.
In the second class, we emphasize the last