The Role of Safety Inventory in a Supply Chain

Safety Inventory: Safety Inventory is inventory carried to satisfy demand that exceeds the amount forecasted for a given period. As such, it tends to have a negative impact on supply chain cost but a positive impact on supply chain responsiveness. Safety inventory is carried because

Product demand and lead time is uncertain, and

A product shortage may result if actual demand during lead time exceeds the forecast demand.

Role of Safety Inventory in a Supply Chain:

Raising the level of safety inventory increases product availability and thus the margin captured from customer purchase.

Raising the level of safety inventory increases the level of average inventory, therefore increases holding costs.

Increased variety and the greater pressure for availability push firms to raise the level of safety inventory they hold. Given the product variety and high demand uncertainty in most high-tech supply chains, a significant fraction of the inventory carried is safety inventory.

As product variety has grown, however, product life cycles have shrunk. Thus, it is more likely that a product that is “hot” today will be obsolete tomorrow, which increases the cost to firms of carrying too much inventory.

A key to the success of any supply chain is to figure out ways to decrease the level of safety inventory carried without hurting the level of product availability.

For any supply chain, three key questions need to be considered when planning safety inventory:

1) What is the appropriate level of product availability?

2) How much safety inventory is needed for the desired level of product availability?

3) What actions can be taken to improve product availability while reducing safety inventory?

Determining the Appropriate Level of Safety Inventory

The appropriate level of safety inventory is determined by the following two factors:

1) The uncertainty of both demand and supply

2) The desired level of product availability

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As the uncertainty of supply or demand grows, the required level of safety inventories increases. And as the desired level of product availability increases, the required level of safety inventory also increases.

Measuring Demand Uncertainty

Demand has a systematic component and a random component. The goal of forecasting is to predict the systematic component and estimate the random component.

The estimate of the random component is the measure of demand uncertainty.

Random component is usually estimated by the standard deviation of demand or forecast error.

Uncertainty of demand during lead time, and not just a single period, is what is important

Measuring Product Availability

Products availability reflects a firm’s ability to fill a customer order out of available inventory. There are several ways to measure product availability. Some of the important measures are described below:

Product Fill Rate (fr): Product fill rate is the fraction of product demand that is satisfied from product in inventory. Fill rate is equivalent to the probability that product demand is supplied from available inventory.

Order Fill Rate: Order fill rate is the fractions of orders that are filled from available inventory. Order fill rate should also be measured over a specified number of orders rather than time.

Cycle Service Level (CSL): CSL is the fraction of replenishment cycles that end with all customer demand being met. A replenishment cycle is the interval between two successive replenishment deliveries. The CSL is equal to the probability of not having a stockout in a replenishment cycle.

Replenishment Policies

A replenishment policy consists of decisions regarding when to order and how much to reorder. Replenishment policies may take any of the following two forms

1) Continues Review: Inventory is continuously tracked, and an order for a lot size Q is placed when the inventory declines to the reorder point (ROP).

2) Periodic Review: Inventory status is checked at regular periodic intervals, and an order is placed to raise the inventory level to a specific threshold.

These inventory policies are not comprehensive but suffice to illustrate the key managerial issues concerning safety inventories.

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The Importance of the Level of Product Availability

The level of product availability is measured using the cycle service level or the fill rate, which are metrics for the amount of customer demand satisfied from available inventory.

The level of product of availability, also referred to as the customer level, is one of the primary measures of a supply chain’s responsiveness.

A supply chain can use a high level of product availability to improve its responsiveness and attract customers, thus increasing revenue for the supply chain.

A high level of product availability requires large inventories, which raise supply chain costs.

Therefore, a supply chain must achieve a balance between the level of availability and the cost of inventory. The optimal level of product availability is one that maximizes supply chain profitability.

Factors Affecting Optimal Level of Product Availability

The two key factors that influence the optimal level of product availability are:

Cost of overstocking the product

Cost of understocking the product

The cost of overstocking is denoted by Co and is the loss incurred by a firm for each unsold unit at the end of the selling season.

The cost of understocking is denoted by Cu and is the margin lost by a firm for each lost sale because there is no inventory on hand. The cost of understocking should include the margin lost from current sales as well as future sales if the customer does not return.

The optimal level of availability is obtained by balancing the costs of overstocking and understocking.

As the cost of overstocking increases, it is optimal to lower the targeted level of product availability.

As the lost margin from being out of stock increases, it is optimal to raise the targeted level of product availability.

Managerial levers that improve supply chain profitability through optimal service levels:

A manager may increase supply chain profitability by:

Increasing the salvage value of each unit overstocked

Decreasing the margin lost from a stockout

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Using improved forecasting to reduce demand uncertainty

Using quick response to reduce lead times and allow multiple orders in a season

Using postponement to delay product differentiation

Using tailored sourcing with a flexible short lead time supply source serving as a backup for a low-cost supply source.

Setting Optimal Levels of Product Availability in Practice

Beware of Preset Levels of Availability:

Often companies have a preset target of product availability without any justification. In such a situation, managers, should probe the rationale for the targeted level of product availability.

A manager can provide significant value by adjusting the targeted level of product availability to one that maximizes profits.

Use approximate costs because Profit-Maximization Solutions are Quite Robust:

Companies should avoid spending an inordinate amount of effort to get exact estimates of various costs used to evaluate optimal levels of product availability.

Levels of product availability close to optimal will often produce a profit that is close to the optimal profit.

A reasonable approximation of the costs will generally produce targeted levels of product availability that are close to optimal.

Estimate a Range for the Cost of Stocking Out:

It is often not necessary to estimate a precise cost of stocking out. Using a range of the cost, a manager can identify appropriate levels of availability and the associated profits.

Often, profits do not change significantly in the range, thus eliminating the need for a more precise estimation of the cost of stocking out.

Ensure Levels of Product Availability Fit With Strategy:

A manager should use the level of product availability suggested by the analysis along with the firm’s strategic objectives when setting the level of product availability.

A firm may find it appropriate to provide a high level of product availability for a low-volume item that is not very profitable but is required by important customers.

Tailor Your Response to Uncertainty:

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A manager should recognize that strategies such as quick response and postponement are more effective when the underlying unpredictability is large.

Thus, for the portion of demand that is relatively predictable, one should focus on the lowest cost production method, even if it is not responsive.

The unpredictable portion of demand, however, should be served using a more responsive approach, even if it is more expensive.

The Role of Transportation in Supply Chain

Transport refers to the movement of products from one place to another and that the beginning of

the supply chain in dealing with customers. Where is the new vision and wide in the work of

transport, including supply chain management and logistics, and procurement. The cost of

shipping and transport, for example, arrived in shipping and transport costs in the United States

almost 6% of gross domestic product.

Many manufacturers and retailers were able to use the state in managing the supply chain to

reduce inventory and storage costs, with the possibility of delivery to the client quickly.

Any successful supply chain linked to the use of a large and adequate transportation. For

example, Wal-Mart has been used effectively respond to the transportation system to reduce

overall costs. In developing countries, Wal-Mart is running across the docking, a process in the

product that is exchanged between the trucks so that each truck to go to a retail store and product

suppliers a different form.

At the same time, the exponential growth in shipment from China to create opportunities for

bottlenecks on both. That is where many leading companies that having invested in the purchase

of large offices in China, India, and elsewhere.

From this point shows that are two keys players in any means of transport that takes place within

the supply chain. Shipper is the party, which requires the movement of product between two

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points in the supply chain. Carrier is the party who moves or transports the product. For example,

when Dell uses UPS to ship the computers from the factory to the customer, Dell is the shipper

and UPS is the carrier.

1.1 Transportation in supply chain cost

Chopra and Meindle stated for two kinds of transportation cost:

1.1.1 Inbound transportation costs are the costs that included the bringing material into

a facility.

1.1.2 Outbound transportation costs are the costs that sending material out of a facility.

The relationship between both is the outbound transportation cost per unit is higher than inbound

costs because the inbound is typically larger. (Chopra & Meindle, 2007,p78).

They also mintioned increasing the number of facilities can decrease total transportation cost,

which refer to the figure

2. Modes of transportation

The supply chains follow combination modes of transportation following:

2.1 Air fright logistic (air)

Airfreight logistics is very important in industries and services to complete the supply

chain and functions. Where they provide with the speed of delivery, as well as a

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reduced risk of damage, security, flexibility and ease of access to good views of the

ordinary, but the disadvantage is the high courier fees. Reynolds, Feighan (2001) and

said air cargo logistics is selected 'when the value per unit weight and relatively high

speed of delivery is an important factor. The properties of airfreight logistics in the

following:

(1) aircraft, airports and separated. Therefore, the industries only need to prepare

aircraft for its operation.

(2) it allows for faster delivery in long-haul destinations.

(3) air freight transport is not affected by the terrain.

The data indicate that the transport of goods in the market continues to grow.

There is a view of the directions of global markets and logistics and air cargo also to

change their services. Future directions for the development of airfreight, and

integration with other transport modes, and the internationalization of the coalition,

and the integration of the airlines and the pattern of the future of logistics, and air

freight to cooperate with other modes of transport. Such as sea and land transport, to

provide service on the base just in time, and transport from door to door. (YUE,

TSENG, & TAYLOR, 2005)

Land logistic (truck, rail, water, and pipeline)

Land logistics is considered very important in the logistics activities. They are

providing services for air transport and maritime transport from airports and ports.

Additional logistical capacity, the positive ground is the high-level access in the wild.

The major means of transport logistics land transport by rail, road transport and

pipeline transport.

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For rail transport to and comparative jeopardy of high endurance capacity, the less

the impact of climatic conditions, and low power consumption, but that the

disadvantages of high cost of basic facilities and the difficulty in the cost of

maintenance, with the lack of flexibility of the pressing demands, and time-

consuming in the organization of railroad cars. As for the transfer of land, he has the

advantages of investment funds cheaper, and ease of access is high, and the mobility

and availability. On the other hand, Disadvantages, low capacity, low and safety, and

slow. The advantages of pipeline transportation of high capacity, less the impact of

climatic conditions, and cheaper the process of drawing, and the continuation of the

means of transport; disadvantages of costly infrastructure and the difficulty of control,

goods, specialization, and needs regular maintenance.

The excessive use of road transport also brings many problems, such as traffic

congestion, pollution and traffic accidents. In the future, to improve road transport in

the transport efficiency and reliability, a revolution in the field of transport policy and

management is required, for example, pricing. (YUE, TSENG, & TAYLOR, 2005)

Package carriers

Package carriers are transportation copmanies such as FedEx, The United States

Postal Service (USPS), and the Uninterruptible Power Supply (UPS), The package

can be small because the backage cariers use air and should weight about 150 pounds,

also package carriers are expensive and cannot compete with less than truckload

carriers on price for large shipments. Thus, shippers use package carriers for small

and time sensitive shipments. Package carriers also pickup the package from the

source and deliver it to the destination site. With an increase in just in time (JIT)

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deliveries and focus on inventory reduction, demand for package carriers has grown.

(Chopra & Meindle, 2007. P389)

For example, the goal of DHL is nothing less than to transform the logistics

industry and to deliver beyond our customers' expectations wherever and whenever

they need us - by offering the most comprehensive suite of services and becoming the

only genuine one-stop source for logistics solutions, globally.

The supply chain in package carrier for DHL express is the flow of goods, within

information and finance. It starts by sourcing raw materials which content semi-

finished goods, that are scheduled and transported into factories to be made into

finished products (see Diagram up). Then pass through warehouses or distribution

centres and are delivered to retailers, wholesalers or direct to consumers' homes or

business premises. Finally, aftermarket activities involve the maintenance and repair,

or the return and recycling, of products at the end of their life. Supply chain planning

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optimises overall flows and inventories, by balancing resources with demand at all

stages. (DHL)

3. Transportation infrastructure and policies

The transportation is infrastructure that means roads, seaports, airports, rail, and

canal. All these exist along nodes and links of transportation network. All countries are

taken responsibility a significant role in building and managing these infrastructure

elements. The transportation and infrastructure focuses on operational and policy issues

within transportation and infrastructure areas that affect logistics operations.

4. Discussions

How can quickly deliver products to consumers with a common consensus on the

control operators?

That the integration of logistics services and e-business is the current trend is

currently in some companies. In order to obtain position that is more beneficial and

building a complementary relationship, which is its reliance on networks and industries,

such as Yahoo and E-Bay, and often cooperate with the logistics industry. Integration can

reduce the middle-level procedures. For example, producers can immediately provide

products to more customers of the station. To reduce costs by more efficiently. Besides,

companies do not have to take inventory and warehouse costs only, and therefore it

becomes a modern industry of the lower cost and more efficient division of

specialization. For example, customers can obtain an order of goods shops. Through E-

logistics, and the state of competition in industries could be promoted in the knowledge

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economy.

Moreover, to promote business activities should include transport systems in various

stages. The integration between different applications is to provide comfort through the

promotion of the system of information flow and business processes. For consumers and

businesses can make more efficient and easier than through the assistance of e-commerce

and the Internet. With physical delivery, still rely on the transportation system to end

processes. The cost of transport may be one-third of the cost of logistics. At the same

time, transport systems and techniques required in almost every activity of logistics

services.

The Role of IT in a Supply Chain

Importance of Information in Supply Chain

Information is a key supply chain driver because it serves as the glue that allows the other supply chain drivers to work together with the goal of creating an integrated, coordinated supply chain.

Information is crucial to supply chain performance because it provides the foundation on which supply chain processes execute transactions and manager makes decisions.

Without information a manager cannot know what customers want, how much inventory is in stock, and when more product should be produced or shipped.

What is Information Technology (IT)

IT consists of hardware, software, and people throughout a supply chain that gather, analyze, and execute upon information.

IT serves as the eye and ears (and sometimes a portion of the brain) of management in a supply chain, capturing and analyzing the information necessary to make a good decision.

For instance an IT system at a PC manufacturer may show the finished goods inventory at different stages of the supply chain and also provide the optimal production plan and level of inventory based on demand and supply information.

Characteristics of Information

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To support effective supply chain decisions, information must have the following characteristics:

1) Information must be accurate: Without information that gives a true picture of the state of the supply chain, it is difficult to make good decisions.

2) Information must be accessible in a timely manner: Accurate information often exists, but by the time it is available, it is either out of date or it is not in an accessible form.

3) Information must be of the right kind: Companies must think about what information should be recorded so that valuable resources are not wasted collecting meaningless data while important data go unrecorded.

4) Information must be shared: A supply chain can be effective only if all its stakeholders share a common view of the information that they use to make business decisions.

Information is used when making a wide variety of decisions about each supply chain drivers. These are

1) Facility: Determining the location, capacity, and schedules of a facility requires information on the trade-offs among efficiency and flexibility, demand, exchange rates, taxes, and so on.

2) Inventory: Setting optimal inventory policies requires information that includes demand patterns, cost of carrying inventory, costs of stocking out, and costs of ordering.

3) Transportation: Deciding on transportation networks, routings, modes, shipments, and vendors requires information about costs, customer locations, and shipment sizes to make good decisions.

4) Sourcing: Information on product margins, prices, quality, delivery lead times, and so on, are all important in making sourcing decisions. Given sourcing details with inter-enterprise transactions, a wide range of transactional information must be recorded in order to execute operations, even once sourcing decisions have been made.

5) Pricing and Revenue Management: To set pricing policies, one needs information on demand, both its volume and varies customer segments’ willingness to pay, and on many supply issues, such as the product margin, lead time, and availability. Using this information firms can make intelligent pricing decisions to improve their supply chain profitability.

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