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Chapter 12Managing Uncertainty in a Supply Chain: Safety InventoryCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraLearning ObjectivesUnderstand the role of safety inventory in a supply chain

Identify factors that influence the required level of safety inventory

Describe different measures of product availabilityExamine Inventory Replenishment Policies and Vendor Managed Inventory

Utilize managerial levers available to lower safety inventory and improve product availabilityCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraThe Role of Safety InventorySafety inventory is carried to satisfy demand that exceeds the amount forecastedRaising the level of safety inventory increases product availability and thus the margin captured from customer purchasesRaising the level of safety inventory increases inventory holding costsCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraThe Role of Safety InventoryThree key questionsWhat 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?Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra

The Role of Safety InventoryFigure 12-1Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraDetermining the Appropriate LevelDetermined by two factorsThe uncertainty of both demand and supplyThe desired level of product availability

Measuring Demand UncertaintyD =Average demand per period sD =Standard deviation of demand (forecast error) per periodLead time (L) is the gap between when an order is placed and when it is received

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraEvaluating Demand Distribution Over L Periods

The coefficient of variation

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraMeasuring Product AvailabilityProduct fill rate (fr)Fraction of product demand satisfied from product in inventory

Order fill rateFraction of orders filled from available inventory

Cycle service level (CSL)Fraction of replenishment cycles that end with all customer demand being metCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraReplenishment PoliciesPeriodic reviewInventory status is checked at regular periodic intervalsOrder is placed to raise the inventory level to a specified thresholdContinuous reviewInventory is continuously trackedOrder for a lot size Q is placed when the inventory declines to the reorder point (ROP)

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraImpact of Replenishment Policies on Safety InventoryFigure 12-6

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraContinuous Replenishment and Vendor-Managed InventoriesA single point of replenishment

CRP wholesaler or manufacturer replenishes based on POS data

VMI manufacturer or supplier is responsible for all decisions regarding inventory

SubstitutesCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraCollaborative Planning, Forecasting, and Replenishment (CPFR)Sellers and buyers in a supply chain may collaborate along any or all of the followingStrategy and planningDemand and supply managementExecutionAnalysis

Retail event collaboration

DC replenishment collaborationCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraCommon CPFR ScenariosCPFR ScenarioWhere Applied in Supply ChainIndustries Where AppliedRetail event collaborationHighly promoted channels or categoriesAll industries other than those that practice EDLPDC replenishment collaborationRetail DC or distributor DCDrugstores, hardware, groceryStore replenishment collaborationDirect store delivery or retail DC-to-store deliveryMass merchants, club storesCollaborative assortment planningApparel and seasonal goodsDepartment stores, specialty retailTable 10-2Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraCollaborative Planning, Forecasting, and Replenishment (CPFR)Store replenishment collaboration

Collaborative assortment planning

Organizational and technology requirements for successful CPFR

Risks and hurdles for a CPFR implementationCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraCollaborative Planning, Forecasting, and Replenishment (CPFR)Figure 10-4

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraCollaborative Planning, Forecasting, and Replenishment (CPFR)-Indian ExperienceIndian 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)

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraCollaborative Planning, Forecasting, and Replenishment (CPFR)-Godrej Groups GCPLGodrej 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.

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraRaheja Groups HyperCity- benefits due to the adoption of CPFRIncrease of 25-30% in food salesDecrease of 2% in stock levelsIncreased revenueLower inventory holding cost, positively impacting company profitabilityHigher availability of product on the shelf with nominal out-of-stocksImproved brand loyaltyAssured customer retention with improved shopping experienceElimination of expired stocksReduction in write-offsLonger shelf life for consumption

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraImpact of Aggregation on Safety InventoryThe safety inventory savings on aggregation increase with the desired cycle service level CSLThe safety inventory savings on aggregation increase with the replenishment lead time LThe safety inventory savings on aggregation increase with the holding cost HThe safety inventory savings on aggregation increase with the coefficient of variation of demandThe safety inventory savings on aggregation decrease as the correlation coefficients increaseCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraImpact of Correlation on Value of AggregationTwo possible disadvantages to aggregationIncrease in response time to customer orderIncrease in transportation cost to customerCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraInformation CentralizationOnline systems that allow customers or stores to locate stock

Improves product availability without adding to inventories

Reduces the amount of safety inventoryCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraSpecializationInventory is carried at multiple locations

Should all products should be stocked at every location?Required level of safety inventoryAffected by coefficient of variation of demandLow demand, slow-moving items, typically have a high coefficient of variationHigh demand, fast-moving items, typically have a low coefficient of variationCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraProduct SubstitutionThe use of one product to satisfy demand for a different productManufacturer-driven substitutionAllows aggregation of demandReduce safety inventoriesInfluenced by the cost differential, correlation of demandCustomer-driven substitutionAllows aggregation of safety inventoryCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraComponent CommonalityWithout common componentsUncertainty of demand for a component is the same as for the finished productResults in high levels of safety inventor

With common componentsDemand for a component is an aggregation of the demand for the finished productsComponent demand is more predictableComponent inventories are reducedCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraPostponementDelay product differentiation or customization until closer to the time the product is soldHave common components in the supply chain for most of the push phaseMove product differentiation as close to the pull phase of the supply chain as possibleInventories in the supply chain are mostly aggregateCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraManaging Safety Inventory in a Multiechelon Supply ChainIn 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 stagesCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraThe Role of IT in Inventory ManagementIT systems can helpImprove inventory visibilityCoordination in the supply chainTrack inventory (RFID)

Value tightly linked to the accuracy of the inventory informationCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraEstimating and Managing Safety Inventory in PracticeAccount for the fact that supply chain demand is lumpyAdjust inventory policies if demand is seasonalUse simulation to test inventory policiesStart with a pilotMonitor service levelsFocus on reducing safety inventoriesCopyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraSummary of Learning ObjectivesUnderstand 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.

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraSummary of Learning Objectives2. 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.

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraSummary of Learning Objectives3. 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.Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraSummary of Learning Objectives4. 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.

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraSummary of Learning Objectives4. 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.

Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. KalraGroup work for review next classIdentify various SCM decisions made during Product Availability Design and determine effectiveness evaluation criteria for each decision . Copyright 2013 Dorling Kindersley (India) Pvt. Ltd.Supply Chain Management: Strategy, Planning, and Operation, 5/e Authors: Sunil Chopra, Peter Meindl and D. V. Kalra