A New Framework for Safety Stock Management

Safety stock has always posed a challenging dilemma for supply chain managers.  There are two primary decisions in determining safety stock: Whether to keep any safety stock at all; and How much stock should be kept to reduce inventory costs and reduce potential lost sales[i]. 

Traditional inventory management techniques, such as the Economic Order Quantity, have been used by inventory professionals to determine the optimal reordering points to minimize inventory costs, ordering costs and stock out costs.  Often times professionals use a minimum order quantity in stocking which is tied to the EOQ level.  When the demand and lead times are known the optimal reorder point, ROP, can be calculated as: ROP = d*l, where d is demand and l is the lead time.  Sometimes it is useful to build into that equation the optimal buffer or safety stock.  Safety stock levels can be calculated as a fixed safety stock, a time-based calculation or a statistical calculation[ii]. 

In calculation of the statistical safety stock it is convenient to approximate the demand side service level factor called Z.  However it becomes necessary to further convert the lead time, into a factor of the forecast period used in Z.  L then becomes √l/t, and the equation for safety stock becomes Z*d*√l/t.  The optimal reorder point then become d*l + Z*d*√l/t.  Currently inventory managers have begun to incorporate demand-side variations, however it is important for managers to start incorporating supply-side variations into their statistical calculations[iii].

Currently Lynne Pastor teaches a class as the Heinz College called Spreadsheet Modeling and Analysis that goes over some of these techniques and calculations.  Question:  Do you know of other statistical analysis tools, such as ARIMA, auto-regressive integrative moving averages, to help supply chain managers accurately forecast demand and set optimal reorder points?

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[i] Luthra Nitesh, Roshan Ravi. A New Framework for Safety Stock Management. Cognizant. December 2011. Cognizant 20-20 Insights. http://www.cognizant.com/recenthighlights/a-new-framework-for-safety-stock-management.pdf

[ii] Luthra Nitesh, Roshan Ravi. A New Framework for Safety Stock Management. Cognizant. December 2011. Cognizant 20-20 Insights. http://www.cognizant.com/recenthighlights/a-new-framework-for-safety-stock-management.pdf

[iii] Luthra Nitesh, Roshan Ravi. A New Framework for Safety Stock Management. Cognizant. December 2011. Cognizant 20-20 Insights. http://www.cognizant.com/recenthighlights/a-new-framework-for-safety-stock-management.pdf