Between theory and practice of inventory management – part 2
Between theory and practice of inventory management – part 3
Inventory and the proper shaping of its size remain at the center of attention for managers at various levels of management. Despite the development of new logistics concepts aimed at reducing inventory, in many cases, ensuring the desired level of service still relies on a properly defined safety stock, and determining batch sizes (deliveries) continues to have a significant impact on costs.
The typical structure of inventory, shown in Figure 1, distinguishes three essential parts:
• cycle stock (current, working) – resulting from periodic deliveries and current consumption
• safety stock – being the justified non-working part of the inventory, acting as a buffer against random “unpredictable” demand fluctuations and random delivery delays, to ensure the proper level of customer service
• excess stock as an unjustified non-working part.
The purpose of this series of articles is to point out the risks that may arise from excessive “trust” in classical formulas used to calculate parameters controlling inventory replenishment. These formulas are well described in the literature and are also implemented in most commercially available IT systems supporting enterprise and supply chain management. The problem is that the application of these formulas, and especially the correctness of the results obtained, are usually conditioned by specific assumptions and limitations. Subsequent articles will present examples of situations where simple and convenient theoretical solutions require adjustments when confronted with real-world conditions. They will be presented using the example of implementing a simple inventory replenishment system based on the reorder point. The first part of the series will be devoted to the safety stock portion, and the second part will concern the cycle stock portion.
Inventory replenishment in a system based on the reorder point
The ordering model based on the reorder point functions according to simple principles:
• an order can be placed at any time
• an order is placed when the free (available) inventory is less than or equal to the previously calculated reorder point level
• free inventory (FI) is calculated as follows:
FI = I + OI – RI
where:
I – inventory in stock,
OI – previously placed orders and inventory in transit,
RI – reserved inventory.
• the reorder point is determined by the following formula:
RP = D • T + SS
where:
D – average demand in the adopted unit of time (e.g., day),
T – average replenishment cycle time (expressed in these units),
SS – safety stock.
• safety stock, in the basic model, is determined according to the formula:
SS = ω • σDT
where:
ω – safety factor depending on the adopted service level and the type of demand frequency distribution,
σDT – standard deviation of demand during the replenishment cycle time.
• the value of σDT depends on the variability of demand and the variability of the replenishment cycle time.
The article comes from the magazine “Logistyka” 5/2008.