December 9, 2011

Determining Optimal Level of Product Availability - Review Notes

Chopra and Meindl's book, Supply Chain Management: Strategy, Planning, and Operation, is a comprehensive introduction on supply chain management.

Co = Cost of overstocking
Cu = Cost of understocking

For seasonal items with single order purchase or acquisition

Critical Cycle Service Level (CCSL) that provides the best tradeoff

CCSL = Cu/(Cu +Co)

Optimal Order Quantity = NORMINV(CCSL, Demand, Standard Deviation of Demand)

For Continuously Ordered and Stocked Items

Demand can be backlogged with a penalty Cu

In this case optimal cycle service level CSL = 1 - HQ/RCu

H = Cost of holding one units for one unit of time
Q = Lot size for replenishment (bigger lot sizes result in bigger cycle inventories)
R = Average demand per unit time
Cu = penalty per stockout of unit

Safety stock = NORMSINV(CSL)*SDL
SDL = standard deviation during lead time

If Demand During Stockout is Lost

Optimal Service Level = 1 - [HQ/(HQ + RCu)]

Managerial Levers to Improve Profitability In the Presence of Stockouts and Excess Inventories

1. Increase the salvage value of excess inventory
2. Decrease the margin lost from stockouts

Manufacturers can have a policy of buying back unsold inventory from retailers. This will increase salvage value of the retailers and hence they will hold more inventory. Manufacturers can take big orders but allow the flexibility to the retailer to reduce the quantity received depending on the demand.

Vendor managed inventories will eliminate some of the issues and strategies to induce retailers to hold more inventory.

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