Safety Stock Determination

In Economic Order Quantity (EOQ) systems, safety stocks are to be kept and they have to be specified to calculate the reorder point. Safety stocks are kept to minimize the chances of stock out. If the average lead time of past receipts and average lead time consumption of the last year are used to calculate the reorder point, in 50% of the reorders, stock outs can take place.

One of the methods of determining safety stock to reduce the probability of stock out,  is to assume that lead time will not vary, but the demand varies. The standard deviation of demand can be determined and a safety factor can be used based on normal distribution tables.

If safety stock is kept equal to one standard deviation of demand during lead time the service level (probability of stock being available during the time the item is on order) will go up to 84.13%. If the safety stock is made equal to two standard deviations of demand during lead time the service level (probability of stock being available during the time the item is on order) will go up to 97.72%.

Plossl and Wight advocate using mean absolute deviation (MAD) in the place of standard deviation. The standard deviation can be approximated as 1.25 times MAD.


Recent articles and research papers on the topic

Safety stock analysis: A tutorial
http://scm.ncsu.edu/scm-articles/article/safety-stock-analysis-inventory-management-models-a-tutorial

A new framework for safety stock management - Cognizant insight note December 2011
http://www.cognizant.com/InsightsWhitepapers/A-New-Framework-for-Safety-Stock-Management.pdf

Concepts for Safety Stock Determination under Stochastic Demand and Different types random production yield, February 2011
Working Paper, University of Magdeburg
http://www.fww.ovgu.de/fww_media/femm/femm_2011/2011_03.pdf


Originally posted on Knol: http://knol.google.com/k/narayana-rao/safety-stock-determination/2utb2lsm2k7a/ 594#
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