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This web site is designed to help navigate
you through the mountain loads of information about inventory
management.
Once again in real life situations one rarely comes across lead times and usage rates that are known with certainty. When usage rate and/or lead time vary, then the reorder level should naturally be at a level high enough to cater to the production needs during the procurement period and also to provide some measure of safety for at least partially neutralizing the degree of uncertainty. The question will naturally arise as to the magnitude of safety stock. There is no specific answer to this question. However, it depends, inter alia, upon the degree of uncertainty surrounding the usage rate and lead-time. It is possible to a certain extent to quantify the values that usage rate and lead-time can take along with the corresponding chances of occurrence, known as probabilities. These probabilities can be ascertained based on previous experiences and/or the judgmental ability of astute executives. Based on the above values and estimates of stock-out costs and carrying costs of inventory it is possible to work out the total cost associated with different levels of safety stock. Once we realize that the higher the
quantity of safety stock, the lower will be the stock-out cost and the
higher will be the incidence of carrying costs, the formula for
estimating the reorder level will call for a trade-off between stock-out
costs and carrying costs. The reorder level will then become one at
which the total stock-out costs (to be more precise, the expected
stock-out costs) and the carrying costs will be at its minimum.
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