Elsevier
Karl Inderfurth
Uni,,ersity of Bielefeld. Universitdtsstr. 25. V-4800 8ielefeM I. Germany
Abstract
Determining appropriate safety stocks in s:o~chastic mu iti-stage production/distribution systems is a very difficult task.
Approaches for optimal determination of safety stocks r~garding cost objectives and service level restrictions which are
~uitable for practical applications can only be found for a very limited class of multi-stage inventory problems like prob-
lems of strictly serial structure or special two-stage production/distribution systems.
h, this paper a procedure fo, determining the optimal size and dlstribution of safety stocks in a general serial or divergent
production/distribution process ruled by a base-stock control po!.'.'cyis presented. This approach especially allows for
taking into occount the impact of end-item demand correlation on distribution and size of safety sleeks by using risk-
pooling effects in divergent systems.
A powerful dynamic programminz algorithm for solving the safety stock optimization problem is developed, and im-
pacts of pro~!-~m~arameter varizrons or~ ~he optimal solution are discussed.
suits only for rather specific serial or two-stage considcratlon of these dependencies for two-stage
~ystems (see, e.g., [ 10,I 1 ] ). Thus, for consider° systems withou~ taking into account positive or
ing quite general production or distribution negative correlation of final-stage demands and,
structures a decoup!ing cf lot-sizing and safety in general, needing more or less rough and cum-
stock determination is necessary. A separated bersome approximations (see [ 14,15 ] ). On the
safety stock policy, how,~~,,~r. is appropriate for a other hand this assumption asserts that an ex-
system with a lot-for-let ordering policy, for in- treme inflexibility is involved in the production/
stance as is performed by using a base-stock con- distribution operating system which is hardly to
trol pale (see [ 12] ). bc found in practice.
Much work has been done in developing ap- ha practicai situations intermediate-stage safety
proaches for multi-stage safety stock de~ermi,m- stocks usually have to protect against some kind
tion with given shortage costs. Since for practical of normal risk fl'om u ., ~. .,.L. .a , ;n t , "e s e.g. against
purposes service level ~-eqtfirements are easier to normal variability of demand. In case of e:tces-
formulate than shortage cost functions we will sive variability an intermediate production or
deal w'_'th safety stock optimization problems de- distribution stage will pecform extraordinary ac-
scribed as follows: how should in multi-stage in- tions like accelerating internal processing or ini-
ventory systems - - using a base-stock control tiating express delivery from outside suppliers to
policy - - safety stocks been sized and located all fulfill its service commitments. Such emergency
over the system in order to minirrfize the ex- actions are made possible by a certain level of
pected costs of interstage inventories ana to operating flexibility. Now, in many cases it is
guarantee specified service levels for the final quite realistic to assume that by using safety
stocks and excess operating flexibility each inter-
stage products.
In this paper we wil! restrict our ~c,nsidera- hal stage is totally reliable meaning that conse-
quences of interstage safety stock shortages for
tions to multi-stage p r o b l e m s pith general diver-
customer service levels are avoided. This is es-
gent structure for two reasons. First, divergent
pecially true if a minimum amount of alternative
structures cover a lot of v e ~ important practical
flexibility is given and if internal service levels
multi-~tage systems like many chemical produc-
are set appropriateiy high. However, this reliabil-
tion processes (e.g. production of active ingre.-
ity condition seems to be far more realistic than
clients in the pharmaceutical industry) or like
the rigid assumption of neglecting any kind of
pure mu!fi-stage distribution processes. Sec-
._,.
. . .........
. . *;--,, ficx~b~iity that is supposed in the com-
•, . u , s , u,~ aiialysis of divergent systems gives
mon approaches (for further discussion see
specific insights in safety stock optimization for
[12]).
other ~truetures. Serial systems are just special In the context of our considerations we will not
cases of divergent systems, and for convergent include costs for usage of operating flexibility and
systems the effect of component commonality c,~ its impact on the safety stock decisi~r, assuming
safety stocks is very much related to the effects that often a certain capacity of slack resources is
studied in divergent systems (see [ 13,14] ). Al- given (as a strategic component) which is fixed
most all approaches developed for determining and can be used without additional costs.
appropriate safety stocks in divergent produc- e~. safety stock optimization procedure based
tion or distribution systems deal with situations upon the described flexibility assumptions has
where internal unability for fulfilling unexpected been presented by Simpson [ 16 ] for a serial pro-
demand on intermediate stages by using safety duction structure without capacity restrictions for
stocks leads u n a v o i d a b l y to shortages at down- stock building. It will be shown that this ap-
stream stages and to deteriorations of customer proach can be extended to general divergent
service levels. This assumption is vezy critical ib- structures resulting in solution procedures which
two reasons. On the ~...,:.-ehand th;.s situation yields bring about im0ortant practic-ai benefit~ like a,~
.. _ ............. .v.,.A-:, . u r n the impact of plicability to large divergent multi-stage struc-
single-stage service levels on the overall cus- tures and possibility of consideri,ug correlation
tomer service levels, only allowing for analytical between e,,u-,,~m " -' :+~ demands.
105
I ! ! ', i
I | | I | I
I I I I I l
' '~tage 1 I s~.age 2 ~ Istage n-11 stage n I
P I I "'" I
to be satisfied instantly. Thus, taking into ac- safety stock coverage time at stage s
count an additional increase of the coverage time ( u , = S , _ ~+ t s - S , ) , and state variable zs defined
by the review period for the final product holds as replenishment time not yet covered at stage s
r _ ~ ~ /~, _t., -t. 1 t2) before the safety stock a!!oc~tion decision
(z,=5~_~+ts), minimizing the total inventory
With h~ as holding costs for product i the safety holding costs in (P. 1 ) can be pertbrmed by eval-
stock carrying costs at stage i can be written as uating the following recursive relations of dy-
h~L leading to a safety stock optimization prob- namic programming using backward recursion
lem for the serial s)~tem (P.1 that can be for- (for s = 1,2 ..... n - i ):
mulated as follows:
~£(Zs)=min{c~x/~+f~+l(Z~--u,+t,+~) } (6)
n-]
•f - 7 I
r- I
t~ k-C3- ! O
1 (9
l
I
i
I
i
I I
J
I I
!
stage I staae 2 • -- stage r
I |
Input data of the stochastic end-item demands Using base-stock co~ltrol in d~'mrgent systems
are variances and correlation coefficients for end- means the'* at each intermediate stage the cumu-
item dema.~ds: lative :Jemand of corresponding final-stage items
ha~ to be replenished. Intermediate safety stocks
a~ = d e m a n d variance of final-stage item k are used to pro~ect against stochastic fluctua-
(k~E). tions of cumulative demand up to a maximum
~.~ =correlation c~e;'ficicnt of demands for ceasonable e.no'ant represented by fixed internal
items Icand I ( k~E, leE, k # l). service levels. Now taki~=g into consideration an
For divergent stractures demand variances of over-all inter:~al set ,ice level of 1(;0% (by safety
intermediate-stage items depend on variances stocks and ooP:at!ng ~e;:ib!l~ty) allocation prob-
and correlation cocIficicnts o ~ re!arid end-items lems ot optimal distributing scar~ e safety stocks
as well as on corresponding (multi-stage) pro- to alternative succeeding products will not exist.
duction coefficients: Simultaneously it is possible to guarantee de-
sired service levels for final-stage products pre-
aikt7 k venting situations of unbalanced inventories for
keE(i)
end-items which can occur in circumstaqces of
+ ~, ~ a,~a,takalpkt, i e V (8) limited internal delivery service (see [ 14,17 ] ).
: ~ E ( i ) I~E(i), Transferring the concept of service times a
I#k
straightforward extension of the serial systems
Equation (8) shows that in divergent systems the approach of optimizing safety stocks can be car-
risk of demand variability for intermediate-stage fled out considering the fact that in divergent
products is less than the "average" risk of the systems each stage contains several inventories
corresponding final-stage items, except for the with more than one successor-customer but on!y
case of completely positive correlation, resulting one predecessor-suppher.
from pooling the end-item risks. Now, again using service times S, (i~ V) as de-
i08
cision vafiab!es the safety stocks Ij (je VUE) can ( s = 1,2 ..... r) and redefine the decision variables
be written as u~ and state variables z~ analogously to the serial
system's situation, taking into consideration that
L=qiaix//S,,~i)+ti-Si fori~ V (9)
now there bus to be distinguished between pro-
l~.=qka~.x/S,,(k)+tk+ 1 for k~E duction stage (s) and product U):
Thus the safety stock optimization problem in di-
vergent systems (P.2) has the following structure: ,~s~=S:,,,) + t,-S~ (ieP(s)) ( 11)
Zsi = S v ( i ) - b I i
Min C = ~c,q/~,,,+ti-S~i
i e 1~"
Tl, is results in a state transformation as follows:
keE
z,;= z.,~.(,) - us,v~i, + ti ( 12 )
subject to
with ieP(s) and s' as stage corresponding to
O<~S~<~t~+S,,.), i e V
product v(i) and zll =fi
S.~:=0 With these definitions the cost criterion in
(P.2) can be written as
wherecj=Ib.q aj (_/=1,2 ..... n).
For this pro blem - - like for the similar serial
structure problem - - an extreme point property C= ci + ~ ckv/Zsi- Usi+tk
s= I \ i , ~ P ( s ) keN(i),
of the optimal solution can be shown to exist still keE
meaning that the optimal service time for each (13)
product is equal either to zero or to its over-all
replenishment time (see [ 18 ] ): Thus, the optimization prob!em can be charac-
terized as a specia! mtfl~dimensio~a! allocation
Si*e{O;S,*,¢r +~}, ieV (10) problem. The task is to find that allocation of re-
This again leada to an "all-or-nothing"opolicy for plenishment lead times to be protected by safety
determining the sin~,Je item safety stocks. That stocks in each production route over z.ll stages of
means that the distribution of safety stocks in the the whole system which minimizes the corre-
whole system is such t b - t safety stocks at each sponding expected inventory, holding costs.
stage have to protect a / i n s t aggregate demand For this problem the recursive relations of dy-
risks CO;rC~or, di::g ~:; e ~me period determined namic programming for the minimum costs in
b y t h e sum ofprocessL ; e a d times of all preced- state z~ ~ as extension of (6) ~ t n m out to be
ing items up to the next predecessor with a posi-
tive safety stock,
The extreme point property (lO) leads to a re-
f~,(~,,)=
Usia- U,i(
E cMz~,-u,,+t~+l
mm~c~,/Us,+k~N(~),
keE
duction of service time combinations by allow-
ing only e ~ ~ . . . . ,~:~, m - )
combinations.
Again a dy=amie pro~ra.m.rrdng procedure can +j e NE( i ) , f,,,(z,,-u,,+tAt (14)
be used for a~ ;'ffective numerical solution of the j(E E
safety stock optimization problem taking into
account the dynamic structure of the multi-stage f~r s = 1,2 ..... r - 1 and i~P(s)
service time determination and the simplifica- with initial condition
tions made possible by the extreme point
property. f:=O, Vi~P(r)
To translate the safety stock optimization
problem (P.2) into a dynamic optimization Based on these recursive equations the backward
problem one i:as to d e f n e ~u~ a . , . , ~ . - decision solution procedure starts at stage r - 1 and con-
states s equivalent to the production stages sists of parallel solving IP(s) l functional equa-
109
tions at each stage. The possibility of reduc:ng the h,=l, h2=h5=2, ]~3=h4=3
two-dimensional optimization problem at each
stage to [P(s)[ one-dimensional ones, which is a3=10, a4=20, as=25
of high importance for the efficiency of numeri- The desired customer service level shall be given
cal solution-procedures, stems from the fact that as 99% for each of the three final items. The in-
the optimization of s'afety stocks for each prod- ternal safety stock •.e. |. .viul~
~'-- l~¥Glb
' .... '- a r ~ set to '~""'
~1'770~
uct at a given stage can be performed indepen- tt,o. Assuming normally distributed demands this
dently from the others at the same stage. Because results in identical safety factors for all products
of the solution's extreme point property decision being q,=2.33 ( i = 1,2,...5).
space O~ and state space Z~, are strongly re- First, we assume that there is no corrclation
stricted containing only 2 and (as maximum) s between the final-stage demands
elements, respectively:
P34 "~/~. 3 = t 0 4 5 = 0
u ~ t~,= {0,Zs~} ( 15 ) Solving this specific safety stock optimization
2si~ Zsi = { ti,ti + t~.(i),...,ti+ tv(i) + "'" + t, problem (P.2) yields the following result for op-
timal service times
Thus, the dynamic programming algorithm of-
fers an extreme powerful procedure tn solve safety ST=0, S~=2
stock problems for real world divergent produc- This result means that safety stocks have to be
tion structures (e.g. with more than 10 stages and held for product 1 (raw mate' ial) and for the
100 products) without large computational three final-stage products while intermediate-
eflbrt. stage product 2 has not to be stocke~a for safety
purposes. The raw material safety stock has to be
4. Safety stock allocation and correlation of large enough to guarantee an immediate supply
demands for the succeeding processing operations to man-
ufacture products 2 and 5. The safety stock for
end-item 5 must protect against excess demand
To demonstrate possible outcomes of the safety
for the periods of its own processing lead time
stock optimization procedure and to discuss the
(plus the review period) while for the other final
impact o~ system parameters, especially correla-
products safety stocks have to take into account
tion coefficients, on amount and distribution of
the additional lead time of proce3sing product 2,
safety stocks in the whole system we use a simple
for which a buffer stock is not implemented.
example of a three-stage divergent production
Formulation of optimization problem (P.2)
structure as shown in Fig. 3.
makes evident that, in general, the amount of
Structure and demand parameters are as-
safety stocks in the system depends on all of the
sumed to be
system parameters. Now, it is well known from
a13-~-a14=a15~-a23=a24= l single-stage inventory theory that increasing lead
-*;,.n~-~Sa t w~ll n~ ri~in~_ service levels and demand
tl=l, t2=/5=2, t3=t4=! variability result in safety stock increases tbr a
special product. The same holds, in principle, for
the multi-stage casc overlapped, however, by the
safety stock allocation results.
For the impact of the system parameters on the
allocation decision general rules are not easy to
C}- P3", obtain because they depend very much on the
concrete type of production structure. The in-
ventory cost minimization objective will shift
safety stocks to products where holding costs are
:ctativ eiy small. Such, in tendency stock keeping
Fig. 3. Three-stage production/inventory system. at upstream stages is preferred.
llU
TABLE 1
"I I - v a l u e
700
680
660
cy
300
280
! -size
26oI ',/
I
-1 0 +I
I I-policy I-policy I P3q
I I
I t
T h e same holds for increasing risk-pooling Next, different specific types o f d e m a n d cor-
changes g e n e r a t e d by decreasing c o r r e l a t i o n o f relations a n d t h e i r influences o n d i s t r i b u t i o n a n d
final-stage d e m a n d s . Because this effect is o f spe- size o f safety stocks for o u r e x a m p l e shall b e
cial interest for d i v e r g e n t p r o d u c t i o n / i n v e n t o r y considered.
structures is shall b e i n v e s t i g a t e d in m o r e detail. T h e results in T~ble 1 show t h a t in the case o f
Ill
PB
f-- -
I+ 1
-1 ;'- P A
, \ 7 D
"1
complete positive correlation of all demands risk-pooling in the divergent production system
safety stocks only are reasonable to be held at the under consideration.
final stage. Successive decreases in the amount of Figure 4 gives an impression of the influence
correlation generate a shift of safety stocks to up- of continuous variation of one correlation coef-
stream stages using, corresponding risk-pooling ficient - - here referring to the demands of prod-
chances. In case of extremely negative correla- ucts 3 and 4 - - on size and value of safety stocks
tion, finally, safety stocks are spread all over the in the system. It can be seen that with reaching
system. Depending on the correlation situation critical amounts of correlation the I-policy and
all of the four feasible safety stock policies (i- inventory sizes are changing by leaps whereas tl~e
policies) may turn out to be optimal. stock values and inventory costs are varying
As can be seen the overall value of safety stocks continuously.
The combined impact of more than one corre-
in the system is falling with decreasing amount
lation coefficient on the safety stock policy is
of correlation showing the effects of product-de-
demonstrated ".'nFig. 5, where is set tOn=P34 a,.ld
pendent risk diversification on holding cost min-
rOB=P.*5 =/745"
imization. Neverthe!esz, the overall safety stock Figure 5 shows that within the region of feasi-
size may rise with decreasing correlation because ble Combinations of correlation coefficients
of the effects of time-dependent risk diversifica- IPAI ~<I and IPBI ~<~/0.5(pA+ 1 ) compact ,rob-
tion on holding safety stocks at the, however more regions - - marked by differently shaded areas - -
expensive, final stage level caused by large re- are connected with specific optimal safety stock
plenishment lead times. Table 1 shows that for policies. Here again a tendency appears resulting
extreme negative correlation the safety stock vol- in a concentration of safety stocks at the final
ume is almost the same as for complete positive production stage for high positive correlation and
correlation but its value is 15% tess. This gives us in a wide dispersion when correlation has a largo
information about cost saving opportunities by negative amount.
112
13 B~ker, K.R., Magazine, M.J. and Nuttle, H.L.W., 1986. policies in a muir-warehouse system with lead times and
The effect of commonality on safety stock in a simple random demand. In: L.B. Schwartz (ed.), Multi-Level
inventory model. Manage. Sci., 32: 982-988. Production/Inventory Control Systems: Theory and
14 Van Donselaar, K. ~.nd Wijngaafd, J., 1987. Common- Practice. North-Holland, Amsterdam, pp. 51-67.
ality and ~fety stock;. Eng. Costs Prod. Econ., 12:197- 18 Indeffurth, K.~ i989. Zur Festlegung von Sicherheits-
•~ t x .4
~u,.t. bestaenden in mehrstufigen Lagerhaltungssystemenmit
15 Van Donselaar, K. and WijrLgaard, J., 1986. Practice! divergierender Struktur. Discussion Paper No. 203, De-
application of the echelon apr~roach in a system with di- partment of l:cononfi~s, Uni-;cr~i~y cf B~.clcfcld,
vergent production structures. In: [ i9], pp. 182-196. Bielefeld.
16 Simpson, K.F., 1958. In-process inventories. Oper. Res., 19 Axsaeter, S., Schneeweiss, Ch. and Silver, E.A. (eds.),
6: 863-873. 1986. Multi-stage Proauction Planning and Inventory
17 Epnen, G. and Schrage, L., 1981. Centralized ordering Control. Springer, Bedim