CHAPTER 12 | MANAGING INVENTORY 547 … 12.35 Gainesville Cigar stocks Cuban cigar
ID: 361736 • Letter: C
Question
CHAPTER 12 | MANAGING INVENTORY 547 … 12.35 Gainesville Cigar stocks Cuban cigars that have vari- able lead times because of the difficulty in importing the product: lead time is normally distributed with an average of 6 weeks and a standard deviation of 2 weeks. Demand is also a variable an normally distributed with a mean of 200 cigars per week and a standard deviation of 25 cigars. a) For a 90% service level, what is the ROP? b) What is the ROP for a 95% service level? c) Explain what these two service levels mean. Which is preferable? PxExplanation / Answer
A Service level indicates probability of stock out
When demand of a product is fluctuating, a firm always needs to maintain a buffer stock (also called safety stock) in its inventory which would be used to replenish unforeseen additional requirement from time to time. Higher the quantity of buffer stock, higher will be chances of meeting the sudden spike in demand. Conversely if buffer stock quantity is low, lesser will be the chance of meeting the additional demand requirement.
This chance factor is what is meant by Service level. For example, a Service level of 95% means that in a fluctuating demand condition, probability of meeting this additional demand will be 0.95 or 95%. Same interpretation will hold good for 90% service level. Quite obviously, higher the quantum of buffer or safety stock, higher is the probability of meeting the demand and hence higher will be the service level. Therefore, quantity of safety stock which will be required to maintain a service level of 95% will be higher than quantity of safety stock required to maintain a service level of 90%.
Higher service level means higher chances of meeting customer demand and hence increased sales. However, this comes at a cost in terms of additional inventory inventory in form of safety stock and hence overall higher Inventory holding cost. Therefore, a trade-off between value derived from higher chances of meeting customer demand vs additional inventory holding cost must be doming to decide whether a 90% or 95% service level will be better.