International Journal of Production Economics, 24 ( 1991 ) 103-113 103

Elsevier

Safety stock optimization in multi-stage inventory systems

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.

I. Introduction multi-stage system, too (see [3 ] ). Because find-

Practical approaches for solving stochastic
multi-stage production/inventory_ or distribu-
tion/inventoi-y problems mostly base on a heu-
ristic procedure of separating the problem into a
deterministic multi-stage problem using fore-
casts of the stochastic components and into the
problem of fixing safety buffers to protect against
forecast errors (see [ i ] ). While multi-stage co-
ordination of deterministic lot-sizing is per-
formed in the framework of systems of a-~aterial
or distribution requirement planning (MRP/
DRP) determination of safety buffers usually is
carried out stage by stage without considering in-
terstage dependencies.
Stochastic ~nfluences in multi-stage systems
result from uncertainties with respect to external
demands, to processing lead times, and to yields
of processes. In this paper we concentrate on the
- - ord:.narily - - most important factor of de-
m a u d u n c e r t a i n t i e s w h i c h have to be covered by
safety stocks. Traditional MRP approacl~e~
strictly restrict safety stocks to the end-item level
(see [2 ] ). More flexible approaches allow for lo-
catio,n of szfety stocks at upstream stages of the
ing the appropriat~ clistribufion and quantifica-
tion of safety stocks in a general multi-stage en-
vironment is a difficult task, quite simple
approaches of coordinated stock determination
like using safety time norms or hedging (by over-
estimating future Oemz~d) have been suggested
(see [4] ). However, these procedures lack of in-
tegrating cost minimization aspects of safety
stock distribution, especially neglecting the in-
fluence of stochastic dependencies of demands for
different end-items.
Now, cost-oriented procedures of safety stock
location and sizing intend to determine the safety
stock distribution which minimizes processing
and inventory (holding and shortage) costs, pos-
sibly taking into account additional service level
restrictions. As results from basic research on
multi-sta~e stochastic inventory problems (see
[ 5-9 ] ) a simple structure of the optimal multi-
stage lot-sizing and safety stock policy is only to
be shown for very spec'.'~tproblem classes ~multi-
~tzge serial or specific cenvergent and divergent
~ ~ Froce~in~ costs). Even
systems without tt,_v,~
heuristic approaches for combining lot-sizing and
safety stock optimization offer practicable re-

0925-5273/91/$03.50 © 1991 Elsevier Science Publishers B.V. All rights reserved.

104
suits only for rather specific serial or two-stage
~ystems (see, e.g., [ 10,I 1 ] ). Thus, for consider°
ing quite general production or distribution
structures a decoup!ing cf lot-sizing and safety
stock determination is necessary. A separated
safety stock policy, how,~~,,~r. is appropriate for a
system with a lot-for-let ordering policy, for in-
stance as is performed by using a base-stock con-
trol pale (see [ 12] ).
Much work has been done in developing ap-
proaches for multi-stage safety stock de~ermi,m-
tion with given shortage costs. Since for practical
purposes service level ~-eqtfirements are easier to
formulate than shortage cost functions we will
deal w'_'th safety stock optimization problems de-
scribed as follows: how should in multi-stage in-
ventory systems - - using a base-stock control
policy - - safety stocks been sized and located all
over the system in order to minirrfize the ex-
pected costs of interstage inventories ana to
guarantee specified service levels for the final
stage products.
In this paper we wil! restrict our ~c,nsidera-
tions to multi-stage p r o b l e m s pith general diver-
gent structure for two reasons. First, divergent
structures cover a lot of v e ~ important practical
multi-~tage systems like many chemical produc-
tion processes (e.g. production of active ingre.-
clients in the pharmaceutical industry) or like
pure mu!fi-stage distribution processes. Sec-
•, . u , s , u,~ aiialysis of divergent systems gives
specific insights in safety stock optimization for
other ~truetures. Serial systems are just special
cases of divergent systems, and for convergent
systems the effect of component commonality c,~
safety stocks is very much related to the effects
studied in divergent systems (see [ 13,14] ). Al-
most all approaches developed for determining
appropriate safety stocks in divergent produc-
tion or distribution systems deal with situations
where internal unability for fulfilling unexpected
demand on intermediate stages by using safety
stocks leads u n a v o i d a b l y to shortages at down-
stream stages and to deteriorations of customer
service levels. This assumption is vezy critical ib-
two reasons. On the ~...,:.-ehand th;.s situation yields
.. _ ............. .v.,.A-:, . u r n the impact of
single-stage service levels on the overall cus-
tomer service levels, only allowing for analytical
considcratlon of these dependencies for two-stage
systems withou~ taking into account positive or
negative correlation of final-stage demands and,
in general, needing more or less rough and cum-
bersome approximations (see [ 14,15 ] ). On the
other hand this assumption asserts that an ex-
treme inflexibility is involved in the production/
distribution operating system which is hardly to
bc found in practice.
ha practicai situations intermediate-stage safety
stocks usually have to protect against some kind
of normal risk fl'om u ., ~. .,.L. .a , ;n t , "e s e.g. against
normal variability of demand. In case of e:tces-
sive variability an intermediate production or
distribution stage will pecform extraordinary ac-
tions like accelerating internal processing or ini-
tiating express delivery from outside suppliers to
fulfill its service commitments. Such emergency
actions are made possible by a certain level of
operating flexibility. Now, in many cases it is
quite realistic to assume that by using safety
stocks and excess operating flexibility each inter-
hal stage is totally reliable meaning that conse-
quences of interstage safety stock shortages for
customer service levels are avoided. This is es-
pecially true if a minimum amount of alternative
flexibility is given and if internal service levels
are set appropriateiy high. However, this reliabil-
ity condition seems to be far more realistic than
the rigid assumption of neglecting any kind of
._,.
. . .........
. . *;--,, ficx~b~iity that is supposed in the com-
mon approaches (for further discussion see
[12]).
In the context of our considerations we will not
include costs for usage of operating flexibility and
its impact on the safety stock decisi~r, assuming
that often a certain capacity of slack resources is
given (as a strategic component) which is fixed
and can be used without additional costs.
e~. safety stock optimization procedure based
upon the described flexibility assumptions has
been presented by Simpson [ 16 ] for a serial pro-
duction structure without capacity restrictions for
stock building. It will be shown that this ap-
proach can be extended to general divergent
structures resulting in solution procedures which
bring about im0ortant practic-ai benefit~ like a,~
plicability to large divergent multi-stage struc-
tures and possibility of consideri,ug correlation
between e,,u-,,~m " -' :+~ demands.

The remainder of this paper is organized as
follows. In the next section the safety stock op-
t:~mization problem for the basic case of serial
multi-stage systems is described. Solution prop-
erties are discussed, and a powerful dynamic
programming algorithm for numerical solution is
presented. Then the case of divergent system is
discussed, and an extension of the serial ease re-
suits is presented. Following this, supported by a
simple example of a divergent system, the sensi-
tivity of the optimal safety stock solution with re-
spect to differeot problem parameters, especially
to demand correlation, is studied. Finally, nee-
essa_ry extension~ of the pr,.se
. . . ......
. a approach arc
discussed,
2. Safety stock c,ptimization in serial systems
A serial multi-stage system can be character-
ized as in Fig. 1 representing e.g. an n-stage pro-
duction system with stock points at each stage.
Associated with each stage i(i= 1,2 ..... n) is a
known and constant processing lead time ti. Fixed
(multi-stage) production coefficients ai, indi-
cate how many units of product i are used for
manufacturing a single unit of final-stage prod-
uct n. The demand process for the final product
is assumed to be stationary w~th independent,
normally distributed random variables charac-
terized by variance a 2. The dependent variances
of the upstream stage demands then are given by
a,=a~-a2~, i=1,2 ..... n - i
The customer service level a~ is defined as the
proportion of periods in wh'ch the current de-
mand if fully satisfied from the final stage stock.
Unsatisfied demand is assumed to be back-
ordered. This leads to a service factor q. - - com-
puted as a , ~ percentile of the standard normal
distribution, which is used to determine the sat~ty
stock
I !
I |
I I
' '~tage 1 I s~.age 2
P I
Fig_ !. Serial production/inventorysystem°
105
z,, = q,,. ~,. #~ (l)
which guarantees to cover demand uncertainties
over the leplenishment lead time of 2 periods with
the desired custnmer ~ervice.
For the intermediate production stages service
factors qi ( i = 1,2,...,n- 1 ) are given as well, anal-
ogously computed from internally determined
service levels for each stage to satisfy regular de-
mand fluctuations from the downstream stage out
of safety stocks. This is equivalent to setting tar-
gets to the probabilities of being charged with ex-
traordinary operational actions at each stage to
keep delivery commitments for the vmceeding
stage.
Now, the task of setting interstage safety stocks
,,,~,., ,o minimize the expected system hold-
ing costs providing desired customer and inter-
nal service levels can be formulated by using so-
called service times Si ( i = 1,2 ..... n) as decision
variables (see [ 16 ] ). A service time Si is defined
as the maximum span of time that may elapse be-
fore an order placed against stage i, within the
framework of a given service level, will be ful-
filled. The minimum service time for a stage
equals zero maaranteeing immeciiate supply of the
downstream stage (S~> 0) while the maximum
service time is equal to the time for replenishing
the inventory from the upstream ~tzge, i.e. the
sum of stage processing time and upstream stage
service time ( Si <~S,_ ~+ t~).
Given certain service times, for each interme-
diate stage i ( i = 1,2...,n - I ) a replenishment time
span o f S : ~+ t e - S , has to be covered by a safety
stock 1i. qnis analogously to ( 1 ) results in
li=q~a,x/S,_~+b-Si, i = l~2,...n- 1 (2)
For the final stage the service time S, has to be
set to zero (S, = 0) because customer orders have
! ', i
| I | I
I I I l
~ Istage n-11 stage n I
I "'" I
 !06
to be satisfied instantly. Thus, taking into ac-
count an additional increase of the coverage time
by the review period for the final product holds
r _ ~ ~ /~, _t., -t. 1 t2)
With h~ as holding costs for product i the safety
stock carrying costs at stage i can be written as
h~L leading to a safety stock optimization prob-
lem for the serial s)~tem (P.1 that can be for-
mulated as follows:
n-]
~vmi ~. = Z. '~,V ~'i- 11- ' i - oi 1- c,,x/ ;~,_ l + i, + l
i=l
~ubject to
O~.Si<~S,_l+t~, !=1,2 ..... n - I
So,--0
where cj=h:q/rj ( j = 1,2,...n).
It can be shown (see [16] ) lhat for this non-
linear optimization problem the optimal solu-
tion is characterized by an extreme point prop-
erty saying that the service time at each stage
takes on either its minimum or its maximum fea-
sible amount
S~e{O;S~_,+t,}, i = 1 , 2 ..... n - i
This corresponds to an "all-or-nothing"-policy for
setting safety stccks according to (2) and (3)
meaning that between any two stages either there
is sufficient inventory for complete decoupling of
the two stages or there is no inventory at all.
The extreme point property in (4) results in a
finite number of 2 "- t feasible service time poli-
cies. Feasible service times are therefore re-
stricted tc zero or to accumulated successive pro-
cessing times
S*e{O,t,t~+t~_, ..... t ~ + t j _ , + . . . + t , }
The numerical solution of the optimization
problem (P. 1 ) most efficiently can be calculated
by a simple dynamic programming procedure us-
ing the dynamic character of the multi-stage stock
allocation problem combined with the ~peciai so-
lution property. In order to transpose the prob-
lem (P. 1 ) into a dynamic optimization problem
one has to define appropriate decision and state
variables for the decision respectively produc-
tion stages s = 1,2 ..... n - 1.
With decision variable u, interpreted as the
safety stock coverage time at stage s
( u , = S , _ ~+ t s - S , ) , and state variable zs defined
as replenishment time not yet covered at stage s
before the safety stock a!!oc~tion decision
(z,=5~_~+ts), minimizing the total inventory
holding costs in (P. 1 ) can be pertbrmed by eval-
uating the following recursive relations of dy-
namic programming using backward recursion
(for s = 1,2 ..... n - i ):
~£(Zs)=min{c~x/~+f~+l(Z~--u,+t,+~) } (6)
with the initial condition
f,..(z,) = C,X/~, + 1
The extreme point property given in (4) and (5)
allows for restricting decision space U~ and state
space Z, to 2 respectively s elements
u:--U~={O,z~} (7)
z,~Z,={t,,t~+t~_l ..... t,+t,_, + ' " + t , }
Using this extreme decision and state space re-
duction the computational effort o f the dynamic
programming approach can be reduced to a huge
extent.
(4)
3. Safety. stock optimization in divergent systems
Using the results for safety stock determina-
tion in se:'ial systems, now a safety stock optimi-
zation procedure for general dive-g: at ~ystems as
shown in Fig. 2 shall be derived.
Products/inventories are numbered from 1 to
n while stages are counted from 1 to r ( r < n ) al-
low:,ng for more than one product/inventory at
each stage. Each p r o d u c t / i n v e n t o r y - - except for
the first and final s t a g e - - is characterized by just
(5) one predecessor and one or more successors. Each
item is assigned to the highest possible stage in
the whole structure.
For describing the safety stock problem the
f:bllowing notations are used for sets of products/
inventories:
E = final-stage i~.ems.
V = intermediate-stage items.
N( i) = i m m e d i a t e successors of item i ( ie V).
E(i) =final-stage items succeeding i ( i t V).
v(i) =predecessorofitem i (it VOE).
P(s) = i t e m s assigned to stage s ( s = 1,2 ..... r).
 107

•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 |

Fig. 2. Divergent prodt~ction/inventory system.

Input data of the stochastic end-item demands
are variances and correlation coefficients for end-
item dema.~ds:
a~ = d e m a n d variance of final-stage item k
(k~E).
~.~ =correlation c~e;'ficicnt of demands for
items Icand I ( k~E, leE, k # l).
For divergent stractures demand variances of
intermediate-stage items depend on variances
and correlation cocIficicnts o ~ re!arid end-items
as well as on corresponding (multi-stage) pro-
duction coefficients:
aikt7 k
keE(i)
+ ~, ~ a,~a,takalpkt, i e V
: ~ E ( i ) I~E(i),
I#k
Equation (8) shows that in divergent systems the
risk of demand variability for intermediate-stage
products is less than the "average" risk of the
corresponding final-stage items, except for the
case of completely positive correlation, resulting
from pooling the end-item risks.
Using base-stock co~ltrol in d~'mrgent systems
means the'* at each intermediate stage the cumu-
lative :Jemand of corresponding final-stage items
ha~ to be replenished. Intermediate safety stocks
are used to pro~ect against stochastic fluctua-
tions of cumulative demand up to a maximum
ceasonable e.no'ant represented by fixed internal
service levels. Now taki~=g into consideration an
over-all inter:~al set ,ice level of 1(;0% (by safety
stocks and ooP:at!ng ~e;:ib!l~ty) allocation prob-
lems ot optimal distributing scar~ e safety stocks
to alternative succeeding products will not exist.
Simultaneously it is possible to guarantee de-
sired service levels for final-stage products pre-
venting situations of unbalanced inventories for
end-items which can occur in circumstaqces of
(8) limited internal delivery service (see [ 14,17 ] ).
Transferring the concept of service times a
straightforward extension of the serial systems
approach of optimizing safety stocks can be car-
fled out considering the fact that in divergent
systems each stage contains several inventories
with more than one successor-customer but on!y
one predecessor-suppher.
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-

tions at each stage. The possibility of reduc:ng the
two-dimensional optimization problem at each
stage to [P(s)[ one-dimensional ones, which is
of high importance for the efficiency of numeri-
cal solution-procedures, stems from the fact that
the optimization of s'afety stocks for each prod-
uct at a given stage can be performed indepen-
dently from the others at the same stage. Because
of the solution's extreme point property decision
space O~ and state space Z~, are strongly re-
stricted containing only 2 and (as maximum) s
elements, respectively:
u ~ t~,= {0,Zs~}
2si~ Zsi = { ti,ti + t~.(i),...,ti+ tv(i) + "'" + t,
Thus, the dynamic programming algorithm of-
fers an extreme powerful procedure tn solve safety
stock problems for real world divergent produc-
tion structures (e.g. with more than 10 stages and
100 products) without large computational
eflbrt.
4. Safety stock allocation and correlation of
demands
To demonstrate possible outcomes of the safety
stock optimization procedure and to discuss the
impact o~ system parameters, especially correla-
tion coefficients, on amount and distribution of
safety stocks in the whole system we use a simple
example of a three-stage divergent production
structure as shown in Fig. 3.
Structure and demand parameters are as-
sumed to be
a13-~-a14=a15~-a23=a24= l single-stage inventory theory that increasing lead
tl=l, t2=/5=2, t3=t4=!
C}-
Fig. 3. Three-stage production/inventory system.
109
h,=l, h2=h5=2, ]~3=h4=3
a3=10, a4=20, as=25
The desired customer service level shall be given
as 99% for each of the three final items. The in-
ternal safety stock •.e. |. .viul~
~'-- l~¥Glb
' .... '- a r ~ set to '~""'
~1'770~
tt,o. Assuming normally distributed demands this
results in identical safety factors for all products
being q,=2.33 ( i = 1,2,...5).
First, we assume that there is no corrclation
between the final-stage demands
P34 "~/~. 3 = t 0 4 5 = 0
( 15 ) Solving this specific safety stock optimization
problem (P.2) yields the following result for op-
timal service times
ST=0, S~=2
This result means that safety stocks have to be
held for product 1 (raw mate' ial) and for the
three final-stage products while intermediate-
stage product 2 has not to be stocke~a for safety
purposes. The raw material safety stock has to be
large enough to guarantee an immediate supply
for the succeeding processing operations to man-
ufacture products 2 and 5. The safety stock for
end-item 5 must protect against excess demand
for the periods of its own processing lead time
(plus the review period) while for the other final
products safety stocks have to take into account
the additional lead time of proce3sing product 2,
for which a buffer stock is not implemented.
Formulation of optimization problem (P.2)
makes evident that, in general, the amount of
safety stocks in the system depends on all of the
system parameters. Now, it is well known from
-*;,.n~-~Sa t w~ll n~ ri~in~_ service levels and demand
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
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
at upstream stages is preferred.
 llU

TABLE 1

Correlation coefficients ~nd optimal safety stocks

correlation coefliclems optimal safety stocks l-policy safety stock

P34 P35 P45 11' /* i_* i~ ,~; size value

+1 +i +1 0 0 52 104 !17 [] 273 702

+1 C f) 0 0 32 104 It7 [] 273 702
0 0 0 78 0 47 93 I01 [] 319 699
-1 0 o 0 40 33 66 117 [] 256 610
-! +1 -1 35 33 33 66 101 ~ 268 599

"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

Fig. 4. Safety stock optimization for var'yingps4 (with Pr5=P,s =0).

T h e same holds for increasing risk-pooling
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
final-stage d e m a n d s . Because this effect is o f spe-
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
structures is shall b e i n v e s t i g a t e d in m o r e detail.
Next, different specific types o f d e m a n d cor-
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
size o f safety stocks for o u r e x a m p l e shall b e
considered.
T h e results in T~ble 1 show t h a t in the case o f

f-- -
I+ 1
-1
, \
"1
Fig. 5. Correlation and safety stock policy.
complete positive correlation of all demands
safety stocks only are reasonable to be held at the
final stage. Successive decreases in the amount of
correlation generate a shift of safety stocks to up-
stream stages using, corresponding risk-pooling
chances. In case of extremely negative correla-
tion, finally, safety stocks are spread all over the
system. Depending on the correlation situation
all of the four feasible safety stock policies (i-
policies) may turn out to be optimal.
As can be seen the overall value of safety stocks
in the system is falling with decreasing amount
of correlation showing the effects of product-de-
pendent risk diversification on holding cost min-
imization. Neverthe!esz, the overall safety stock
size may rise with decreasing correlation because
of the effects of time-dependent risk diversifica-
tion on holding safety stocks at the, however more
expensive, final stage level caused by large re-
plenishment lead times. Table 1 shows that for
extreme negative correlation the safety stock vol-
ume is almost the same as for complete positive
correlation but its value is 15% tess. This gives us
information about cost saving opportunities by
Ill
PB
;'- P A
7 D
risk-pooling in the divergent production system
under consideration.
Figure 4 gives an impression of the influence
of continuous variation of one correlation coef-
ficient - - here referring to the demands of prod-
ucts 3 and 4 - - on size and value of safety stocks
in the system. It can be seen that with reaching
critical amounts of correlation the I-policy and
inventory sizes are changing by leaps whereas tl~e
stock values and inventory costs are varying
continuously.
The combined impact of more than one corre-
lation coefficient on the safety stock policy is
demonstrated ".'nFig. 5, where is set tOn=P34 a,.ld
rOB=P.*5 =/745"
Figure 5 shows that within the region of feasi-
ble Combinations of correlation coefficients
IPAI ~<I and IPBI ~<~/0.5(pA+ 1 ) compact ,rob-
regions - - marked by differently shaded areas - -
are connected with specific optimal safety stock
policies. Here again a tendency appears resulting
in a concentration of safety stocks at the final
production stage for high positive correlation and
in a wide dispersion when correlation has a largo
negative amount.
112
5. Further research
In this paper a procedure for solving the safety
stock problem in a general divergent produc-
t i o n / d i s t r i b u t i o n system was presented. The spe-
cific assumptions underlying the problem for-
mulation may cause some l~mimtions to the
applicability c~f the approach. It is a matter of
further research to relax the most restrictive as-
sumptions without endangering the practicabil-
ity of the solution prccedure.
It can be shown, for instance, that the fixing of
constant processing lead times can be replaced by
allowing lead times for the final production stage
processes to be variable in certain ranges. G i v e n
that the sum of final-stage lead times is equal to
a fixed a m o u n t thi~ represents a situation, where
a fixed capacity tbr fina!-stage operations (e.g.
manpower for assays of active ingredients in the
last stage of pharmaceutical production) can be
allocated to the single processes determining their
lead times, For this case of c o m b i n e d allocation
of safety stocks and lead times an extreme point
property of the solution still can be shown to ex-
ist (see [ 1 8 ] ) .
In our procedure it is assumed that a lot-for-lot
production takes place. Despite of the rising im-
portance of logistic concepts which favour reduc-
ing of lot-sizing this assumption can be critical.
Especially for chemical processes the planning of
considerable production lots can be appropriate
for ecor~omic reasons. In this case safety stock
determination which does not allow for the exis-
tence of lot sizes at certain points ot the produc-
tion structure will overestimate the size of nec-
essary safety stocks. Coordination of safety stock
evaluation and lot-sizing in a multi-stage system
is, rather difficu~ t~ do. A procedure for multi-
stage safety stock determination with respect to
given lot-sizes is presented in [3]. For m u t u a l
coordination, perhaps, an extension of an ap-
proach in [10] for serial systems to problems
with a divergent structure can lead to applicable
results.
A very strong restriction, of course~ is g,_',~,a by
tlie assampfi,,n of tolal reliability of all interme-
diate production stages. This assumption results
from the opinion that using safety stocks is only
one action of faci~;g uncertainties in production
or distribution systems. There are a lot of other
instruments producing flexibility to cover uncer-
tainties which result from d e m a n d as well as from
supply and production processes. In practice all
of these methods arc used simultaneously to pro-
tect against all kinds of risks. The appropriate co-
ordination of these instruments is a very difficult
task. The same holds for estimating the a m o u n t
of reliabi!i~:y of each process given by the level of
flexibility described. If this reliability can not be
assumed 1o reach 100%, of course, the safety stock
optimization procedure described in this paper
wil! not guarantee the required customer service
le;::!s. Then a modification of the solution is nec-
essary which in a simple way could be performed
by increasing the concerning internal safety stock
service levels in some heuristic manner, sup-
ported by simulation techniques.
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