Risk Pooling

1. Risk Pooling John H. Vande Vate Spring, 2006 1

2. Safety Stock Basics • n customers • Each with lead time demand N(m, s) • Individual safety stock levels • Choose z from N(0,1) to get correct probability that lead time demand exceeds z, • Safety stock for each customer is zs • Total safety stock is nzs 2

3. Safety Stock Basics • Collective Lead time demand N(nm, ns) • This is true if their demands and lead times are independent! • Collective safety stock is nzs • Typically demands are negatively or positively correlated • What happens to the collective safety stock if demands are • positively correlated? • Negatively correlated? 3

4. Risk Pooling Case 3.3 p 64 The impact is less than the sqrt of 2 law It predicts that if 2 DCs need 47 units then a single DC will need 33 The impact is greater than the sqrt of 2 law It predicts that if 2 DCs need 5.5 units then a single DC will need 4 Pooling Inventory can reduce safety stock 4

5. Inventory (Risk) Pooling • Centralizing inventory can reduce safety stock • Best results with high variability and uncorrelated or negatively correlated demands • Postponement ~ risk pooling across products 5

6. Examples • Describe techniques for pooling risk 6