When the wage 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 then procurement period and also to provide some measure of safety for at least partially neutralizing the degree of uncertainty.
How much should the magnitude of safe stock be?
It depends on the degree of uncertainty surrounding the usage rate and lead-time. It is possible to a certain extent of to quantify the values that usage rate and lead-time can take along with the corresponding ‘chances of occurrences’ known as ‘probabilities’. These probabilities can be ascertained based on the previous experiences and the judgmental ability of executives. Based on the above values and estimated stock out costs and carrying costs of inventory it is possible to work out the total cost associated with different levels of safety stock. Higher the quantity of safety stock, the lower will be the stock-out cost and the higher will be the incidence of carrying costs. Thus the reorder level will call for a trade-off between stock out costs and carrying cost. The reorder level will be such that the total stock out cost and the carrying cost will be at its minimum.
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