Strategic safety stocks in supply chains with capacity constraints May 2008 , revised January 2009

We generalize the guaranteed-service (GS) model for multi-echelon safety stock placement to include capacity constraints. We first develop an extension of the single-stage base-stock model to include a capacity constraint. We then use this result to model a multi-stage system with a base-stock operating policy. We establish that we can adapt the existing algorithms for the unconstrained case to solve for the safety stocks in a capacitated system. We then consider a multistage system in which stages censor their orders, based on their capacity limits. Again we analytically characterize the necessary base stock levels, and develop an extension to the existing dynamic programming algorithms to find the optimal base stock levels and safety stocks. The censored order policy leads to a better solution compared to that for the base-stock policy. Indeed, we find that the total holding costs for the censored order policy can be less than that for the corresponding base-stock system without capacity constraints.