Achieving the holy grail of inventory management – the magical balance of minimal inventory while meeting variable customer demand in the face of unreliable supply – is only possible with optimal safety stock levels.
Without optimal safety stocks, the value of inventory and product availability continuously oscillates between too much inventory and stocks-outs based on where the loudest noise is coming from:
- Customers and/or sales saying “I can’t believe you are out of stock of that!”
- Finance saying “we need to reduce our inventory value!”
Why do we need safety stock?
Safety stock is inventory required to mitigate the risk of stock-outs due to uncertainties in supply and demand – it is our insurance against running out of stock and protects our fill rate (and sales revenue).
For example: if we knew exactly what we were going to sell each day and our suppliers always delivered the quantity we ordered on time, there would be no need for safety stock.
- Sales are hard to forecast as products may sell smoothly, seasonally, sporadically, slowly or the product may be new
- Suppliers may deliver early, on time or late
- Suppliers may deliver the quantity we ordered, too little or sometimes even too much
Setting safety stock for the right reasons
By monitoring how well we forecast a product and how reliable the supply is, we are able to dynamically adjust safety stock.
We decrease safety stock for products that are more likely to end up with excess, where:
- We continually forecast more than we sell
- Suppliers predominantly deliver early or more than we ordered
We increase safety stock for products with a risk of running out of stock, where:
- We continually sell more than we forecast
- Suppliers predominantly deliver late or less than we ordered
Other factors that influence safety stock
- The length of the lead time
- Supplier minimum ordering constraints
- The frequency of ordering
Target fill rate + inventory risk = more predictable outcome
Driving your inventory investment by target fill rate settings that reflect your market offer and applying the “inventory risk”, results in an optimal safety stock level for every single product. In every location. Everyday.
Not only are we protecting the fill rate, we are targeting the fill rate we want to achieve and computing safety stocks to deliver that fill rate. With optimally set safety stocks we take investment away from products that do not need it and invest more in products that do.