The Correct Safety Stock Level is not Simple

In the past year, 25% of the search-term visits to our TopDown Lean Systems website have involved the words simple and/or Excel, usually associated with safety stock. Clearly, and understandably, businesses and individuals are looking for a better, easier safety-stock tool. When the word simple is included, the hope is that a simple calculation may not be perfectly precise, but it may be close enough. And, of course, Excel’s ad-hoc analytical abilities, combined with a simple calculation, could provide quick, easy, acceptably-correct safety-stock analyses and updates. So is simple also close enough?

Albert Einstein said, “Make everything as simple as possible, but not simpler.” How would we know if a safety-stock calculation is simple enough, but not simplistic, or too simple? First, let’s make a list of factors that our intuition tells us might affect safety stock:

  • Target service level –higher service levels require more safety stock
  • Lead time – longer lead times require more safety stock
  • Demand variation – more variation requires more safety stock
  • Lead time variation – more requires more safety stock

So far, so good. Most safety-stock calculations attempt to address these factors. But our experience tells us there are more factors. Here’s just one factor, and we’ll discuss more in following blog postings:

Service level type – Do you measure your actual service-level performance with on-time delivery (OTD)? OTD is a quantity-based fill rate, determined as demand quantity fulfilled on time ÷ total demand quantity.

Did you know that the z factor, or service-level multiplier, in a simple safety-stock formula does not represent OTD fill rate? The z factor represents a much harsher service-level measurement: the probability of no stockouts. The z factor is simple, but will it get you close enough?

Consider an example:

Say that your target OTD for item ABC is 95%. This means that if total demand was 20,000 units, 19,000 should be fulfilled on time. Now, compare this to a 95% probability of no stockouts for item ABC: Out of 100 order lines for ABC, 95 lines were filled on time with no shortages (in other words, no shortage events).

If each order line is for a quantity of 1, then OTD and the probability of no stockouts are the same. But what if the average order line is for a quantity of, say, 200? The probability of no stockouts is 95% when 95 lines are fulfilled complete and on-time, and 5 lines may be just one unit short.

In this example, 95% probability of no stockouts equates to an OTD of 99.975%! ((95 lines * 200 on time) + (5 lines * 199 on time)) ÷ 20,000.

99.975% OTD sounds great. But if your target is 95% OTD, the extra inventory (safety stock) required for the increased service level is excessive.

Do you measure your actual service levels using OTD or a similar fill rate?

Are you looking for a correct way to set safety stock, so that you achieve your service-level targets without unnecessary inventory?

Nothing could be simpler than sending us your data, and we will send you your correct, comprehensive and optimal safety-stock levels. Contact us for more info on how simple we can help make it for you!

One thought on “The Correct Safety Stock Level is not Simple

  1. Have the supplier “own” the inventory until you ship it as well as bearing responsibility for safety stock. If you are managing a complex operation you have got a lot more than maintaining correct safety stock levels to worry about. Is AAPL successful? Do you know what their inventory turns are? And their their Service Level? Jobs was no dope.

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