What is Wrong with Current Safety Stock Calculations?

When you need to maximize your financial results by balancing your inventory levels and customer-service performance, a “simple” or Excel-based safety-stock calculation may seem to be the right choice, but it can be dangerous!

You need safety stock for your random variations in demand and replenishment lead time — the unforeseeable timing of spikes, dips, intermittency, and delays. This randomness is quantifiable, but it’s not simple, especially with complex MRP parameters — MOQ, EOQ, ROQ, min-max, package size, etc.

There are plenty of simple safety-stock calculations but beware; they are too simplistic to optimize both inventory and fill rate. For example, you’ve seen this popular, common safety-stock formula:

You face at least six real-world issues that a “simple” safety-stock formula like this cannot address:

  1.  A simple formula ignores MRP parameters, as if they weren’t important.
  2. A simple formula assumes that your world is normal and steady, so it doesn’t take non-normal demand patterns into account. A simple normality-based formula gives you unreliable results.
  3. You measure your service level as a quantity-based fill rate, but a simple formula measures service level as the probability of no stockouts, ignoring this fundamental and important difference. Yes, you can introduce a fill-rate factor to the formula, but this merely makes it more complex, not correct.
  4. You know that past-due demand or usage often carries over, making other demand late — but a simple formula assumes that this doesn’t happen.
  5. Because a simple formula ignores fill rate, skewed demand patterns, MRP parameters and carry-over demand, it cannot provide you with reliable expected service-level and inventory-performance results.
  6. Some of your inventory items cannot be profitably expedited, and some of your customers will not accept expediting. They demand the highest confidence that they will consistently meet service-level targets. A simple formula cannot provide this confidence.

We will take a look at each of the above issues, as they relate to current safety stock calculation methods, in a future blog entry.

We invite your comments, and look forward to the discussion.

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