Why do service levels have a powerful impact on profitability?

Sam Phipps

Last updated: March 21, 2023
Sam Phipps

“I need a 100% service level” – a typical expectation of both management and commercial departments. Purchasing & operational divisions however, have a much better understanding of service levels and appreciate that attaining 100% is a utopia. In practice, determining an appropriate service level is an extremely complicated undertaking.

Optimise your service levels

For many businesses, the criteria for setting service levels is unclear and as a consequence, service level targets are set as a given figure (based on a quick and vague analysis). Furthermore, the quality of the service level is difficult to measure as the effects only emerge after a certain period of time. It is only when an inappropriate service level has a negative impact on safety stock inventory for example, that the service levels are reviewed and quickly adjusted (without any real analysis). Thus, service levels are not reviewed regularly. Should this worry you? Only if you think that service levels are a powerful instrument that have the potential to impact both your profit margins and overall business performance.

Do service levels really have such a powerful influence on your margin? And can a well-thought out service level provide your organisation with a valuable asset?

Margin boost

service levels When describing a service level in its purest form, you are describing your company’s goal. It is a translation of your business strategy to your inventory strategy: you are deciding to what extent you want to satisfy your customer’s needs based on your stock capacity.

The service level is an operational translation of the maximum profit you want to generate.

When defining a service level, a number of components have to be taken into consideration including turnover, capacity, customer demand and cost. These components and their relations can be defined on an article level. For example, knowing that the cost component has an exponential character, an appropriate service level on an article level can result in a large margin boost at an assortment level.

Finding an optimal service level thus results into a margin boost on an article level, which in turn leads to a large margin increase at an assortment level. In addition to this, the insight into your assortment’s margin performance can also lead to further opportunities to increase margins over time.

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