All companies want to guarantee the sale, and for this, they need to have the right products, at the right time, in the right quantity and in the right place. For this reason, it is essential to understand what inventory security means since inventory plays a critical role in increasing the profitability of a business.
The following is a compilation of the most common questions and answers within the supply chain.
TO WHAT EXTENT SHOULD YOU TAKE CARE OF YOUR AVAILABILITY?
Safety stock is the additional level of inventory businesses hold to minimize the risk of stock out. However, being overly cautious can quickly result in costly excess and obsolescence: both of which will erode margins. So what factor should you take into account when determining the optimal level of safety stock?
WHY DO YOU NEED SAFETY STOCK?
Now, in the last few days, a lot of cities are running out of toilet papers. Even though it seems like a roaring success for the companies selling it, the short supply left many customers disappointed. So, should the retailer have invested in more stock to cover this unexpected demand? Is it possible to plan for such a massive fluctuation in demand? The answer to the question is: probably.
Ultimately, the optimal safety stock is all about striking a balance between service levels, investment in stock and risk.
WHAT FACTORS SHOULD SAFETY STOCK ACCOUNT FOR?
Even for the most accurate demand forecasts, actual demand will always vary to some extent. Likewise, your suppliers will not consistently deliver your orders precisely on time or in the exact agreed quantities. The purpose of safety stock is to protect against demand and supply volatility to achieve the target service levels.
While many factors can influence the requirement for safety stock, there are four key areas which must be accounted for:
- Volatility in demand
- Lead-times and supplier reliability
- Service level targets
- The “real” risk of going out of stock
HOW DOES UNCERTAINTY IN DEMAND IMPACT THE REQUIREMENTS FOR SAFETY STOCK?
Imagine that demand for a product was consistently 100 units a month. Ensuring you have enough stock to satisfy this demand would be easy. However, the reality is that demand will vary significantly month to month. Even if the average monthly demand was a hundred units, actual demand could change and thus, without the optimal level of safety stock, the business would be plagued by stockouts and excess.
In simple terms, for any given service level, products with relatively stable demand patterns, the need for safety stock may only be minimal. However, for products with more sporadic demand patterns, the need for buffer stock will be much higher.
HOW CAN LEAD-TIME INFLUENCE THE NEED FOR SAFETY STOCK?
Another key purpose for the safety stock is to cover uncertainty during the period. This is the time between making an order and actually receiving the goods. For products with short lead times such as just 1 day, this is not so much issue. After all, you only need to cover the demand for 1 day. Even if you receive an unexpected order during the cover period, this will only be an issue for one day until the new order is received.
However, for items with long lead-times such as goods sourced from the Far East, the level of risk is likely to be far higher. Given that it could take up to 12 weeks for an order to be shipped over, there are far more days of demand to cover and more opportunities for things to go wrong. As a result, to maintain availability until the inventory can be replenished, the need for safety stock increases.
SHOULD SAFETY STOCK COVER SUPPLIER RELIABILITY ISSUES?
Determining how best to cover for supply volatilities can often be a difficult decision. After all, who should pay the price for supplier performance issues? Should you really have to invest in additional inventory to cover your supplier’s late deliveries?
In the same way, demand deviates from what was expected, there will always be some deviation in the anticipated lead time and the actual delivery times. The causes of these deviations are, in many cases, unforeseen and unavoidable. However, these supplier issues can still have a detrimental impact on customer service levels. As a result, some amount of safety stock should be established to mitigate the risk of stockouts.
However, if supplier lead times are consistently wrong, investing in additional safety stock may not be the best approach. After all, safety stock is only a short-term solution to cover for uncertainties in supply and thus will not improve the situation in the long term.
If a supplier always takes 3 weeks longer to deliver than what was agreed, the question should be asked, is the promised lead time realistic in the first place? With this in mind, instead of investing in safety in this instance, the business should investigate the root cause of the issues and renegotiate the contract accordingly.
WHY DO SERVICE LEVELS HAVE SUCH A BIG IMPACT ON SAFETY STOCK?
Service level targets, their purest form, is a description of a business’s corporate goals to the inventory strategy. In essence, you are deciding to what extent you want to satisfy your customer’s needs based on your stock capacity.
Although a common expectation of the business, maintaining 100% availability across the entire product range is not possible. Thus, management must determine to what extent they want to satisfy demand. While establishing an optimal service level can provide a margin boost, if the service level target is inappropriate, this will result in an unacceptable number of stock-outs or crippling excess.
Service levels are a significant driver of safety stock as the higher the service level, the more substantial requirement there is for stock to ensure availability.
After all, when you decide to make an investment in safety stock, you are essentially committing valuable working capital. For products of strategic importance, this is probably not a problem. However, for slow-moving items or items of relatively low importance to the business or customer, the money locked into these products could be better invested elsewhere across the business.
Given that the relationship between service levels and safety stock is exponential, the service level target must be well aligned with across essential products within your business, whether this is by-product category of based on customer importance, or a combination.
WHAT IF THE “REAL” RISK OF GOING OUT OF STOCK IS LOW?
We have already highlighted the volatile nature of supply and demand. However, just because uncertainty exists, this does not necessarily mean you will go out of stock. Certain circumstances negate the need for a product to have a level of safety stock. But in what situation would a product have a natural layer of protection?
The relationship between safety stock, lead times and supplier reliability is clear; however, the impact of order quantities are often overlooked. Imagine if the minimum order quantity for a product was the equivalent one entire year’s demand. This would mean that you would only have to make one order per year. So, even if the product was subjected to high levels of volatility, the high level of inventory that results from the MOQ would mean that you always have plenty of time to respond should stock levels start to fall. Instead of holding safety stock, the order moment could be brought forward.
HOW APPROPRIATE ARE YOUR SAFETY STOCK LEVELS?
Determining the right level of safety stock is easier said than done. However, when assessing your own safety stock situation, you must ask two questions: Do you have enough stock to meet demand? Do you have too much? There is a fine line between too much and too little.