Why do service levels have such a big impact on safety stock?
Service level targets, it 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 stockouts or crippling excess.
Service levels are a major driver of safety stock inventory as the higher the service level, the greater 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 inventory is exponential, it’s vital that the service level target is well aligned with across key products within your business; whether this is by product category of based on customer importance, or a combination.