WHAT’S DRIVING YOUR AVAILABILITY LEVELS?
Do you have enough stock to meet demand? Do you have too much? How can you ensure your service level targets satisfy the expectations of the business while still keeping investment in stock under control?
Can establishing more appropriate service levels actually help boost margins?
For stock-holding businesses, availability is everything! However, while the commercial departments within the business may expect 100% availability, supply chain leaders understand that this is neither an achievable nor beneficial target to aim for. Given the risk of obsolescence and the cost of holding inventory, holding excess stock can have a hugely adverse impact on profit margins as well as unnecessarily tying up valuable working capital. But how can you ensure your service level targets satisfy the expectations of the business while still keeping investment in stock under control?
In many businesses, the criteria for setting service levels is often 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 for example, that the service levels are reviewed and quickly adjusted (without any real analysis). Thus, service levels are not reviewed regularly enough. Should this worry you? Only if you think that service levels are not a powerful instrument that has 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 organization with a valuable asset?
In our opinion, an optimal service level provides two major benefits:
1) It can be an enormous margin-boost on an article level
2) It can provide you with a huge amount of insight:
- How does your business strategy align with your inventory strategy?
- Are you using the right business rules?
- Are you outperforming your competitors?
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. However, unless you have a complete understanding of your assortment, how can you be sure that you are making the right inventory decisions? After all, while a slow-moving line may seem like a costly waste of space in your DC, for certain customers, these items could well be the sole reason they buy from your business. Equally, if an item offers only a minimal return in terms of customer benefit or profit, is it really worth investing time and money ensuring that this item is always available?
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 at an article level. For example, knowing that the cost component has an exponential character, an appropriate service level at an article level can result in a large margin boost 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.
Insight into internal processes
The advantage of a well-adjusted service level goes beyond margin increases as a thorough analysis also provides greater insight into your internal processes. By internal processes, we mean the processes that should mitigate both the supply chain factors and the demand chain factors.
A service level reflects your ability to meet demand and the capacity you are willing to use to satisfy this demand. If it is based on the right criteria, it should fit with your company’s strategy and the capacity of its processes. If your capacity is not based on the right criteria, it may not have the desired effects. This occurs because certain supply and demand influences are not taken into account and as a consequence, this can cause a margin decrease. In that case, simply increasing or decreasing your service level can make the issue even worse.
Your service level should be a reflection of your internal processes and the maximum profit they could possibly generate. From the service
level and its effects, we can derive:
- To what extent the internal processes can handle the service level
- What this process input means for every individual article
You should ask yourself which element you want to change; the inventory process or the service level. Either way, one should be adapted around the other. However, there is a risk that you adapt the wrong one, which can lead to a decrease in the quality of both elements. This, in turn, can have severe consequences!
In conclusion, the right determination of your service level can have a considerable effect on your margin, but it can also give you insight into the extent to which your internal processes and their capacity can be improved and aligned to your organizational goals.
How to get started?
The determination of a quantitative fact, based on quantitative data only, requires a formula. The correct determination of a quantitative fact, based on more than quantitative data alone, requires a perspective: the correct perspective.
With regards to the perspective of a service level, we mainly mean the way the cost and turnover components are approached. We should look at the relevant process input for each article. Superficial quantitative criteria like a turnover (ABC analysis) and the cost of safety stock should also be taken into consideration. However, we have to accept that there are also other, less quantifiable criteria in play. For instance; think of the actions your customers will take in the event of stock-outs, is the expected turnover guaranteed? The quantification of the appropriate service level is a company-dependent exercise, in which we should be able to determine the process input per article. Quantifying these criteria is not an easy thing to do. However, it is possible!
Would you like to have a more elaborate guide about how to determine the right service level for your organization? In the near future, we will publish a whitepaper including an extensive exercise helping you to determine your service level in a more pragmatic way.