Safety Stock Strategies: Path to Profit
“Just carry enough inventory so we never have a lost sale.”
“Add a couple of weeks of supply to make sure we don’t run out of stock.”
Are these statements you’ve heard before? They tend to be common solutions for most distributors. However, carrying the same amount of safety stock for all items is an extremely costly and inefficient approach to inventory management. Determining the proper service goal strategy can be one of the most profitable decisions successful distributors make.
A delicate balance exists between service levels attained (orders filled from available stock) and the investment in safety stock necessary to obtain that service. Inventory managers and analysts are constantly asked to do more with less. They are constantly asked questions like:
- “How many weeks of inventory are on hand?”
- “What is the current inventory turn rate?”
- “How's our service level?”
If you think of your inventory in layers, safety stock is the bottom layer or layer that you rely on to make sure your service goals are met. The safety stock strategies allow you to make sure you are getting the best possible return in service from your safety stock investment.
For example, assume that you have two items in your inventory. Item number one sells an average of 40 units per month, has a purchase price of $2, and has a standard deviation of 10% or 4 units per month. Item number two also sells at an average rate of 40 units per month, has a purchase price of $2, and has a standard deviation of 100% or 40 units per month. If you applied the same service level goal to every item in your inventory, both items would have the same service level objective
If you use a conventional inventory management system, you might assign the same service level goal to both items even if you stratify them and assign higher service objectives to the faster sellers. Since the two items sell at the same average rate, both items would have the same velocity code and service level goal.
By contrast, consider the service level objectives established by a safety stock strategy that minimizes lost sales dollars. The safety stock investment on the two items has been optimized to give you the greatest service in dollars for a given safety stock investment. You have the same overall objective of providing 96% service to your customers, but your replenishment system has made the safety stock investment so that your total investment in safety stock is greatly reduced.
In the following table, you are looking at the same two items. Notice the individual service level goals that has been given to each. The safety stock investment has been greatly reduced but overall service provided to the customer is the same. You now have provided an overall service level to your customers of 96%, but have done so with a substantially less safety stock. To provide the same service level using a conventional system you would need almost 14% more safety stock. Instead of reducing your inventory, you could choose to keep the same investment in inventory but provide better service to your customers.
You can choose to provide the same overall service level to your customers and reduce your safety stock investment or maintain the same safety stock investment and provide much better service to your customers.