What is the real role of safety stock and how is it important to the replenishment process?
For the average wholesale or retail business the forecast is the basis of the replenishment formula, but not the only factor.
What about the other factors that impact the result that is derived from the forecast?
The two major contributors to the calculated Safety Stock value is the Demand Deviation and the target Service Level. Depending on the values for these components, the safety stock value can be significant.
Let’s consider the current service level target is 98%. This is a realistic service level for most stocking items across multiple industries. Next, consider the item has a moderate demand deviation of 30%. This means the historical demand has varied an average 30% from the average demand. The safety stock value in this example is determined by considering the variance above the forecast and then applying the service level target. For example, if the forecast is 100 and the deviation is 30% there is a chance that a future period will have a demand of 130. To achieve the targeted service level of 98% you would need to be able to fill 127.4 of the 130 requested. This would require 27.4 units of safety stock.
This simple example illustrates how important the historical demand data used should accurately reflect “normal” demand. The term “normal” means that the demand history does not contain usual spikes or outliers. If the demand contains these spikes and outliers your safety value will be exaggerated in order to cover these demands.
As your demand becomes more consistent and predictable the demand deviation will decrease and in turn the safety stock amount will decrease. For some items this unfortunately will never happen and they will be erratic in nature. For these items you will always need some level of safety stock and that level can be adjusted by the service level assigned.
So as you can see, safety stock works together with the forecast and is a necessary factor for achieving the assigned service level set in the system. Manually adjusting the safety stock can result in service level issues if the history is accurate and maintained.