Last month, we discussed safety stock as a necessary cost of doing business. It is required to help you prevent stockouts. But this insurance is expensive. We don’t want to provide a specific item with more safety stock than it needs. The deviation method of calculating safety stock helps accomplish this goal. The deviation method applies more safety stock to those items with a larger deviation (i.e., difference) between actual usage and the forecast. These are the items that are more likely to run out of stock.
To utilize the deviation method,
- calculate the average deviation between the forecast and actual usage over the previous three months. Consider this example:
In February, the demand forecast for the product was 50 pieces and actual usage was 60 pieces resulting in a deviation or difference of 10 pieces. In March, the demand forecast was 76 pieces and actual usage was 80 pieces, which produced a deviation of four pieces. The average deviation is:
(10 + 4) ÷ 2 = 7 pieces per month
Note that the deviation for April, in which demand exceeded usage, is not considered in our calculation of safety stock. Why? Because if the prediction of what customers want exceeds actual usage, safety stock is not needed! Probably there already is more than enough of the item on the shelf.
- The average deviation is multiplied by a deviation multiple. The deviation multiple used is dependent on the customer service level you want to provide. The customer service level is defined as the percentage of line items for the product shipped complete, in one shipment, by the promise date. The higher the multiple, the more safety stock you need to maintain and the higher the customer service level. Generally, the following multiples will usually achieve the corresponding projected levels of customer service:
|Dev Multiple||Proj Service Level|
If our goal is a 95% customer service level, multiply the average deviation by a multiple of two (7 * 2 = 14 pieces) for most items. A deviation multiple of five (7 * 5 = 35 pieces) should achieve a 99% customer service level for those designated “critical” items. Using this method provides more safety stock to those items whose usage is more erratic. But be careful! Using a higher deviation increases your investment in stock inventory, often resulting in lower profitability.