Inventory Management with the COVID-19 Pandemic – Part 2
Managing your Safety Stock

Many of our clients are reporting that their overall revenues are far lower than they were before the pandemic while their expenses remain the same or have increased. They need to immediately reduce expenditures while at the same time doing the best possible job of meeting their customers’ needs. In this newsletter, we would like to review a simple analysis you can perform that will guide you to reduce your purchases while minimizing the negative effects on customer service.

When forced to reduce inventory, many distributors first look to get rid of dead stock and remove slow moving inventory from warehouse. But, this course of action presents several challenges:

  • It is often difficult to liquidate dead stock. After all, if your customers don’t want this material, it will probably take a lot of effort to find someone who does want it.
  • Your customers may depend on you having some of your slow-moving products always on the shelf just in case they need them. The availability of these products contributes to your reputation as a “reliable supplier” and helps to differentiate you from your competitors.

We have found that a more effective way to trim your inventory is to “micro-manage” your fast-moving products that also have a high cost of goods sold value. These products not only sell frequently but also represent a lot of dollars moving through your inventory. Reducing the stock of these products in most cases will substantially reduce your inventory investment while increasing turnover (i.e., your opportunities for earning a profit). The challenge is to ensure that any stock reduction does not negatively affect customer service. In the last newsletter, we discussed adjusting your demand forecasts, that is, your predictions of the quantity of each stocked item that will be sold or used in the upcoming week or month. In this issue, we will discuss managing safety stock of your high cost, fast moving items.

 Safety stock (also known as safety allowance) is reserve inventory you maintain to protect against stock outs due to unusual demand or delays in receiving a replenishment shipment. Like any other type of insurance safety stock is an expense, not an investment. You do not want to maintain more safety stock for an item than you need to achieve your desired level of customer service. As with demand forecasts many distributors use one common formula for maintaining safety stock (often 50% of lead time usage or a certain number of day’s supply). They do not realize that individual items might need more, or less, safety stock.

 To help determine if your safety stock quantities are appropriate, perform a residual inventory analysis. For each of the previous three months perform the following calculation for each high cost, fast moving item:

 Forecast + Current Safety Stock – Actual Usage = Residual Inventory

The total of the forecast and safety stock equals the quantity of each product you were planning on selling or using plus your “insurance” inventory. Actual usage is what was sold or used. The balance is residual inventory or what was left on the shelf (perhaps gathering dust).

 If the residual inventory (in terms of day’s supply) for a product is continually high (maybe greater than 21-day supply) consider lowering the safety stock quantity. If the residual inventory is low (maybe less than a four or seven-day supply) consider increasing the safety stock quantity.

 Note that this simple formula to calculate residual inventory does not consider variations in the lead time. We have found it is best practice to set the anticipated lead time for each item equal to the longest normally anticipated lead time for the product. For example, if the lead time for an item ranges from two to four weeks, set the lead time in your system equal to four weeks. By fine tuning your anticipated lead times and safety stock quantities, you will maintain your desired level of customer service with the lowest possible investment.

Take the “fat” (i.e., surplus stock of fast-moving products) out of your inventory and keep the muscle (i.e., inventory that helps meet the goal of effective inventory management). Not only will this help you survive these challenging times, but help you prepare for the next upturn in the economy!