A lot of software packages advise buyers to purchase enough stock so that the product demand is met during the “replenishment horizon”. The replenishment horizon is equal to the sum of:
• Demand during anticipated lead time
• Demand during the upcoming order cycle
• Safety stock
The anticipated lead time is the amount of time you predict it will take to acquire the product from your supplier. The order cycle represents how often you place replenishment orders with the vendor. Safety stock is insurance inventory, protecting you from stock outs due to unusual usage or delays in receiving a replenishment shipment from the supplier.
For example, let’s say an item has a forecast of 60 pieces per month (i.e., two pieces per day), a lead time of 10 days, an order cycle of seven days and safety stock of four day’s usage. To cover your needs during the replenishment cycle you would need a total of 42 pieces:
Lead Time Usage (20 pieces) + Order Cycle Usage (14 pieces) + Safety Stock (8 pieces)
This method works well if you consistently sell two pieces per day throughout the month. But what if you sell the entire month’s forecast quantity of 60 pieces in one transaction? Even with safety stock, you probably will not have enough inventory on hand to fulfill this request, despite the fact that actual usage was equal to the demand forecast.
A “best practice” replenishment system must ensure that you can fulfill your customers’ needs even when demand is not level or consistent. How can you do this?
• Consider adding a feature to your system to ensure that calculated safety stock quantities are not less than a typical customer order quantity. You can calculate the typical order by dividing the total usage recorded over the previous 12 months by the number of customer orders received over the same time period. For example, if you sold a total of 360 pieces of an item during the past 12 months in six transactions, the typical order quantity would be 60 pieces.
• For items that are critical to customer service you might consider raising the minimum safety stock quantity to two times the typical order quantity.
It would be wonderful if there were perfect consistency in the way customers ordered products. Unfortunately we have to overcome erratic or “lumpy” demand in our quest to achieve effective inventory management.