Protecting Customer Service – Part 2

Last month we began a discussion of safety stock.  That is, “insurance inventory” to protect against unusually high demand or delays in receiving a replenishment shipment from the supplier of an item.  Though we found that some items need more safety stock than others, most organizations maintain safety stock quantities with some general rules that are applied to all stocked products.  Typical safety stock policies include:

  • Safety stock is equal to a fixed percentage of lead time usage (typical value is 50% of lead time usage)
  • A specific number of day’s supply is maintained as safety stock (typical value is seven to 14 days)

Either of these methods result in some products having too much safety stock (unnecessarily tying up funds, suppressing inventory turnover, and taking up too much warehouse space) while other items have too little safety stock (resulting in additional stockouts and disappointed customers). 

Better customer service usually is obtained at a lower inventory investment if safety stock is applied to specific items as it is needed.  One way to do this is to calculate safety stock quantities on the average deviation, or difference, between the forecast and actual usage over the past several months.

To utilize this method:

STEP 1: Calculate the average deviation of an item over the previous three months. Consider this example:

Month Forecast Usage Deviation
Feb 50 60 10
Mar 76 80 4
Apr 80 70 -10

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! There is probably more than enough of the item on the shelf.

STEP 2: 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:

Deviation Multiple Aprox. Customer Service Level
2 95%
3 97.5%
4 98.5%
5 99.0%

If our goal is a 95% customer service level, multiply the average deviation by the deviation multiple of two (7 * 2 = 14 pieces).  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.