Safety stock targets are hard to calculate. But in spite of this, whenever there is an inventory reduction project, the first thing everyone wants to do is calculate the ideal target safety stock number.
A lot of executives understand that there is some ideal safety stock number that minimizes stockouts while keeping inventory low. And of course there is. However, a lot do not know what’s involved in calculating that number.
At their core, target safety stock formulas factor in supply variability and demand variability. There are classical calculation methods to do this. But while that may sound simple enough, getting the data to accurately run the methods is hard.
Over time, various academic institutions and consulting firms have developed their own methodologies to calculate safety stock. Some are better than others, but ultimately, it’s hard to arrive at a number that does not elicit some debate.
Go ahead and try searching for safety stock calculation methods and you’ll get different approaches. (All equally right depending on the context.)
Moreover, to do it right, you need some smart folks who have experience in doing it. Typically, this can be a 3-6 month project. That’s a lot of time and expensive resources. But let’s see what you gain and decide if it’s worth the effort.
What Happens After You Calculate Safety Stock
So you have your shiny new safety stock target. Now what happens?
To begin with, it’s hard to imagine your existing safety stock targets being way out of the ball park. If let’s say, ideal would be around 60 days, it’s hard to see how you could be surviving if you kept say 15 days.
On the other hand, it’s hard to see how management can let operations run say at 120 days in this case (2x “ideal”). Over time, that would probably have faced cost reduction pressure.
Is it possible to be way out of the ball park? Of course. But then in those cases, engaging in a resource heavy safety stock calculation project is not the answer. Try to pick out the low hanging fruit first and get to the ball park.
So again, let’s say your target is already at 60 days. The project is done and it says your ideal target is 58 days. Would that be a life altering bit of information? Will you significantly change anything in your operations to hit this target? You probably won’t. How about 55 days? 50 days? Maybe.
At any given time your inventory will be fluctuating within some band over your original 60 day target anyway. The two day difference above just gets caught up in this band. You’re better off just tightening your fluctuations around your existing target.
The above scenario is actually still a bit less controversial. But now, what if the number tells you to go to 62 days? What if it says go to 70 days? Do you think management will then now allow inventory to increase? Again, it’s possible. But it’ll probably not happen.
What will likely happen is that they will revisit the methodology (used by the experts you hired) and start questioning its accuracy or soundness. Then maybe the methodology will be tweaked to arrive at a number that does not require an increase in inventory.
Or worse, they’ll just ignore the results and carry on business as usual.
Sounds ridiculous, yes. But first, these do happen. Second, and more important, the tweaked methodology may actually be totally solid, fact-based and justifiable. Again, this is because we’re trying to apply a perfect approach to the imperfect reality of managing complex operations.
The Target Will Not Reduce Your Inventory
Knowing the ideal safety stock target will not reduce (or optimize) your inventory. Posting a speed limit (based on civil engineering calculations) will not automatically make drivers drive slower. They still need to actually…well…drive slower.
So, to reduce inventory, you still need to put in the hard work like:
- Manage cycle times
- Reduce the bullwhip effect of independent “ordering” and buffering
- Batch size evaluation
What to Do
Here’s what’s worked for us:
- Calculate your baseline days of supply performance. Monthly buckets tend to work well for a lot of situations, but feel free to change based on your company.
- Refresh monthly as part of the Sales & Operations Planning process.
- Set a working safety stock target of 5-10% below historical.
After you set the working target, closely monitor your fill rates, stockout and low stock rates. If you experience a significant increase, then perhaps it’s best to bring inventory levels back up. (Or better, address non-inventory reasons for stockouts).
Next, monitor your fluctuations around your target. You will have to balance these fluctuations with batch sizes and cycle time of course. However, experiment with ways to tighten the band around the safety stock target.
Back to You
What have you done in your own companies? Does this approach of “experimenting” feel risky? We’d love to get your ideas.