In this post we address the question "Why will you benefit from our calculation when there are alternative methods freely available?" We will look at two methods promoted on the web showing their limitations. Our calculation method overcomes all of these limitations giving a solution that can be safely applied to in most practical cases.
1 Uncertain Demand Formula
Safety Stock = Target Service Factor x Standard Deviation of Demand x Square Root of Lead Time
This formula can be used where demand is the only variable and gives a similar answer to our calculation but only if we ignore orders cover a single period of demand, can be placed every period, supplier performance is perfect and we have no future periods in which all customer orders are known. In practice this is not often useful as:
- Replenishment orders often cover multiple periods of demand and big reductions in safety stock can be made!
- Supply processes don't always deliver according to the planned lead time. While the formula can be extended to cover lead time variation the statistical model used does not account for the fact that when an order is delayed there will knock on delays on other orders for the same product and safety stock will be underestimated!
- Often orders are known for the first period(s) in your material plan and this decreases the need for safety stock - the formula does not account for this important variable (many ERP systems call this the Forecast Horizon - after the horizon planning is based on net forecast).
- In practice this theoretical formula is useful in very limited cases!
2 Max – Average Formula
Safety Stock = (Maximum Sales x Maximum Lead Time) – (Average Sales x Average Lead Time)
This is a very poor method and likely to result in safety stocks that are too high because it tries to ensure that stock covers a "worst case" (maximum lead time and maximum demand happening together).
Mathematically this is poor because it uses a single result from the statistics available rather than considering the whole sample you have for each variable - demand and actual lead time.
Philosophically it is poor because inventory policy is governed by extremes rather than on what will happen most of the time. Worse, two extremes are multiplied together!
Whichever way you view this a pair of "outliers" are going to determine your stock if you use this method! If applying this it is essential to check for outliers coming from one off situations that will not occur again.
For B and C class products there is a real danger of creating excess stock that will eventually hit your profit.
Even on A class items with demand that is consistently high the high safety stock is a problem: Extra stock can probably be used quickly but:
· Funding for stock is not unlimited and high stocks on A class products may mean you need to scrimp on stock levels for B and C products.
· Production capacity is finite and at times of high demand when your capacity is at a pinch point some of it will be uselessly applied in rebuilding unnecessary stock levels with higher costs from overtime working as a result.
The formula completely ignores order size - if replenishment orders cover multiple periods then less safety stock is needed and using this method will, again, result in unnecessarily high inventory.
The use of this method must be restricted to products with very consistent demand (in both past and future) and frequent supply and then it should only used with a check for outliers that will not repeat (e.g. long lead time on first ever delivery, peak demand from priming the supply pipe etc.).
Our conclusion is that SafetyStock ExpreSS offers a much better safety stock calculation than either of these methods and we encourage you to try it!