Safety Stock—Insurance for Customer Service
One of the most common inventory management questions I get is, “Hey Jason, I keep running out of my ‘A’ items and I seem to have a boatload of my ‘C’ and ‘D’ items. How do I fix this?”
Let’s face it, one of the biggest components of customer service is having the right stuff at the right place at the right time. One could argue that “right price” is part of the formula, but that isn’t the point of this article. In the above-stated scenario, we are really talking about making sure that our inventory is balanced and that we satisfy our customers to a high degree within the bounds of investable cash.
In distribution, we have a couple of anomalies that make it difficult for us to maintain a perfect inventory balance. The first anomaly is erratic demand. Sometimes, our crystal ball is unclear as to when our customers will order a product and how much they will order when they do. The second anomaly is supplier lead time. Although a supplier can estimate when a product will hit your dock, it is not a perfect science. Life happens in both anomalies and therefore we must “insure” items against running out of stock.
On the sales end, it is common for a large unanticipated sale to wipe out our stock of a certain item. While the sales team celebrates, the inventory management team scrambles to replenish the stock. If that doesn’t happen, the celebrants tend to look unfavorably on the inventory management team when the next order faces a blank shelf. Instead of pointing fingers, the sales team should do its part to smooth this stocking situation. When customers order abnormal quantities of items, the sales team should ask them if they need the full quantity immediately.
Perhaps the customer can take some of the order to get started and the balance in a few days or the supplier can drop ship the whole quantity. This is how the sales and replenishment teams can work in tandem to improve customer service.
On the supplier end, the lead time days are usually consistent. However, suppliers are also subject to lifealtering events that affect business. A short supply of critical raw materials or disruptions in transit could push the lead time back several days or weeks. A few years ago, a longshoremen’s strike in southern California caused wide disruption in the supply chain. Back when I was a distributor, one of our key suppliers went through an MRP software conversion and couldn’t ship consistently for six months. Regardless of the reason, we need to do our best to be prepared.
Safety stock is our insurance policy against stock out. Conceptually, we buy additional inventory to protect us from these anomalies. Ideally, we will never dip into this extra stock. In a practical world, we will dip into the safety stock on a regular basis.
Add safety stock to items that our customers request most often and expect us to have on the shelf when they call. Listen to your customers and they will tell you what to put on the shelf.
Given that we have a limited amount of money to invest in inventory, how should we apply our insurance to give us the best shot at satisfying the customer? There are couple of schools of thought.
Some advisors believe in boosting safety stock to items with a high degree of volatility or unpredictability. The advisors in this camp base their advice on mathematical formulas, such as standard deviation, to determine predictability. While I don’t dispute the high-brow reasoning of adding inventory of those products further away from the standard deviation, I tend to follow a little more low-brow approach. I believe that we should add safety stock to items that our customers request most often and expect us to have on the shelf when they call. This falls in line with my belief in a customer-centric view of inventory management. Listen to your customers and they will tell you what to put on the shelf.
We should use our software settings to drive up the safety stock of high-hit items and minimize (or eliminate) the safety stock of the lower-hit items. Going back to the scenario we started with, we can see the company probably didn’t pay attention to their safety stock settings. Look, I get it. Safety stock settings probably aren’t high on your priority list when you go through an ERP implementation. When you have questions you need answered and fields you have to set, sometimes you just leave the default setting in place. However, if all stocking items are treated the same, the high-hit items don’t receive enough safety stock, which creates stock outs, and the lower-hit items receive too much safety stock and we find ourselves in a surplus situation.
If you find yourself struggling with an inventory imbalance, investigate how safety stock settings are applied in your distribution software package. Some allow you to apply a percentage and others require days of stock as the setting. Regardless of the method, both base the setting on usage during the lead time. If you want to be in the customer service business, add insurance to the items your customers ask for most frequently. By spending a little extra money on these high-hit items, you give yourself the best chance of having the right products in the right place at the right time. If you have further questions about this topic or any other distribution-related conundrum, I am just an email away. Good luck!