{"id":4397,"date":"2021-06-24T12:06:53","date_gmt":"2021-06-24T10:06:53","guid":{"rendered":"https:\/\/acopa.de\/en\/?p=4397"},"modified":"2022-06-30T14:46:31","modified_gmt":"2022-06-30T12:46:31","slug":"mastering-inventory-safety-stock-calculations","status":"publish","type":"post","link":"https:\/\/acopa.de\/en\/2021\/mastering-inventory-safety-stock-calculations\/","title":{"rendered":"Mastering Inventory – Safety Stock Calculations"},"content":{"rendered":"\n\n\n\n[et_pb_section fb_built=”1″ admin_label=”section” _builder_version=”3.22″ min_height=”1817.1px” custom_margin=”-16px|||||” custom_padding=”||15px|||”][et_pb_row admin_label=”row” _builder_version=”3.25″ background_size=”initial” background_position=”top_left” background_repeat=”repeat” custom_margin=”-41px|auto|-18px|auto||” custom_padding=”||15px|||”][et_pb_column type=”4_4″ _builder_version=”3.25″ custom_padding=”|||” custom_padding__hover=”|||”][et_pb_text admin_label=”Text” _builder_version=”4.9.5″ _module_preset=”26ec2043-f6e2-4f7b-90cd-475fe5543578″ background_size=”initial” background_position=”top_left” background_repeat=”repeat” max_width=”800px” custom_padding=”0px|||||” hover_enabled=”0″ sticky_enabled=”0″]
Author: Daniel J. Sperling<\/h6>\n

Inventory planning is a crucial yet challenging discipline within supply chain management. Safety stock (or buffer stock) is the amount of carried inventory to prevent shortfall of materials. The calculation of the ideal safety stock is often volatile, uncertain, complex, and ambiguous. So where do I need to start to setup my inventory ideally? Simply put, a clear understanding of lead times, target service levels, the demand and consumption situation and further business specific factors need to be considered.<\/p>\n

Business Impacts<\/span><\/strong><\/h2>\n

But<\/span> let <\/span>us<\/span> take<\/span> a few<\/span> steps back<\/span> and<\/span> take<\/span>a business <\/span>perspective.<\/span> Why<\/span> is<\/span> it so important<\/span> to have<\/span> an<\/span> ideal <\/span>inventory <\/span>level?<\/span> Th<\/span>e answer<\/span> is easy.<\/span> Inventory<\/span> levels<\/span> that <\/span>are inaccura<\/span>te, have a large impact on business costs and <\/span>revenues.<\/span> Carry<\/span>ing<\/span> too<\/span> little<\/span> inventory<\/span> puts<\/span> your<\/span> business <\/span>at risk of stockouts, while too much inventory leads to too <\/span>much<\/span> tied <\/span>up<\/span> working<\/span> capital.<\/span> Both<\/span> scenarios<\/span> have <\/span>financial<\/span> impacts.<\/span> On<\/span> the<\/span> one<\/span> hand,<\/span> due<\/span> to<\/span> certain <\/span>materials being not availab<\/span>le, production needs to halt and <\/span>causes<\/span> downtime <\/span>costs.<\/span> On<\/span> the<\/span> other<\/span> hand,<\/span> not<\/span> fulfilled <\/span>customer orders, can manifest in additional fees, <\/span>penalties, or <\/span>in<\/span> the worst case, the entire loss of <\/span>customers. Maintaining a well calculated safety stock <\/span>can prevent stockouts based on the desired service Level <\/span>and optimize working capital. <\/span><\/p>\n

\u00a0<\/span><\/p>\n

Understanding (Target) Service Levels<\/span><\/strong><\/span><\/h2>\n

Th<\/span>e term service<\/span> levels <\/span>relates<\/span> to<\/span> the<\/span> customers <\/span>pers<\/span>pective<\/span> and<\/span> how<\/span> a business<\/span> is willing<\/span> to<\/span> serve<\/span> its <\/span>customers.<\/span> While<\/span> looking<\/span> at the<\/span> definition<\/span>, service<\/span> level <\/span>d<\/span>epicts a percentage of how many stockouts a business is <\/span>willing<\/span> to risk.<\/span> A service<\/span> level<\/span> of 95% states<\/span> that<\/span> the <\/span>business<\/span> is willing<\/span> to accept<\/span> 5% stockouts<\/span> during <\/span>replenishment cycles.<\/span> Service levels can be adjusted as <\/span>required. But <\/span>i<\/span>t is important to keep in mind, that a higher <\/span>desired service level<\/span>, requires a significantly higher safety <\/span>stock<\/span> level.<\/span> In safety<\/span> stock<\/span> calculations <\/span>this<\/span> factor<\/span> is <\/span>described<\/span> as<\/span>R-Factor<\/span> (or<\/span> Z-Factor). <\/span>The<\/span> R-Factor<\/span> is <\/span>determined<\/span> by the<\/span> inverted<\/span> standard<\/span> distribution<\/span>. Safety <\/span>stock<\/span> is not<\/span> designed<\/span> to protect<\/span> a<\/span> business<\/span> from<\/span> all <\/span>stockouts, just the majority of them. <\/span><\/p>\n

\u00a0<\/span><\/p>\n

How Much Risk Is Acceptable – Protecting Against Variability<\/span><\/strong><\/h2>\n

Calculating the ideal safety stock level requires <\/span>solid <\/span>knowledge about the variabilities in the supply chain <\/span>(<\/span>Figure<\/span>1)<\/span>. <\/span>Fac<\/span>t<\/span>ors that are widely <\/span>considered in safety <\/span>stock calculations are the variability in <\/span>lead time <\/span>and the <\/span>va<\/span>r<\/span>iability in <\/span>d<\/span>emand during <\/span>lead time. <\/span>These two <\/span>dimensions have the strongest impact on safety<\/span>stock<\/span>, yet <\/span>they are not <\/span>the only <\/span>uncertain<\/span>ties<\/span>. <\/span>The forecast quality <\/span>and the amount of replenishment are factors that can be <\/span>added to adjust the safety stock at a later point in time.<\/span><\/p>\n

<\/span><\/p>\n

Risk Of Lead Time Variability<\/span><\/strong><\/h2>\n

A criti<\/span>cal <\/span>to <\/span>manufacture products<\/span>, consisting of <\/span>several <\/span>c<\/span>omponents and materials<\/span>, is the lead time. <\/span>Industries <\/span>th<\/span>at <\/span>are <\/span>highly <\/span>affected by lead times <\/span>suffer <\/span>the <\/span>f<\/span>rom lead time <\/span>variability. <\/span>Without <\/span>supply, <\/span>production is delayed or in the <\/span>worst case can come to a halt. <\/span>Eliminatin<\/span>g <\/span>or\u00a0 reducing <\/span>uncertaint<\/span>y <\/span>of lead time <\/span>opti<\/span>mizes the ideal s<\/span>afety <\/span>st<\/span>ock <\/span>level and ensures a stable production outpu<\/span>t<\/span>. <\/span>Th<\/span>us having <\/span>positive <\/span>effects<\/span>on the own lead time (<\/span>output<\/span>) <\/span>consistency<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

Calculation Formulas<\/span><\/strong><\/h2>\n

Regarding safety stock <\/span>calculations<\/span>, business have <\/span>different <\/span>options <\/span>to calculate the right level<\/span>. <\/span>The choice of <\/span>the right <\/span>formula<\/span>is <\/span>dependent<\/span>on the business <\/span>itself, <\/span>the <\/span>data available<\/span>, <\/span>the <\/span>targe<\/span>t <\/span>service level<\/span>and the <\/span>desire<\/span>d <\/span>ac<\/span>curacy<\/span>. <\/span>The <\/span>following <\/span>approac<\/span>hes <\/span>provide <\/span>a <\/span>s<\/span>election <\/span>of <\/span>calculations<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

A: Traditional Approach<\/span><\/strong><\/h2>\n

Demand (<\/span>Daily Sales<\/span>)<\/span>\u00d7 <\/span>Period<\/span>= <\/span>S<\/span>afety Stock<\/span>(<\/span>Example: <\/span>5<\/span>,000 <\/span>units<\/span>\u00d7 <\/span>30 <\/span>d<\/span>ays (1 month) = <\/span>150,000 units<\/span>\/<\/span>month<\/span>).<\/span><\/p>\n

Intended to give a rule of thumb <\/span>based on the da<\/span>ily sales <\/span>and the stock level <\/span>to be present for a cert<\/span>ain <\/span>period (e<\/span>.<\/span>g. <\/span>a month). <\/span>By simply multip<\/span>ly<\/span>ing <\/span>the formula provides <\/span>the <\/span>number <\/span>of units necessary over the <\/span>defined period. <\/span>The <\/span>traditional approach serves as <\/span>a good starting point<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

B: Reduction Of Demand Variability<\/span><\/strong><\/h2>\n

R<\/span>–<\/span>Factor <\/span>\u00d7 <\/span>\u221a(Total Lead Time\/Period)<\/span>\u00d7 <\/span>\u03c3 Demand = Safety Stock<\/span><\/p>\n

Formula B can be used, when the <\/span>uncertainty to be <\/span>only <\/span>arises from the lead time perspective<\/span>. <\/span>Additionally a<\/span>constant<\/span>, <\/span>rel<\/span>iable <\/span>demand <\/span>is <\/span>required <\/span>to make th<\/span>is formula <\/span>feasi<\/span>ble<\/span>. <\/span>Presum<\/span>ing <\/span>Demand bei<\/span>ng the only uncertainty, <\/span>the formula looks as <\/span>depicted above<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

It’s Not About Mitigating All, But The Majority Of Stockouts<\/span><\/strong><\/h1>\n

<\/span><\/strong><\/p>\n

<\/span><\/strong><\/p>\n

C: Reduction Of Lead Time Variability<\/span><\/strong><\/h2>\n

R<\/span>–<\/span>Factor <\/span>\u00d7 <\/span>\u03c3<\/span>Total Lead Time<\/span>\u00d7 <\/span>\u00f8<\/span>Demand = Safety Stock<\/span><\/p>\n

In case of constant demand <\/span>and <\/span>varying lead times the <\/span>formula needs to be adjusted <\/span>a<\/span>ccordingly<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

D: Reduction Of Independent Variability In Demand And Lead Time<\/span><\/strong><\/h2>\n

R<\/span>–<\/span>Factor <\/span>\u00d7 <\/span>\u221a(Total Lead Time\/Period<\/span>\u00d7 <\/span>\u03c3 Demand<\/span>) + <\/span>(<\/span>\u03c3<\/span>Total Lead Time<\/span>\u00d7 <\/span>\u00f8<\/span>Demand<\/span>)<\/span>= Safety Stock<\/span><\/p>\n

The fourth a<\/span>pproach <\/span>co<\/span>mbines the calculation of both <\/span>uncertainties (<\/span>B and C) <\/span>and puts the<\/span>m <\/span>into relation <\/span>while <\/span>considering them independently. It is the most effective <\/span>basic cal<\/span>culation for t<\/span>o<\/span>determin<\/span>e<\/span>safety stock <\/span>level<\/span>s<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

E: Consideration Of Additional Variability In Supply (Delivered Amount)<\/span><\/strong><\/h2>\n

R<\/span>–<\/span>Factor <\/span>\u00d7 <\/span>\u221a<\/span>(<\/span>(Total Lead Time\/Period<\/span>\u00d7 <\/span>\u03c3 Demand<\/span>) + <\/span>(<\/span>\u03c3<\/span>Total Lead Time<\/span>\u00d7 <\/span>\u00f8<\/span>Demand<\/span>)<\/span>+ <\/span>(<\/span>\u03c3<\/span>Supply Quantity)<\/span>)<\/span>= Safety Stock<\/span><\/p>\n

Other fac<\/span>tors can be included in the formula to <\/span>amplify <\/span>and <\/span>adjusting <\/span>the last approach<\/span>. <\/span>Only dimensions that have a <\/span>significant impact <\/span>on<\/span>stoc<\/span>k<\/span>–<\/span>and service levels<\/span>are <\/span>recommended<\/span>.<\/span><\/p>\n

<\/span><\/p>\n

Limitations<\/span><\/strong><\/h2>\n

Every <\/span>business is <\/span>unique <\/span>and has different requirements <\/span>towards the<\/span>inventory<\/span>. Therefore, there <\/span>is no out<\/span>–<\/span>of<\/span>–<\/span>the<\/span>–<\/span>box <\/span>solution<\/span>. <\/span>The process of calculating ideal s<\/span>afety stock <\/span>levels is an iterative process<\/span>. <\/span>T<\/span>he formula needs to be <\/span>tested <\/span>and <\/span>adjusted<\/span>.<\/span><\/p>\n

Variation in demand becomes more and more predictable throughout artificial intelligence and machine learning. Nevertheless, all that can be achieved is a further reduction of uncertainty. Advancements in forecasting and calculating safetystock may improve, but event of a short falls of stock will still occur. All formulas are restricted by their mathematical possibilities. Extremes such as single deviations that are far off, seasonality or other uncommon events, will offset the result significantly. The previously stated formulas build a foundation and can be enriched with variables and factors that take these into account (e.g. outlier correction). All calculations are only as good as the data they are based on. With insufficient data quality and quantity, the calculations may not provide feasible results and can put inventory planning at risk. It is always recommended to execute validity checks to prevent critical consequences.<\/span><\/p>\n

<\/span><\/p>\n

Following Up On Safety Stock<\/h2>\n

Advancing<\/span>in the <\/span>topic<\/span>of <\/span>s<\/span>tock<\/span>levels<\/span>and inventor<\/span>y <\/span>planning<\/span>, the <\/span>configuration of reorder points<\/span>,<\/span>become<\/span>s <\/span>evident<\/span>.<\/span>Extending the topic even more, <\/span>Economic <\/span>O<\/span>rder <\/span>Q<\/span>uantity<\/span>(EOQ)<\/span>takes the safety stock <\/span>calculation a step <\/span>beyond<\/span>and is based on the trade<\/span>–<\/span>off between order<\/span>–<\/span>and <\/span>st<\/span>ockholding costs<\/span>. <\/span>These topics <\/span>are<\/span>covered in <\/span>other <\/span>ACOPA whitepapers.<\/span><\/p>\n

<\/span><\/p>\n

REFERENCES<\/span><\/p>\n

1.\u201cSafety Stock Formula: How to calculate it\u201d, D. Robinson (SKUVAULT). Accessed on May 262021 and viewableat: https:\/\/www.skuvault.com\/blog\/safety-stock-formula\/<\/a><\/p>\n

2.\u201cCrack the Code: Understanding Safety Stock and masterin its equations\u201d, P. L. King (CSCP). Accessed May 10 2021 and viewable at: https:\/\/web.mit.edu\/2.810\/www\/files\/readings\/King_SafetyStock.pdf<\/a><\/p>\n

3.\u201cStockout Costs and Effects on the Supply Chain\u201d, M Murray (The balance smallbusiness). Accessed May 25 2021 viewable at: https:\/\/www.thebalancesmb.com\/stockout-costs-and-effects-2221391<\/a><\/p>\n

4.\u201cInventory Optimization with SAP\u201d, M.Hoppe, 2006, SAP Press.<\/p>\n

5.\u201eSupply Chain Management Based on SAP Systems: Architecture and Planning Processes\u201c, P. Mertens,etal.,2009, Springer Berlin Heidelberg.<\/p>\n

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