For years, the question ‘what is the right level of stock’ has been at the core of every organization. Being able to precisely determine that level allows to minimize the cost of inventory while achieving the target service level that allows to reach the desired brand positioning. However, we are forced to notice that nowadays still, most companies find themselves in the position of holding inventories of unsold items and of facing shortages. And these situations exist despite the use of softwares and algorithms that are more and more advanced to define the famous inventory policy. Why is that?
The answer can be found in the definition of stock is, safety stock in particular. Let’s say it, supply chain planners are somehow clairvoyants. In the end they have to foresee future events such as
- So many pieces of that particular products will be sold on that particular day
- My production system will be able to produce exactly that many pieces a day
- My supplier will deliver exactly this number of pieces of this reference at this date
But as many supply chain planners are not blessed with the gift of foresight, when they make a prediction it entails a percentage of error. That error defines the very existence of safety stock. That stock is there for companies to mitigate the errors that inevitably will be made when forecasting a future event.
Let’s take an example that is completely outside of the field of supply chain planning to illustrate this point. Say that you need to attend a very important meeting for which you simply cannot be late. If you are like me, you will check how much time you need to reach your destination and on top of that you are going to add a little extra margin to cover ‘unforeseen mishappenings’. That margin will need to be sized. To do that you will most likely take into account various criteria such as the frequency of public transportation means, the reliability of timetables, are there ongoing demonstrations or other kind of events that can disturb your journey, will your travel happen during rush hour… All these criteria have one thing in common: they depend on the time at which you will be traveling. As a direct consequence then, the very margin you take to make it on time to your appointment will never be the same and will inevitably vary based on your time of travel.
The margin you take on your journey is a perfect analogy for safety stock. It will never be the same because the uncertainty you face regarding the travel time is never the same depending on time of travel. For instance, during the strikes of the French Railway company (SNCF) at the beginning of this year, I found myself taking a 1hour margin for appointments instead of the usual 5 min. In the same way, the demand that you have forecasted, the on time and in full delivery of a supplier or the scrap rate of your production system are as many factors which are time dependent.
Then how can your inventory policy be defined by one number, whatever the time?
I mean, if someone were to ask you what your safety stock is for one product, you will most likely do the following:
- Enter your ERP or the Excel file you use for planning
- Look up the value for safety stock on that product which will be defined in volume or days of coverage
This unique value is usually determined in one of two ways:
- Trust the experience of planners
- Rely on a consulting firm to determine it for you
Once it has been set it will very likely stay the same until the process is repeated, at best, one year after.
Basically, by doing so, you intrinsically imply that the risk you have to absorb is the same whatever the point in time you are looking at. Nevermind whether it is the Chinese New Year or the summer holidays period, you assume that you have the exact same probability that customers demand, suppliers deliveries and production happen exactly as planned whatever the moment.
If I go back to the previous example of the meeting, that is the same as saying that during national strike of public transport companies you take the same 5min to face almost certain traffic jams on the road. Isn’t that exactly what you would call “nonsense”?