Jane’s company is growing fast and experiencing some growing pains. They’re missing orders because they don’t have enough inventory (stockouts). To deal with this, Jane is promoted to the newly created role of Inventory Planner. Management feels that with her analytical skills and common sense, she should be able to do a good job. As far as goals, she’s told by management to plan to meet all the customer demand.
The idea of meeting all the customer demand gives Jane some pause. She’s been with the company for a few years now and knows how extreme demand events occur for reasons that are not clear beforehand. She argues with the management that perhaps this was both an impossible and very expensive goal. After some discussion, a compromise is agreed to — she will plan to meet the demand in 95% of the instances. Management was willing to concede that the most extreme cases of demand were not worth worrying about.
Jane asked around about how to go about solving this problem and her preliminary search led her to the idea of safety stocks. The idea was to keep a little extra inventory on hand to deal with surprises (by way of extreme demand events). The ERP system that the company used even had some functionality to set safety stocks. She researched this functionality and figured out that she could turn it on very easily. Further, she could calculate safety stocks by entering the number of days (coverage period) of demand she wanted to keep as safety stock. So, if she set the number of days as 15, then, the system would keep a safety stock equal to 15 days of demand. Thus, a slow-moving item with an average daily demand of 2 units would get 15 * 2 = 30 units of safety stock. By contrast, a fast-moving item with an average daily demand of 1,000 units would get 15 * 1,000 = 15,000 units of safety stock. This made sense: more demand = more safety stock and vice versa. As far as 95% goes, Jane calculated that four weeks account for 93%+ of a month (28 out of 30 days). She deemed this was close enough to the desired 95%. Thus, the parameter is set to 28 days. After some testing, the feature is turned on and the business starts to use the output as safety stocks, leading to higher levels of inventory. Management is easily convinced to go along as they are able to feel the pain of missed demand.
A year goes by. Jane has been tracking the performance of the new system. She notes that she still occasionally has stockouts while there is too much inventory laying around for other products. The stockouts seemed to be more than the agreed 5% of the time — in some cases, as frequently as 3 out of 12 months.
The business is also beginning to cool down a bit and management is questioning whether too much capital is tied up in the safety stock inventory. They started grumbling about the overall investment in safety stocks. Jane knows she needs to make some changes. This leads to more research on her part and further improvements. But that will be covered in the next post.
Read the next blog in the series here.