How can you reduce safety stock and save money? This article explores several practical methods that can be applied even if you are using a traditional calculation method and don’t want to change it.
To save on safety stock, several approaches can be used:
- Improve supplier discipline
- Increase/decrease the planning horizon or the frequency of deliveries
- Aggregate data across multiple product positions.
Let’s discuss each method in detail. For this, we will need the formula to calculate safety stock.
Formula for Calculating Safety Stock:
Improve Supplier Discipline
If your supplier is reliable and consistently delivers goods at the same time, you can eliminate the demand multiplier from the formula.
Demand - the average demand over previous periods.
By doing so, the amount of safety stock required will decrease.
Increase/Decrease Planning Horizon or Frequency of Deliveries
We can also influence delivery time and planning horizon. For example, increasing delivery frequency and reducing the planning horizon will also lead to a decrease in safety stock.
However, changing these variables must be done cautiously as it can lead to increased uncertainty. For instance, if we reduce the planning horizon from 7 to 3 days, while planning for 7 days might require a safety stock of 3 units per day, planning for 3 days might only require 2 units per day.
Aggregate Data Across Multiple Product Positions
In the formula mentioned earlier, there is a multiplier σD - the standard deviation, which indicates the variability of demand (sales). We can reduce its value, and consequently, the amount of safety stock, by aggregating data. Here are a few ways to do it:
Increase the amount of available statistics over time through the sales statistics of similar products
If the statistics for a specific product are insufficient and highly variable and uncertain, we can aggregate the sales history of similar products. This will provide a longer and smoother sales history, which in turn will positively affect the safety stock amount.
Aggregate the sales history across multiple warehouses
This will also help reduce uncertainty. When we calculate an order for a distribution center, we aggregate the sales history from multiple warehouses. The peaks in the sales history, which would have been evident at each specific warehouse, will be smoothed out in the overall sales history of the distribution center. Consequently, the variability will be much more stable, and the multiplier σD will be lower, leading to a reduction in safety stock. Thus, distribution centers help save on safety stock.
Use a Financial-Risk Model to Assess the Optimal Level of Inventories
Firstly, for this method to be used, the company must calculate the service level. Read more about this indicator in the article "What is Service Level and Why is it Important". Then, it’s necessary to determine what safety stock is most beneficial at which service level:
- Is it necessary to provide our customers with a 99% service level?
- Or does this require maintaining a six-month stock at the warehouse, which is costly? Is this cost-effective for us?
- Or would it be more advantageous to provide an 85% service level?
Perhaps the current situation is not economically beneficial for the company. A financial-risk model can be used to evaluate and adjust this situation further. For more details on how this works, read the article "Probabilistic Forecasting Methods."
