A New Safety Stock Calculation
PurchTips edition #86
How Much Inventory Is Too Much?
One of the most embarrassing situations for a supply chain manager is to run out of stock. Especially if it brings certain operations to a halt.
More inventory guards against stockouts. However, inventory represents costs that executives seek to minimize. You need a balance between high cost and high risk, which involves calculating the safety stock level (SSL) for each key inventory item.
There is no perfect safety stock calculation applicable to all situations. According to the book "Purchasing and the Management of Materials" by Gary Zenz, "The size of [safety stock] depends on the importance of the particular item to the process, the value of the investment, and the availability of substitutes on short notice."
One calculation that I came up with as a benchmark for having too much safety stock is this:
Maximum SSL = MHDU x (MHLT - ALT)
MHDU = Maximum historical daily usage
MHLT = Maximum historical lead time
ALT = Average lead time
The theory behind this safety stock calculation is that you will have just enough inventory in stock if two "catastrophic" events happen simultaneously:
- Your supplier's lead time slips to the longest it's ever been with that supplier; and
- On those days that your supplier is late, your company uses the most inventory it has ever used.
In most situations, this is probably too much safety stock to have on-hand. However, this calculation is a good measurement for determining if your SSL is set too high.
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