The Problem with the Location Isolation of the Calculation of the Dynamic Safety Stock Formula

Executive Summary

• The lack of consideration for relative inventory with the safety stock formula.
• How inventory parameters should be calculated.
• I am getting to the real question of safety stock.
• Infinite planning (The norm) versus constrained planning.

Introduction

In this article, we will cover a significant limitation of how safety stock is calculated. This limitation is virtually omnipresent in supply chain planning software but is remarkably invisible to companies that purchase these applications.

The Lack of Consideration for Relative Inventory with the Safety Stock Formula

One of the primary weaknesses of the inventory parameters like..

• Lot Size (min procurement lot size, min production lot size)
• Reorder Points
• Safety Stock
• Service Level

…is that they are calculated individually or in isolation from both one another per product location, but also separation from the constraints of the system. That is when safety stock is computed, it is calculated for a product location combination without consideration for the other product location combinations in the supply network. When a service level is set at a product location, it is most often set without concern for what the service level on other product locations should be. This creates a scenario of unmatched goals versus the system’s ability to supply to those goals.

This is true for all ERP systems and all advanced planning systems, outside of the lightly installed category of inventory optimization and multi-echelon software, which unfortunately does not incorporate constraints into its inventory (aka service level) optimization.

How Inventory Parameters Should be Calculated

All inventory parameters should be limited based upon the relative consumption of whatever the resource limitations the company faces.

• In some cases, this will be inventory dollars,
• ..in other cases, this will be labor,
• ..in other cases, this will be pallet spots.

There is no one right answer because after seeing many clients at this point, it is clear that different companies value and have various constraints that they face and emphasize.

But standard software does not allow for this connection between constraints and inventory.

Getting to the Real Question of Safety Stock

The question is not so much what is the optimal inventory parameter setting (PLC) for a particular PLC.  Given a limited amount of resource, how should that resource be allocated to the product location database?

The vast majority of companies do not set their inventory parameters this way. What this means is that that values that are calculated, when combined, are often too high for the resources made available to the supply network.

The reason for this is that the service levels that are set by order management/sales, etc.. are too high versus the capacity available at the company. This is because service levels are based upon aspirational goals, (what the company would like), versus what it has the resources to fund.

Therefore the inventory parameter values are usually decreased in a piecemeal fashion in the supply planning process.  This leads to the common problems associated with reactive supply chain planning management.

Infinite Planning (The Norm) Versus Constrained Planning

Constrained planning is a desired capability at many companies. It is a significant motivator for companies that purchase supply and production planning software.

While some applications allow for constraints, in practice, it is scarce for supply planning systems to incorporate anything but production constraints.

More detail on this is covered at this link.

Conclusion

Regardless of the system used, supply planning parameters can be set in a constrained fashion. However, they must be calculated outside of the system (unless a company uses an optimizer — and optimization is anything but a silver bullet in this regard which is itself another topic.)