Just reorder when you hit the safety stock
Both working as a supply chain consultant and as an employee in a supply chain department, I was tasked to lower the safety stock as a cost reduction project, of course without impacting our service levels towards our customers. When discussing strategies with the supply chain managers and analysts, I often heard the phrase ‘we can’t lower our safety stocks, because we re-order when the inventory level hits the safety stock level and it needs to cover the ordering lead time’.
There are two inventory management concepts being mixed up here: safety stock and re-order point. Let’s clear this out.
A reorder point is a certain stock level where, when your inventory level hits that particular level, you reorder the product at your supplier. While your supplier is manufacturing and shipping the product to you, you continue to service your customers with the remaining inventory.
In its most basic form, the re-order point is a fixed value like e.g. 1000 pieces of a certain product. There are more elaborate implementations, such as a re-order point expressed as a certain coverage of past consumption or future demand. E.g. you can configure a re-order point equal to the total amount of the next 3 weeks of the forecast.
Reorder point ordering is something we all use daily. Only one bottle milk left? Let’s go to the store. It’s still surprisingly often used in companies. The advantages are that’s is simple, easy to understand, easy to manage and easy to automate. The drawbacks are that it doesn’t cope well with high fluctuations in demand or supply and seasonality. It makes little sense to re-order your Christmas trees in January because your stock dropped below the reorder point. This example might seem silly, but once you’re managing thousands of products and they become just codes in an ERP system, it becomes easy to miss these things.
The more advanced implementations of re-order point ordering, often supported by ERP systems, can mitigate these negatives, but often have their own drawbacks. E.g. expressing your re-order point as covering the next 3 weeks of the forecast will create a bullwhip effect when the forecast shoots up significantly.
In my opinion, re-order point ordering is a great tool to use for low-value items with a reliable supply. E.g. if you’re a packaging operation, you need a lot of stickers. You can get standard stickers anywhere and they don’t cost much. This is a great item to use this method for.
A safety stock is a certain level of inventory used to cope with uncertainty, either uncertainty from the supply side or from the demand side, or both of course.
Some examples I’ve encountered that generate uncertainty:
- Irregular demand due to your customers’ strange ordering behavior
- Irregular demand due to disruptive actions of competitors, like large price reductions
- Unstable supply due to periodic strikes in customs.
- Long transport lead times overseas.
- Being low priority at your supplier.
Often management will launch a reduction of safety stock project as a cost savings project.
Your first action should be to re-evaluate the current safety stock levels if they are still valid. E.g. you might want to lower safety stock levels for high runners that are now slow movers and provide little value anymore to your business. There are a bunch of software tools and people that will help you make this analysis by analyzing how much coverage the safety stock levels need to be given a certain service level (based on ABC classification), past consumption, future forecast etcetera.
This is a first quick win.
The real work comes when you have to work on lowering uncertainty. It means working together with key customers on the forecast, with key suppliers on forecast sharing and logistics, finding new suppliers etcetera.
Using correct definitions will help you tackle these inventory issues. And there is often serious money to be saved on safety stocks.