Inventory levels are usually set utilizing a minimum maximum (Min Max) technique where the minimum level (the re-order point) leaves the organization with sufficient inventory to cover demand over the lead time gap until the next delivery.
The min stock level is also typically set against usage i.e. if it takes ten weeks to replenish stock and your order usage is one per week your min level would be ten units. This is fine where levels of supply and usage are stable but if there are concerns that either demand will outstrip the level of inventory or lead time might be exceeded safety stock should be considered.
From our article on seven wastes and just in time (JIT) supply – excess inventory is not usually considered a good thing – extra inventory requires investment. However, where there is a trade off in customer service levels, increased investment in inventory, can ensure that a high service level can be achieved against fluctuating demand supplier performance. The requirement for safety stock is typically determined by the acceptable risk of stock out.
There are many statistical tools available that can be used to calculate how much inventory is required – this typically will depend on the target service level – and how much demand fluctuation can be seen. In an ideal world where consumption and supplier performance can be readily predicted the requirement for safety stock can be mitigated but where a high service level is required safety stock can be more practically applied.
How safety stock is physically applied to an ERP system can vary. In some cases this may simply mean the minimum inventory level is altered – in others the safety stock is detailed specifically. Due to the cost of inventory there will usually be an approval route to sign off the cost – in most cases following approval a demand trigger will be loaded to facilitate the purchase of the material.
Once a safety stock has been established its important to review it against usage profiles and supplier lead times – once these can be stabilized there is an argument to state that the safety stock could be reduced or abolished (for that line item). To facilitate this, the business should establish a periodic review process which would typically be executed by the materials management function.
