Is a higher service level ALWAYS the best option for inventory optimization?
“Availability” as a KPI Measurement
A common Key Performance Indicator (KPI) when it comes to inventory optimization is some measure of “availability” of an item when it is needed by the customer. In simple words, service availability means “What percentage of the time was an item available when a customer needed it?” How this availability is tracked and measured is a topic with many different answers, and perhaps a different blog post, but most everyone agrees that if you are selling things you need to have an idea of how often your items are available. So that, you know, you can make money. It is hard to make money if the things you are selling are not on the shelf!
Why in the world would you not want to have items ALWAYS be available?
Many times in the course of our work we will run across some statement to the effect of “We think that we are at about a 95% service level but we would really like to have that much higher. In fact, we feel it should be nearly 100% availability.” This would seem to make logical sense, right? Why in the world would you not want to have items ALWAYS be available? There are actually many reasons why this might not be the case, one of which is fairly obvious and another specific example where it is not.
“…the higher your service level is then the value of your inventory needed to support that service level will be multiples higher.”
Many of us that have been involved in supply chain learned at some point that the value of inventory is an exponential function of the desired target service level. To state this a different and simpler way, the higher your service level is then the value of your inventory needed to support that service level will be multiples higher. At 95% service level, your inventory value to support that service level on a set of items might be around $6M USD (for example). However, at 99% service level the inventory value you need to carry on the same set of items will be nearly double to $12MM. Obviously, there is a very real business decision to be made on whether it is worth it to double inventory for a higher service level. What are our customer’s expectations? What are the costs for a missed order? These are but a few of the business impacts that need to be considered, but the beauty of Right Sized Inventory’s advanced analytics software that simulates a supply chain is that our clients can always know exactly how much inventory they will carry at a certain service level. This makes the process of business strategy so much more efficient and based on facts rather than “feel”.
Other reasons you may not always want a higher service level
So that is the reason that is known to many of us on why you may not always want a higher service level, but is that the only reason? As I learned recently with a client, it is not! This situation involved a set of items that had a specific shelf-life constraint. The issue prior to their implementation of RSI’s solution was that these specific items would experience a lot of loss due to expiration. A big batch of the items would expire and need to be thrown in the dumpster, quite literally. But the client could not figure out why exactly. Upon RSI analysis, it was discovered that the demand was very volatile on this item, but even more of a factor was that the lead times were long and consuming most of the shelf life. This facility had a broad-stroke availability metric each item needed to be hit according to company leadership. Simply put, this equation was mathematically impossible. They could not have high availability, a relatively short shelf life, and a long lead time. It was quite literally impossible.
So what was the solution? On these specific items, it was decided that a LOWER service level was the most prudent answer because an occasional stock out or partial fill of an order was a better problem to have and manage than simply throwing stock away on a regular basis. Very rarely would any day be a complete miss, but at a lower availability they had some partial orders to the customer that could be made up for in subsequent shipments. The bottom line is that this was a far better solution to the bottom line.
Advanced analytics and supply chain simulations were able to show exactly what was happening
Right Sized Inventory’s advanced analytics and supply chain simulations were able to show exactly what was happening, why it was occurring, and give good actionable data to solve a conundrum that had been plaguing this particular location for a long time. Proving WHY a lower service level might be the best business decision was not something we necessarily envisioned with RSI, but any solution should be able to provide fast, accurate, explainable, and actionable results which allows the user to provide answers that make sense…even when the answer is not what was expected!
At Right Sized Inventory, we know our solution does this and we are always happy to learn new ways to apply the software and new answers to unique problems.
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