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Determination of the safety stock in supply chain management

Uncertain or fluctuating customer demand makes it necessary to realize a certain level of product availability in order to avoid delivery bottlenecks and provide customers with the desired service. High product availability provides a level of responsiveness, but increases costs by holding a high level of inventory that is rarely used. Low product availability, on the other hand, lowers inventory costs but results in a higher proportion of customers who cannot be served on time.

So the main goal of inventory management is to find a balance – an optimal product inventory volume.

What is safety stock?

Safety stock is maintained to cover demand in the event of unforeseeable fluctuations in demand and to avoid product shortages. This type of inventory cushion is also referred to as safety stock or buffer stock.

In theory, we can use formulas to calculate in the optimal number of units per order (EOQ – Economic Order Quantity) and the reorder point (ROP). The resulting ideal inventory behavior is obtained under the constraint that demand and lead time are constant. In real life, of course, this is not the case. Both demand and lead time fluctuate, resulting in ideal deviating inventory behavior.

How to calculate the safety distance?

The question is how to calculate safety stock in the supply chain to find the right balance between inventory costs and customer satisfaction.

Proper sizing of safety stock is one of the most difficult tasks in inventory management. To answer the question of how much and when we should reorder, we must first calculate the optimal number of units per order. This can be done with a purely mathematical approach using linear optimization. We can look at the supply chain as a mathematical model and calculate inventory based on input parameters (e.g. service level) using a set of linear equations and an LP solver.

However, we need to consider the dynamics of network processes as well as operational risks, demand fluctuations across multiple levels. This means that the analytical approach with simple formulas for safety stock will not work in reality for complex, lean and agile networks.

Dynamic simulation can be represent supply chain operations as they actually are, providing the technical means to determine the correct safety stock under given constraints.

Simulation is the best technology available today for detailed inventory police planning for four reasons:

  • It captures processes over time and allows analysts to examine incremental changes in a system and review inventory levels at any point in time.
  • It can take into account the uncertainty of the real world. Variable factors such as delivery times and demand volumes can affect supply chain performance. Simulation can account for these variations by using stochasticity to create more accurate forecasts and increase the resilience of the supply chain.
  • Simulation provides analysts with the ability to calculate all the statistics they need. This allows the performance of a supply chain to be evaluated from multiple angles when determining inventory strategy.
  • Simulation can capture the uniqueness of each supply chain and represent the complexity and unique characteristics of a company’s business without compromise.

Source: The AnyLogic Company

To find out the benefits of simulation and how it can help determine the right inventory strategies, watch the webinar on simulation-based inventory optimization.

Deepen the topic in our free web seminar

Learn more about how dynamic simulation is proving to be the only reliable way to deal with supply chain uncertainties. Register for our web seminar on 26.01.2023 from 11:00 to 12:00

Or simply contact our SCM expert Till Fechteler for an individual consultation.