Click the image for details For distributors, inventory is a difficult problem to solve. On one hand, distributors want to fill their warehouses with best-selling products; on the other hand, they fear that the goods in the warehouse won't sell. Especially for frozen food and ice cream distributors, how can they maximize efficiency within limited cold storage? In distributor inventory management, many people know about safety stock, but most distributors understand safety stock as the threshold to prevent stockouts. However, this is not a standard definition. So what exactly is safety stock, and how should we set it? What is Safety Stock? According to Baidu Baike, safety stock is buffer inventory prepared to guard against uncertainties in future supply or demand (such as a large number of sudden orders, unexpected interruptions in delivery, or sudden delays). Its size depends on the uncertainty of supply and demand, customer service level (or order fill rate), as well as stockout costs and inventory holding costs. If the customer service level is high, safety stock increases, leading to lower stockout costs but higher inventory holding costs. Conversely, if the customer service level is low, safety stock decreases, resulting in higher stockout costs but lower inventory holding costs. The determination of safety stock is based on mathematical statistics. First, assume that inventory fluctuations occur around the average consumption rate, with the probability of demand being above or below the average being equal, resulting in a 50% stockout probability. The larger the safety stock, the lower the probability of stockouts; but larger inventory can lead to excess stock. Based on the popularity of different products and customer requirements, stockouts should be maintained at an appropriate level, allowing a certain degree of stockout to occur. Inventory Classification Currently, inventory is divided into three categories based on function: cycle stock, safety stock, and excess stock. Cycle stock is inventory generated to meet normal demand within the replenishment cycle. It is the inventory needed for a future period (i.e., within the replenishment cycle). The root cause of cycle stock is the replenishment cycle. How to understand this? Distributors need time to prepare and arrange ordering, delivery, and sales; all require time to execute, meaning they all have a certain cycle. During this cycle, demand does not stop; it is continuous. To continuously meet this ongoing demand, we need to prepare a certain amount of inventory based on demand, which is cycle stock. Excess stock is unnecessary inventory, and its root cause is organizational behavior, i.e., inventory caused by certain operations and policies of our organization. For example, if our forecast fails and actual demand falls short of the forecast, the inventory prepared based on the forecast that cannot be consumed becomes excess stock. Similarly, whether in procurement or production, we cannot get exactly what we need; there is always a minimum order quantity issue. The inventory that exceeds actual demand due to minimum order quantities becomes excess stock. The root cause of safety stock is uncertainty; safety stock exists to deal with uncertainty. If everything were certain and there were no surprises, then safety stock would not be necessary and could be omitted. Safety stock is not essential inventory, unlike cycle stock which is theoretically indispensable. Safety stock lies between cycle stock and excess stock. When an unexpected event occurs, safety stock is used and takes on the role of cycle stock; at that time, safety stock is cycle stock. When no unexpected event occurs, safety stock does not function; at that time, safety stock is excess stock. Three Major Factors Affecting Safety Stock Demand Uncertainty: Safety stock deals with uncertainty, so uncertainty is the core factor affecting safety stock. The first major factor affecting safety stock is demand uncertainty. The impact of demand uncertainty on safety stock is that the greater the demand fluctuation, the more safety stock is needed. Supply Uncertainty: The more uncertain the supply, the more safety stock is needed. Supply uncertainty is mainly reflected in the following three aspects: (1) Long procurement lead times; the longer the time, the more unpredictable the changes; (2) Low and unstable on-time delivery rates from suppliers; if you don't know when delivery will occur, it is naturally very uncertain; (3) The quality pass rate and quality stability of supplied products; the lower the pass rate and the more unstable the quality, the stronger the supply uncertainty. Service Level Requirement: The service level, simply understood as the rate of not being out of stock, can also be called the customer service level. The higher the service level requirement, the more safety stock is needed. Unlike the previous two factors, demand uncertainty and supply uncertainty are generally uncontrollable, but the service level requirement is determined by the enterprise itself. The service level may seem higher is better, but a high service level requires high safety stock levels, which incurs additional costs. Enterprises should determine their own appropriate level based on their actual situation. One of the best ways to determine the service level is to quantify it, evaluate the trade-off between service level and stockout costs, and strive for a balance between service level and inventory level. For supply chain management, a 100% service level is not worth the cost; my personal recommendation for the service level is 95%-99%. How to Calculate Safety Stock For most distributors, safety stock calculation often relies on experience. So how can we accurately calculate safety stock? We have summarized several formulas. The size of safety stock is mainly determined by the customer service level (or order fill rate). The so-called customer service level refers to the degree of satisfaction of customer demand, expressed as follows: Customer service level (5%) = annual stockout occurrences / annual order occurrences The higher the customer service level (or order fill rate), the fewer stockouts occur, resulting in lower stockout costs, but due to increased safety stock, inventory holding costs rise. Conversely, a lower customer service level means more stockouts, higher stockout costs, lower safety stock levels, and lower inventory holding costs. Therefore, it is necessary to comprehensively consider the relationship among customer service level, stockout costs, and inventory holding costs to ultimately determine a reasonable safety stock level. For the calculation of safety stock, we use knowledge of statistics, making basic assumptions about changes in customer demand and lead time, and then calculate safety stock under three scenarios: when demand changes, when lead time changes, and when both change simultaneously. Customer Service Level and Safety Factor Table Customer Service Level (%) | Safety Factor z | Customer Service Level (%) | Safety Factor z 100.00 | 3.09 | 96.00 | 1.75 99.99 | 3.08 | 95.00 | 1.65 99.87 | 3.00 | 90.00 | 1.80 99.20 | 2.40 | 85.00 | 1.04 99.00 | 2.33 | 84.00 | 1.00 98.00 | 2.05 | 80.00 | 0.84 97.70 | 2.00 | 75.00 | 0.68 97.00 | 1.88 | Case 1: Demand changes, lead time is fixed constant Once the mean and standard deviation of demand during the lead time are determined, the safety stock SS can be calculated using the following formula: SS = Z * SQRT(L) * STD Where: STD --- standard deviation of demand during the lead time; L --- length of lead time; Z --- safety factor for a given customer service level (see table above) Example: A distributor's average daily demand for a certain brand of ice cream is 20 boxes, and the demand follows a normal distribution with a standard deviation of 2 boxes/day. If the lead time is a fixed constant of 6 days, what is the safety stock required to achieve 95% customer satisfaction? Solution: Given: STD = 2 boxes/day, L = 6 days, F(Z) = 95%, so Z = 1.65. Thus: SS = Z * SQRT(L) * STD = 1.65 * 2 * SQRT(6) = 8.08 Therefore, to achieve 95% customer satisfaction, the safety stock is 8 boxes. Case 2: Lead time changes, demand is fixed constant If customer demand during the lead time is a fixed constant, but the lead time varies randomly, then: SS = Z * STD2 * d Where: STD2 --- standard deviation of lead time; Z --- safety factor for a given customer service level; d --- daily demand during the lead time; Example: In the previous example, if the daily demand for ice cream is a fixed constant of 20 boxes, and the lead time is random, following a normal distribution with a mean of 6 days and a standard deviation of 1.5 days, determine the safety stock for 95% customer satisfaction. Solution: Given: STD2 = 1.5, d = 20 boxes/day, F(Z) = 95%, so Z = 1.65. Thus: SS = Z * STD2 * d = 1.65 * 20 * 1.5 = 49.5 Therefore, to achieve 95% customer satisfaction, the safety stock is 49.5 boxes. Case 3: Both lead time and demand are random In this case, assuming customer demand and lead time are independent, SS is: SS = Z * SQRT(STDSTDL + STD2STD2D*D) Where: Z --- safety factor for a given customer service level; STD2 --- standard deviation of lead time; STD --- standard deviation of demand during the lead time; D --- average daily demand during the lead time; L --- average lead time; Example: In the previous example, if daily demand and lead time are independent and both follow normal distributions strictly, with daily demand having a mean of 20 boxes and a standard deviation of 2 boxes, and lead time having a mean of 6 days and a standard deviation of 1.5 days, determine the safety stock for 95% customer satisfaction. Solution: Given: STD = 2 boxes, STD2 = 1.5 days, D = 20 boxes/day, L = 6 days, F(Z) = 95%, so Z = 1.65. Thus: SS = 1.65 * SQRT(226 + 1.51.520*20) = 50.16 Maximum inventory (finished goods) = maximum daily production × shortest delivery days + safety factor/day Minimum inventory (finished goods) = minimum daily production × longest delivery days + safety factor/day Maximum inventory = average daily sales × maximum inventory days Minimum inventory = safety stock + consumption during procurement lead time Minimum inventory = daily sales × arrival days + safety factor/day Source: Frozen Food Marketing New Distribution will hold the 2019 (5th) FMCG + Internet Conference during the Chengdu Spring Sugar and Wine Fair from March 15 to March 18. This conference will focus on the theme "Breakthrough" , with in-depth discussions among brand owners, supply chain service providers, distributors, retailers, and others. Compared to previous conferences, this summit will be fully upgraded. In addition to original topics such as channel innovation, city distribution logistics, and distributor transformation , it will add multiple parallel forums on new marketing cases, IP + FMCG empowerment, community group buying, and innovative retail . Through three days of ten high-density, high-quality expert sharing sessions, we believe every brand owner and distributor can learn the latest business models, expert insights, and practical methods, finding new tools and approaches for their own breakthrough in 2019 and returning to a path of rapid growth. Review of Previous Conferences -END-